What is IPO?
IPO stands for Initial Public Offering. A company gets access to raise capital through IPOs. Through the raised capital a company infuse capital for necessary growth.
An already listed company is allowed by SEBI to raise capital through IPO when it reaches a certain stage of growth. Typically, when a company’s private valuation reaches $1 billion, it is allowed to raise capital through IPO. But if a company has strong fundamentals, good cash reserve and good profitability potential, SEBI may allow it to go public.
Before IPO, a company applies to SEBI to go public. A privately owned company is allowed to go public when it fulfils the minimum eligibility criteria for raising money from market. Once allowed, the company advertises for the IPO and invite investors to invest in the company.
Prices of equity shares available for public depends on company fundamentals and business model. There is a fixed for opening the IPO. And there is a closing date after a few days. It is usually 3 to 4 days or a little more. After the IPO is closed, it takes a while to allot the shares to the investors. And after a few days the IPO opens on a prementioned day, which is known as the listing day.
A price range is given during application for each share of IPO. The minimum and maximum price is given within which the price is settled before the listing day.
An institutional investor or a retail investor gets the shares on the basis of invested amount.
What are the primary aspects you should consider before planning exit from an IPO?
An investor, after allotment of IPO, should consider the following aspects before planning an exit from IPO.
- If you would like to exit from the IPO on the listing day, you should consider the capital gains tax you have to pay from listing gains. We all know that if an investor stay invested in a stock for more than one year, the investor doesn’t have to pay the capital gains tax. In this case the listing gains from the IPO will be subjected to capital gains tax on the amount of profit.
- Some companies put restrictions on the sale of shares after listing their IPOs for a period. Such periods are known as ‘Lock-Up’ periods. In such cases, main investors and promoters will not be able to get out from the IPO on a listing day. An investor should read the IPO prospectus thoroughly and collect information about sell restrictions.
- The sell restrictions are applied by the SEBI for the sake of investors. Many company promoters earlier, through IPO dumped their shares of the company to the public and made exit from the company. The lock-up period usually lasts for three to six months or more. After the listing of IPOs, the investor has no way to dump their shares in the market and exit from the company. By this time retail investors can sell their shares to others. This step is taken by SEBI to look after the interests of retail investors.
- There are some brokerage firms through which you are buying the IPOs, putting restrictions on the selling of the share after allotment for a specific period. The investor should be aware of that. Though legally a broker cannot put such restrictions, they do sometimes. You can sell your shares disobeying their restriction, but later they may not allow you to buy IPOs through them. As an investor, you should be aware of that.
After considering all these aspects mentioned above, an investor will plan the exit strategy. The investor may consider any of these exit strategies to maximize gains from the IPO.
- Sell the entire lot on the listing day – This strategy often pays handsomely. Many analysts believe that the listing day gains can be more than the share price actually gives return in the first six months or more. Therefore, it is a common practice to on the listing day.
If a share gives very high return on the listing day, it is worth taking. We have seen the share price being almost double the listed price on the listing day. But these are rare occasions. But we often get to see an IPO giving return of 70% or more on the listing day. This amount of profit is worth taking within a very short period.
- Sell part of the holding on the listing day – An expected performance can be obtained from analysts view, from grey market pricing and from the views of brokers. Accordingly, one can plan to sell a calculated amount of shares quantity of allotted shares to avoid loss on investment.
This calculation is done depending on the price on the listing day. Say, you were allotted an IPO @ 40/share. After listing, on the opening day, the price shot up to 70. Then you sell 60 shares @70/share. You can even This covers your initial investment of 4000. Hence, after you sold these shares, you have 40 shares which remain with you. These 40 shares cost you nothing. You can sell these as and when you wish. You may keep these shares for future gains.
- Sell a little quantity at a time(Hedging) – This selling strategy is also known as the sell in instalments strategy. An investor may want to divide the total number of allotted shares into small equal numbers and sell them over time.
This strategy is employed when the listing day gain is small or average. On the listing day, if the gain is not as expected, you may want to sell the shares in instalments and sell them after every quarterly result is declared.
If you divided your shares into 4 equal numbers, you can sell them after every quarterly result comes out over the next year. And if you divided the shares into 8 equal parts, you can sell them over the next two years. This strategy allows you to get the effect of averaging and allows you to get the full effect on the gains of the shares and maximize your profit.
Today, at times, when there are many IPOs, we may not find expected gains on the listing day. Even some IPOs open with negative pricing, even below the price band declared earlier by the company. No investor would like to sell shares at a big loss on the listing day. Without getting panicked, the investor should wait for the share to perform and sell shares after each quarterly result to extract maximum gain from the investment.
- Sell 50% on the listing day – This strategy is similar to the strategy described above. It is usually done, if on a listing day you are getting a hefty profit of around 50% or thereabouts. The remaining 50% can be sold in instalments after every quarterly result comes out. This strategy is effective only when the listing gain is high. The quarterly results window usually gives good profit. Hence, selling at those periods prove to be fruitful.
Investing in IPO is a good way to earn profit. But the outcome of the allotted shares is unpredictable. This creates a sense of insecurity. This is the reason why many retail investors avoid IPOs. But we have seen IPOs also give high returns. Therefore, an investor must be well informed about the company before investing in the IPO. Once allotted, he must also plan an exit strategy beforehand. The strategies mentioned above in this article are proven strategies to optimise maximum gains for the investor.