Benefits of Investing in IPOs in India

Initial Public Offerings (IPOs) are a part of India’s financial ecosystem. For investors, IPOs allow consideration of early shareholding in companies making their public market debut. These offerings, governed by the Securities and Exchange Board of India (SEBI), represent a capital-raising mechanism for companies and a means for investors to consider asset allocation. This guide covers aspects of IPOs for investors, providing information regarding portfolio diversification.

An IPO, or Initial Public Offering, is the process by which a privately-held company offers its shares to the public for the first time. It allows the company to raise equity capital from public investors and transition to becoming a publicly traded firm on recognised stock exchanges like BSE or NSE.

From an investor's perspective, an IPO presents:

• A consideration for investment in businesses at the initial stage of their public lifecycle
  

• Provision of business information via mandatory disclosures like the Draft Red Herring Prospectus (DRHP)
  

• Participation in sectors and companies that were not listed in the secondary market

Investing in IPOs can present several benefits that attract both new and experienced investors. Here are some of them:

1. Opportunity to Participate in Early Growth

When a company lists its shares on the stock exchange, the IPO allows retail and institutional investors to acquire shares prior to open market trading. If the company performs well, early investors could benefit from share price appreciation over the long term.

2. Transparent Information Flow

Companies filing for an IPO disclose financials, risks, management information, and plans through documents like the DRHP and Red Herring Prospectus. These disclosures, reviewed by SEBI, provide investors with information for evaluating the business model and for decision-making.

Key documents include:

• Draft Red Herring Prospectus (DRHP)
  

• Company’s financial statements
  

• SEBI observations and clarifications
  

3. Potential for Listing Gains

When the demand for an IPO exceeds the number of shares on offer, it can relate to a higher listing price. This scenario may present returns for investors who were allotted shares at the offer price. However, listing gains are not guaranteed and depend on market sentiment, investor demand, and macroeconomic conditions.

4. Access to Fast-Growing Sectors

IPOs often feature companies from emerging or high-growth sectors such as:

• Fintech
  

• Renewable energy
  

• E-commerce
  

• Health tech

Participating in these sectors via IPOs can involve exposure to innovation and economic trends.

5. Portfolio Diversification

Adding IPOs to a portfolio introduces exposure to new companies and sectors that may not be available through traditional secondary market investments. This diversification helps reduce overexposure to any one sector or asset class.

Example: A portfolio with banking and FMCG stocks may include a tech startup that has just gone public.

6. Allotment Opportunities for Retail Investors

SEBI mandates reservation of a minimum of 35% of the total issue size for retail investors. This allocation impacts the probability of share allotment, particularly in smaller and medium IPOs.

7. ASBA Facility and Fund Blocking

ASBA (Application Supported by Blocked Amount) is a mechanism where the IPO application amount remains blocked in the investor's bank account until allotment. The funds are only debited upon successful allotment.

Features of ASBA include:

• No upfront payment
  

• Funds can remain in the bank account, potentially accruing interest, during the application window
  

• Funds are unblocked if shares are not allotted
  

8. Ownership and Shareholder Rights

Investors allotted shares in an IPO become part-owners of the company. This ownership is associated with rights such as:

• Voting on company resolutions
  

• Receiving annual reports and updates
  

• Attending Annual General Meetings (AGMs)
  

• Potential for dividends and bonus shares, subject to company declaration
  

9. High-Profile Companies and Public Visibility

Many IPOs are launched by well-known or fast-growing businesses. The listing process can influence the visibility of such companies, which may relate to post-listing liquidity and investor perception.

Before investing, awareness of certain factors that can influence decisions is relevant.Consider the following points:

1. IPO Valuation and Pricing

Understanding the price band and valuation methodology is crucial. Most IPOs use the book-building method, where the price is determined based on bids received during the subscription window.

2. Lottery System in Over-Subscribed IPOs

In highly subscribed IPOs, allotment is done through a lottery system. Investors may not always receive full or any allotment despite applying.

3. Long-Term Business Potential

While short-term price movements from listing day may occur, a consideration for investing in IPOs involves holding shares in companies that demonstrate long-term performance.

4. Risks Involved

Investors should assess both company-specific and market-wide risks:

• Market volatility

• Economic downturns

• Execution risks in the company’s business model

• Corporate governance concerns

These are factual references to past IPOs for a case-based illustration:

• BSE Ltd.: Launched its IPO in 2017 and was oversubscribed, offering an entry into a major Indian stock exchange’s equity
  

• ICICI Lombard General Insurance: Brought India’s general insurance space to broader public investment
  

• Lux Industries: Offered access to the innerwear segment, previously underrepresented in listed equity

IPOs represent an avenue for portfolio diversification and can be a component in wealth creation. From early ownership and transparency to sectoral exposure and liquidity, the benefits of investing in IPOs are multi-faceted. However, it’s crucial to approach IPOs with a well-researched mindset, grounded in an understanding of the business and its growth prospects.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

• SEBI – IPO Guidelines
  

• BSE India – IPO Listings
  

• NSE India – IPO Market Watch
  

• Bajaj Finserv Markets – Benefits of IPO
  

• Kotak Securities – Understanding IPOs
  

• RBI Financial Literacy Handbook