Part 20 - Explained Types of IPO and differences
Part 20 - Explained Types of IPO and differences
An Initial Public Offering (IPO) is a process where a private company offers shares to the public for the first time to raise capital.
There are different types of IPOs, primarily distinguished by their pricing mechanisms and structures.
Below are the main types of IPOs and their key differences, with a focus on their application in India and globally.
Types of IPOs -
Fixed Price IPO:
Description: The company, in consultation with underwriters, sets a fixed price for the shares before the IPO opens. Investors apply for shares at this predetermined price.
Process:
The company announces the share price in the offer document.
Investors submit applications specifying the number of shares they want at the fixed price.
Shares are allotted based on demand, often proportionally if oversubscribed.
Example: Common in India in the pre-1990s era; less prevalent now but still used by smaller companies or in specific markets.
Book-Building IPO:
Description: The company sets a price range (floor and cap) for the shares, and the final price is determined based on investor demand during the bidding process.
Process:
Investors bid for shares within the price band, indicating the price and quantity they are willing to buy.
The company and underwriters analyze bids to set the final issue price, often at the higher end if demand is strong.
Shares are allocated based on bids, with priority to higher bids or institutional investors in some cases.
Example: Most modern IPOs in India (e.g., Zomato 2021, Hyundai Motor India 2024) and globally (e.g., Alibaba 2014) use book-building.
SME IPO:
Description: Small and medium enterprises list on BSE SME or NSE Emerge, raising smaller amounts (typically ₹10–50 crore). Designed to help smaller firms access public capital.
Pricing Mechanisms:
Fixed Price: Dominant for SME IPOs due to simplicity and smaller scale (e.g., Vraj Iron and Steel 2024).
Book-Building: Used occasionally for larger SME IPOs with strong investor interest.
Characteristics:
Smaller issue sizes, primarily retail-driven.
Relaxed SEBI norms (e.g., minimum 50 investors, lower disclosures).
Higher post-listing volatility due to lower liquidity.
Significant contribution to India’s IPO volume (over 50% of 2024’s 327 IPOs were SMEs).
Examples: Vraj Iron and Steel (2024), Sahaj Solar (2024) on NSE Emerge.
Investor Perception: Seen as riskier but attractive for high returns, often oversubscribed due to smaller lot sizes and speculative interest.
Dutch Auction IPO (Reverse Auction or Uniform Price Auction):
Description: Also called a reverse auction, investors bid for shares, and the company sets a single clearing price where all successful bidders pay the same price, regardless of their bid.
Process:
Investors submit bids with the price and number of shares they want.
The company starts with the highest bids and moves downward until all shares are allocated or the offer is fully subscribed.
All successful bidders pay the lowest accepted bid price (clearing price).
Example: Google’s IPO in 2004 used a Dutch auction, though it’s rare globally and in India.
Direct Listing (Direct Public Offering):
Description: The company lists its existing shares on a stock exchange without issuing new shares or using underwriters, allowing current shareholders (e.g., employees, early investors) to sell directly to the public.
Process:
No new capital is raised; only existing shares are sold.
The market determines the share price on listing day based on supply and demand.
No lock-up period for insiders in some cases, unlike traditional IPOs.
Example: Spotify (2018) and Slack (2019) in the U.S.; rare in India due to regulatory constraints.
SPAC IPO (Special Purpose Acquisition Company):
Description: A SPAC, or “blank check company,” raises funds through an IPO to acquire an existing private company, which then becomes public via the merger.
Process:
A SPAC goes public, raising capital from investors with no specific business operations.
The SPAC uses the funds to acquire a private company within a set timeframe (usually 2 years).
The acquired company becomes publicly traded without a traditional IPO process.
Example: Common in the U.S. (e.g., DraftKings 2020); less prevalent in India due to regulatory hurdles but gaining interest.
Key Insights
Fixed Price vs. Book-Building:
Fixed price IPOs are simpler but risk underpricing or overpricing, as the price doesn’t reflect real-time demand. Book-building, dominant in India and globally, offers flexibility and better price discovery, making it suitable for large, high-profile IPOs.
In India, SEBI mandates book-building for most large IPOs to ensure transparency and fair pricing.
Dutch Auction:
Rare globally and in India due to complexity and investor unfamiliarity. It aims to democratize pricing but requires sophisticated investors.
Direct Listing:
Gaining traction in the U.S. for companies with strong brand recognition (e.g., tech unicorns). In India, SEBI’s regulations make direct listings challenging, as they require extensive disclosures and underwriting.
SPAC IPOs:
Popular in the U.S. for bypassing traditional IPO scrutiny but risky due to acquisition uncertainties. In India, SEBI’s strict rules on blank-check companies limit SPAC adoption, though discussions for regulatory frameworks are ongoing.
India-Specific Context:
India’s IPO market heavily favors book-building due to its alignment with SEBI’s regulatory framework and retail investor participation. Fixed-price IPOs are still used by smaller firms or SMEs listing on platforms like BSE SME or NSE Emerge.
The rise of retail investors and platforms like Zerodha has boosted IPO applications, with book-building IPOs like Hyundai Motor India (2024) seeing massive oversubscription.
Global Trends:
Globally, book-building dominates due to its adaptability to market conditions. Direct listings and SPACs are U.S.-centric innovations, reflecting a mature market with high investor risk appetite. Dutch auctions remain niche due to their complexity.
Photo - Key Differences Between Mainboard IPOs and SME IPOs
