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Primary Market Terminology

This chapter helps to understand IPOs in greater depth. Learn about the concepts and processes involved in the public issue of shares.

Gopal Kavalireddi
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The primary market deals with the issuance of shares to public investors, and the terms used in this context are defined as below

 

Promoter

A single person or a group of people who have set up the company, executing the business operations and have offered the shares to the public investors, for the purpose of raising equity capital are termed as the promoters of the company. Their names have to appear as promoters in the prospectus of the company. The promoter group can include relatives of the promoter, subsidiaries of the company or, any corporate body who holds more than 10% of the equity share capital.

 

Draft Red Herring Prospectus (DRHP)

A draft prospectus, also called the offer document, provides the information on the financials of the company, promoters, background, reasons for raising capital etc. It is filed by the Lead Managers with the Securities & Exchange Board of India (SEBI) to provide issue details. The only details not provided in this prospectus are the price and issue period.

 

Red Herring Prospectus (RHP)

The document printed & distributed after obtaining the clearance from SEBI and the Registrar of Companies (ROC), used for advertising the IPO during road shows to various investors. The agreed price band of the share, number of shares to be issued and the issue size are provided only in the final prospectus.

 

Merchant Bankers

Any SEBI registered entity engaged by the promoters, to complete the necessary formalities, manage the issuance by making all necessary arrangements with respect to preparing the prospectus and marketing the securities or acting as manager, consultant, adviser or rendering corporate advisory services for the issuance. In simple terms, the merchant banker manages the book building process, by acting as intermediaries between the company seeking to raise money and the investors. They can also be called as Book Running Lead Managers or BRLM’s.

 

Underwriters

Underwriting is a process where the entity/person takes the responsibility of subscribing to any balance shares not subscribed during the IPO process, basically the ‘under subscribed’ portion of the shares. The financial entities like merchant bankers or brokers taking this responsibility are termed as underwriters. There is a firm commitment by the underwriter to the issuer, to bring in the money to subscribed to the ‘left over’ shares and has to be strictly adhered as per the guidelines of SEBI.

 

Face Value (FV)

It is the nominal/original value printed on the legal share certificate at the time of issuance of shares. Also referred to as ‘Par Value’ or ‘at Par’, it is simply the original cost of share at which it is issued. Commonly, face value of a share is at Rs. 10. Rarely, some companies can be found with face value of Rs. 200 or Rs. 100 also.

 

Issue Price

Also referred to as ‘offer price’, It is defined as the price at which the new shares will be offered to the public, before the shares list on the stock exchange for trading in the secondary market. There are two types of issue prices – fixed price and price discovery through book building process. Since ‘free pricing’ concept was introduced in 1992, the issuing company along with the merchant banker decide the issue price. The issue price is normally at a premium to the face value.

 

Fixed Price

Also termed as the normal public issue. Ever since the introduction of the free pricing concept, the fixed pricing mechanism was relegated to the small and medium enterprise (SME) issuances only. Fixed price issue is where the company and the lead merchant banker decide and fix a price. The investors know the issue price of the share before the company lists its shares on the stock exchange and have to pay the full amount of the shares being subscribed and the demand will be known only when the application date is closed.

 

Book Building Process

Considered as an efficient price discovery mechanism, the issuer provides a floor price (lowest bid) and a ceiling price (highest bid), which provides the price range for the investors to bid for shares. The difference between the floor price and ceiling price cannot be more than 20%. The bids thus collected, help in determining the demand for the shares and thereby, the price which most investors are willing to pay. The book is open for bidding for a period of 3 days. Upon closure of the bid date, the final price is decided and subscribers are allotted the shares based on the bid quantity and final price.

In this process, the demand for the shares can be known each day and investors can estimate the chances of allotment. For every IPO, investor categories are same and a certain portion is reserved for each of the categories, which are segregated as qualified institutional buyers (QIB), non-institutional investors or High Networth Individuals (HNI), retail investors, and employees.

 

Floor Price

The lowest price that investors can bid during a book building process is termed as Floor Price. In the price range fixed by the issuer, the investor has the option to bid at the lowest level or the floor price and depending upon other investors interest in the subscription, can change it upward, till the highest price termed as the Cap Price, to obtain a higher chance of allotment.

 

Cut-off Price

During the book building process, based on the price at which maximum number of bids have been received, the issuer fixes the Cut-off Price, which can also be at the highest price of the price band, also termed as the Cap Price. This price is based on the demand and the maximum bid price offered by most prospective investors. When the issue is oversubscribed, the cut-off price becomes the issue price and the lottery determines the allotment of shares to the investors.

 

Application Supported by Blocked Amount (ASBA)

Contrary to earlier times, when applying to an IPO meant paying the full application amount of shares being subscribed for and a long refund process, nowadays, investors are provided with a facility of just blocking the bid amount, without paying any amount. This is called ASBA facility and since 2016, SEBI has implemented this feature mandatorily for all public issues to be applicable to all investors. By using a Self-Certified Syndicate Bank (SCSB), investors can apply for the IPO and only upon allotment/rejection, the amount would be debited/unblocked from the account.

 

Allotment Process

If the investor demand for the shares is higher than the number of shares on offer, then the issue is said to be ‘oversubscribed’ and vice versa is termed as ‘under subscribed’. If the number of applications are high, then a lottery system is adopted to determine the allotment. The allotment to investors will decrease with rising over subscription and sometimes, can even result in nil allotment. The investors will be informed of their successful application within 5 days from the closure of the bid date. The shares are listed and will start trading from the 6th day onwards.

 

Registrar & Transfer Agents (RTA)

After the allotment formula finalized, a separate entity has to allot the shares to the applicants as per the formula, and maintain the necessary records of the shareholding to facilitate continuity of the process. That entity is termed as RTA or Registrar and Transfer Agent. Furthermore, the RTA will be responsible for all continuing corporate actions between the company and investors, namely, dividend pay-outs, bonus issues, rights issues etc. Regulated by SEBI, they coordinate the IPO process from collection of applications till the issuance of shares to the allotted applicants.

 

Dematerialization

Earlier, the allotted shares to each investor were issued in the form of a security certificate, denoting the ownership of a portion of the company. But this record keeping involved a lot of physical processing and was extremely time-consuming. Hence, in 1996, Dematerialization of the securities was undertaken. It simply means that the shares are held in an electronic format to support easy processing, transfer of shares and to eliminate any fraud/misuse of the share certificates.

 

Depository

An entity which holds the securities in a dematerialized format is termed as a Depository. Regulated by SEBI, there are 2 Central Depositories in India, namely, Central Depository Services India Limited (CDSL) and National Securities Depository Limited (NSDL). Any company opting for an IPO with a size greater than Rs. 10 cr. needs to offer the shares in a dematerialized format, which after being allotted, are held in the depository.

These terms define the primary markets and help in understanding the functioning of the primary markets, the various participants, the process of IPO before any company lists its shares on the stock exchanges for continuous trading by investors.

The Indian IPO market is extremely strong and healthy and in recent years, more and more private companies from diversified sectors are preferring this route to raise capital to fund their growth plans. The stock markets are witnessing many IPO’s from small, medium and micro-cap enterprises, which are operating in the niche segments of the economy and are strategically placed to gain recognition at a global level, thereby expanding their geographical reach, consolidating their costs, boosting their revenues and creating immense shareholding wealth.

 

Next Chapter

Introduction to Secondary Markets

Learn what happens after companies issue IPOs.

Secondary Market Terminology

26 Lessons

This chapter throws light on the stakeholders in the secondary market, their roles and also basic explanations of concepts which are essential for trading/investing.

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Responses

Jinesh commented on April 4th, 2019 at 8:30 PM  
What is the difference between depository and depository participant?


gopal_k commented on April 4th, 2019 at 10:07 PM  
Depository is a holding entity, that holds all tradable instruments like shares, bonds etc in an electronic format and Depository Participants are like our bank relationship managers who interact with the depository on our (customers) behalf to execute transactions, as per our requirement.


Aman commented on April 18th, 2019 at 4:41 PM  
How do you decide which IPO to apply for as there are many options available?


Gopal commented on April 18th, 2019 at 5:20 PM  
It is up to each investor to check the business & growth prospects, fundamentals involving quantitative & qualitative parameters, promoters before investing in any IPO. Most of the above information would be available in the Red Herring Prospectus (RHP) of the company, which would be shared with all investors, post SEBI approval.
Since many investors find it quite difficult to understand all the aspects of a company, they normally rely on the brokerage notes or analysis that is provided for each IPO. Full service brokerages as well as other financial analysts do provide these services.


Bhargav commented on June 7th, 2019 at 12:38 AM  
Let's say an ipo has upper limit of 100 and lower limit of 80. I put a bid for say 95. But finally based on the demand the price of the stock was decided to be 90 only. Will i be allocated at 95 or 90?


Nikhil Chopra commented on April 18th, 2020 at 1:06 AM  
You'll be allotted shares at 90 and remaining 5 will be credited to your account. But it's all depending upon pro rata basis


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