What is an initial public offering (IPO)?
The process of offering shares of a private firm or unlisted company (a company that is not listed on the stock market) to the public in the stock market is known as an initial public offering (IPO). An IPO allows a firm to raise capital from the general public, when the company decides to raise funds for the first time by selling securities or shares to the general public. The people who are given shares become the company's initial shareholders. This is what happens when a private corporation decides to go public.
Prior to being listed on the market, the company had small owners such as family members, angel investors, friends and founders, but during an IPO, the company offers its shares to the public.
Why should we invest in an IPO?
The media normally pays close attention to IPOs because the company is becoming public. IPOs are popular with investors because they produce volatile price movement on the day of the IPO and for a short time afterwards. For new IPOs, there is frequently greater demand than supply. As a result, there is no certainty that all interested investors will be able to buy shares in an IPO.
Those interested in an IPO may be able to apply through their broker, although access to an IPO may be limited to a firm's larger clients in some cases. Another option is to invest in mutual funds or any other investment vehicle that allows you to diversify your portfolio.
How shares are allotted in an IPO, and why you may get none
We've seen several cases where a person applies for shares in an IPO and receives none, but a friend applies for the same amount in the same IPO and receives shares. This is frequently due to the IPO being oversubscribed. Here is how allotment works.
Lot size: a company's entire equity shares on offer are divided into smaller lots, and each retail investor applies in lots. For example, Company A plans to sell 15 lakh shares in an IPO with a lot size of 150 shares per lot, so the total number of lots is 10,000 (15,00,000 ÷ 150). Under SEBI rules, you cannot bid for fewer shares than the lot size. A retail investor bids in lots: 1 lot, 2 lots, 3 lots, and so on.
After all the bids have been submitted, a computer process rejects any bids entered incorrectly. There are then two possibilities:
- When the total number of lots bid for is less than the number of lots on offer, everyone who applied is given their full allotment.
- When the total number of lots bid for exceeds the number of lots on offer, allotment gets a little more complicated. Under SEBI rules, no individual can be allotted less than one lot.
This second case has two sub-cases:
- Small oversubscription: each successful applicant first receives one lot of shares, and the remaining shares are distributed proportionally.
- Large oversubscription: if the issue is so heavily oversubscribed that each successful applicant cannot be given even one lot, SEBI states that lots are allotted by a random draw. The draw is computerised, so there is no favouritism, but many applicants may receive no shares because their names did not come up.
Two reasons you may not be allotted shares
- Your bid was invalid: it had an invalid PAN or demat account number, or there were several applications made under the same name.
- Your name was not drawn in the lottery for allotment (when the issue is heavily oversubscribed). This is by far the most common reason.