Finance / IPOs · August 17, 2021

How Does An IPO Bidding Process Actually Work

Introduction

As per the definition of SEBI. “When an unlisted company makes either a fresh issue of shares or convertible securities or offers it’s existing shares or convertible securities for sale for the first time to the public, it is called an IPO.”

In simpler words, an Initial Public Offering (IPO) is a stage in which a company offers it’s ownership to general public for the very first time before getting traded on the stock exchange.

The company dilutes it’s equity in a return to collect cash from it’s investors. They then use this capital for further expanding the business.

Understanding the importance of an offer document?

When the company is interested to launch it’s first offering, they come out with something called an offer document. This document acts like a brochure, explaining more about company to the desired investors.

An offer document is also like a first look draft containing a lot of information about the company and it’s history. It contains details like the founder’s data, financial condition, objective of raising the money, future plans or the terms of issue etc.

This data is of great importance to the investors before deciding to bid for the offer. The more attractive the offer document, the better will be the subscription.

You can find the offer documents of upcoming IPOs on the official SEBI website

How does the IPO bidding process take place

The bid is dependent on the following:

  1. Type of issues
  2. Participants for fresh issue
  3. Condition of subscription

Types of issues

There are 2 types of issues: Fixed Price Issue and Book Building Issue.

Fixed price issue is a type of issue in which the company decides the price in the offer document. Here the price is already decided by the company and the investors have no say in valuing business.

Book building issue is a type of issue where the price is discovered based on the demand for the securities from the perspective of the investor at various price levels. The price here is flexible and allowed for 20% variation from the floor price.

Types of issues is yet another broad topic which deserves a separate blog for it’s explanation and better understanding. For the simplicity of this blog, we will assume the issue to be of book building type.

Usually, it is seen that the IPOs are floated with a price range. The investors select a particular price from that range to bid for the issue as per their risk taking abilities.

Having a range for the investors can create an opportunity for the investors to select the right price for the security as per the fair value.

Understanding the participants

Finally it is the investor that will decide the how well the floated IPO has performed.

The following are the participants in an issue bidding process:

  1. Retail Investors: They are investors who apply for the issues for a value lower than Rs. 2 lakhs.
  2. High net worth individuals: They are investors who apply for issues for a value higher than Rs. 2 lakhs.
  3. Institutional investors: These are non individual investors or investing firms like mutual fund houses, insurance companies, banks etc.

As per the guidelines for SEBI, there is a maximum cap on which the IPO participants can participate in the bidding process.

The following are the maximum percentage a particular category of investors can invest, despite the demand.

Type of investorMaximum allowable percentage
Retail investor35%
High net worth investor15%
Institutional investor50%
Percentage of allowable participation

From this category, we can say that the initial offering has to be accepted by majority of the investors in order to get the IPO be a success.

Conditions of subscription

The following are the conditions of IPO subscription:

  1. Under subscribed
  2. Rightly subscribed
  3. Over subscribed

If the issue is under subscribed

The issue is considered to be under subscribed if the IPO has collected less than 90% of the value. In this case the issue will not be put on the stock exchange and the money will be refunded back to the investor.

Rightly subscribed IPO

If the IPO is rightly subscribed, then all the participants will get the issue. All the investors will get at least one lot of equity. If the investor has bid for more than one lot, he will receive the other lots based on the equity left after all the investors receive 1 lot each.

This is done so that the issues are spread out to maximum investors to make the stock less volatile after the company starts trading on the stock exchange.

So in this case you can assure that you will definitely get at least one lot. This can also give an indication that this IPO may not be in high demand, which can also result in it opening with lesser premiums.

In the case of over subscription

This can be a case where the demand for the IPO is more than the equity it has to offer. In this case, there will be a random selection process, just like a lottery system and the selected investors will get only one lot.

In the condition of over subscription, you have to be the lucky one get one lot of equity. There will be extremely rare condition that you will get more than one.

This demand can create the IPO be issued with a premium price. This means that the price of the stock will open at a price higher than the bid price. Most of the investors are likely to make most of the profit in this stage itself.

What are the chances you will get an IPO

The chance of you getting the bid is clearly based on probability factors. These factors will depend on the conditions of subscription as explained in the above points.

On top of those conditions, you an follow these techniques to increase your edge of increasing your probability of success

  1. As a retail investor, you should bid for only one lot, as the issue gets over subscribed, it is more likely for the single lot investors to receive the issue in first hand.
  2. Invest with multiple demat accounts, probably from your parents accounts. Here you will increase the probability of you winning the issue if the offer gets over subscribed.

You may also like to read about: Market Capitalization: The Right Way To Track Company’s Growth

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