When a company wants to raise money, one of the ways it can do so is by selling its equity shares to the public. If it happens to be the first public offer of the company, it is known as the initial public offer (IPO).
In an IPO, the promoters share in the company's equity comes down, as the number of shares issued by the company (paid-up capital) increases.
After the IPO, the shares get listed on the stock exchange and shareholders can trade their shareholdings on the bourses.
To make an IPO, a company has to file a prospectus with the Securities and Exchange Board of India (SEBI) stating the purpose of raising the money and disclosing other details of the company and its directors.
Once it is approved by SEBI, the company files the prospectus with the registrar of the company to initiate the process of IPO. According to SEBI norms, a minimum of 30% of any IPO is reserved for retail investors those who are applying for shares worth less than Rs 1,00,000.
The shares are allotted on a pro-rata basis among applicants. That means, if the retail investor portion of the IPO is oversubscribed by two times, every applicant will get half of the number of shares he applied for.
For large investors, whose application size is more than Rs 1,00,000 each, there is a minimum reservation of 10%. In this category too, shares are allotted on a pro-rata basis.
The offer price for shares in a public offer can be fixed before the issue. It can also be discovered through gauging the demand in the market for shares at various price points. The second method is called the book-building route.
In this, the issue manager fixes a price-band rather than a single price for the IPO and asks investors to bid for shares in that price range.
The price band is fixed on the basis of the fundamentals of the company, the performance of share prices of other companies in the same sector on bourses and market survey conducted by issue managers.
An investor can bid for shares at various price levels. Normally, the demand for shares at the minimum price level is the maximum. But when the market is booming, the issue is often oversubscribed at the higher end of the band itself. In such a case, the offer price is ultimately fixed at the upper end of the band.
What is a follow on-public offer?
When a listed company makes a public offer to raise funds, it is called a follow-on public offer. In these cases too, the offer price can be fixed or be discovered through book-building. Normally, the offer price is at a 10-20% discount to the prevailing share price in the market
company can raise funds through a rights issue. In this, the company gives shares only to existing share holders at a certain ratio to the number of shares already owned. For example, in the case of SBI, one rights share is to be given for every five SBI share owned.
Normally, a rights issue has the twin purposes of rewarding the shareholders of the company and raising funds. Shares are, therefore, typically offered at a 30-50 % discount to the prevailing market price.
Therefore, just before a rights issue, the share price of the company goes up.