Chapter 8: What are the different types of IPOs
- Types of IPOs
- Difference between IPOs and FPOs
- Different types of FPOs
- Offer for Sale
Companies take different routes to value the stock price during an IPO. They either use the fixed price method or the book-building method or a combination of two.
So, let’s look at the two pricing methods in detail.
Fixed price IPO
Under this method the IPO share price is fixed before it is made available to the public.
This price is usually set by evaluating the total assets, liabilities, and every other financial aspect.
The IPO price does not fluctuate depending on its demand. The total demand for that IPO is known only after the issue is closed.
Book building IPO
In a book building IPO, the price is determined during the process of IPO. There is no fixed price, but a price band.
The price band is decided based on the company’s financials, the success of the road shows and prevailing market conditions (we have spoken about these in earlier chapters).
The lowest price in the band is the ‘floor price’ and the highest price is the ‘cap price’.
The investors are free to bid for any number of shares, along with the price at which they are willing to pay. The quoted price must be within the price band though.
In the end, the share price is decided based on the bids. The demand of that IPO is published every day as the book is built.
Most companies adopt the book building practice.
Private businesses launch IPOs with an aim to raise capital — this is what the common practice is. A company can’t issue another IPO once it is listed in the stock exchanges.
However, listed companies can issue shares to the public again. They can do so through a follow-on public offer (FPO) or an offer for sale (OFS).
Follow-on public offer
A follow-on offer or follow-on public offer (FPO) entails selling of additional shares by the company.
An FPO is a common strategy deployed by listed companies to raise additional capital. This is sometimes also known as a secondary offering.
So in simple terms, how does an FPO work?
For example, there is a company called ABC, which is already a listed company. It wants to sell additional shares to raise more capital.
For this purpose, company ABC would hire an investment bank to underwrite the offering, register it with Securities and Exchange Board of India (SEBI) and then handle the sale of the secondary shares.
Essentially, there are two types of FPOs:
- Dilutive
- Non-Dilutive
- Dilutive FPO
In case of a dilutive FPO, the company’s board of directors agree to increase the share float in order to sell more equity in the market.
Usually, this kind of FPO is issued to raise capital to reduce current debt or expand the business.
- Non-dilutive FPO
In a non-dilutive FPO, owners of existing, privately-held shares offer their shares in the stock market.
In many cases, holders of privately-help shares are company founders, board of directors and pre-IPO investors.
Usually a non-dilutive FPO happens if the original IPO had a lock-up period. The lock-up period prevents company founders and board of directors from selling their shares during the IPO. A lot of companies agree to have a lock-up period to infuse confidence in the market and provide stability during the IPO.
Therefore, a non-dilutive FPO gives these shareholders a way to monetize their position.
Since existing shares are being resold, the company does not benefit in any way. All the proceeds go directly to the shareholders.
Follow-on offerings are very common in the investment industry. It can be used by companies to raise some extra capital for expenses and expansions.
In some cases, companies may also face a negative feedback since the shares are being diluted and hence, earnings being affected.
Some specific characteristics of an FPO include:
- Unlike an IPO, which includes a fixed or variable price range, the price of a follow-on public offering (FPO) is market-driven.
- Investment banks or underwriters working on an FPO tend to focus on the current market price rather than doing the entire valuation of the company.
Offer for sale
Offer for sale (OFS) occurs when promoter and promoter groups of a listed company can sell their shares in a transparent manner through the bidding platform of a stock exchange.
Non-promoters holding at least 10% of the share capital of a listed company are also allowed to exercise this option.
In simpler terms, when promoters want to dilute their holdings in a company, they make their shares to the wider public.
OFS, introduced in India in 2012, makes it easier for promoters of listed companies to cut their holdings.
OFS is different to follow-on public offering (FPO) on several counts. In an OFS, the company sets a fixed price whereas in FPOs, the companies have a price band.
OFS doesn’t require a lot of paperwork and evaluation. In contrast, issuing an FPO is similar to launching an IPO. A company issuing an FPO has to hire underwriters, notify SEBI and get managers who can manage the entire process.
The third difference is the time period required for the two processes. OFS takes one trading day, while FPOs can last up to five trading days.
Therefore, OFS saves a lot of time, complications and makes the entire procedure very swift.
Another reason why companies launch an OFS is because, in some cases, the seller may offer a discount to retail investors.
Some of the other advantages are:
- Since the system is platform-based, there is no need for a listed company to fill any applications.
- In case of no allotment, money is refunded on the same day.
- An investor can put multiple bids above the floor price set by the company,. This is unlike in IPOs, where the bid price cannot be more than one.
The downsides are:
- SEBI has mandated reservation for certain categories of investors.
- Buying in OFS involves payment of brokerage, securities transaction tax and other charges that investors may have to pay when buying shares on the open market.
The last word
There are different ways a company can choose to determine IPO valuation. Either they fix the price beforehand or let the forces of demand and supply dictate the price.
It is also important to remember that while only private businesses can issue an IPO, listed companies are not strictly barred from issuing new shares to the general public. They can issue new shares either through follow-on public offer (FPO) or Offer for Sale.
What next
Did you know you can buy and sell shares of a company even before an official IPO launch? The next chapter talks about all you need to know about the grey market IPO.