4 Types of IPO Investors

What is an IPO?

An Initial Public Offering, or IPO, marks a company's transition from a privately held entity to a publicly traded one. When a company files for an IPO, it is all set to make a share market debut. Its shares will be made available to the general public for the first time. Companies do so to raise capital by selling their new shares to the general public.

What Are the Different Types of IPO Investors?

Under Securities and Exchange Board of India (SEBI) guidelines, four types of investors can bid for shares during an IPO process. These are:

• Qualified Institutional Investors (QIIs)

Commercial banks, public financial institutions, mutual fund houses, and Foreign Portfolio Investors registered with SEBI fall into this category. Underwriters try to sell large chunks of IPO shares to them at a lucrative price before the start of the IPO. Selling shares to QIIs goes a long way in helping underwriters meet the targeted capital. SEBI mandates that institutional investors sign a lock–up contract for at least 90 days to ensure minimal volatility during the IPO process. If QIIs buy more shares, fewer shares would be available to the general public. This would result in higher share prices. This scenario is ideal for a company because they want to raise as much capital as possible. However, SEBI has laid down rules to ensure companies do not distort the IPO valuations. The regulatory body prohibits companies from allocating more than 50% of shares to QIIs.

• Anchor Investors

Anchor investors are institutional investors who commit to buying a significant portion of an IPO before it is opened to the public. Their involvement provides a level of stability and confidence in the offering, often encouraging other investors to participate. Anchor investors typically receive a fixed allocation of shares at a predetermined price.

Any QII which makes an application of over ₹10 crore, is an anchor investor. Up to 60% of the shares meant for qualified institutional investors can be sold to anchor investors.

• Retail Investors

Retail investors are individual investors who participate in IPOs with smaller investments compared to institutional investors. They play a crucial role in the IPO market, often driven by the potential for substantial returns. Retail investors typically have access to a reserved portion of shares, allowing them to participate alongside larger investors. The minimum allocation under the retail quota is 35%. SEBI has decreed that if the issue is oversubscribed, subject to availability, all retail investors be allotted at least one lot of shares. If the one-lot-to-each-investor is not possible, a lottery system is used to allocate IPO shares to the public.

• High Net-worth Individuals (HNIs)/Non-institutional Investors (NII)

Individuals looking to invest more than ₹2 lakh are categorised as HNIs. Similarly, institutions that want to subscribe for more than ₹2 lakh are called non-institutional investors. The difference between a QII and an NII is that the latter does not have to register with SEBI. The allotment of shares to HNIs/NIIs is on a proportionate basis, i.e., if one applies for 10,000 shares and the issue is oversubscribed 10 times, they would be allotted 1,000 shares (10,000/10). This means they are always allotted shares, regardless of whether the issue is oversubscribed or not. Typically, 1-2% of shares are earmarked for the employees as a way of awarding them for the risk they took in associating with a new company.

Summing Up the Different Types of IPO Investors

Why Do Investors Choose to Invest in IPOs?

Investors are drawn to IPOs for a variety of compelling reasons. One of the primary motivations is the potential for high returns. IPOs often involve companies that are poised for significant growth, providing investors with the opportunity to earn substantial profits if the company performs well post-listing. This potential is especially attractive to those looking to maximise their investment portfolios quickly.

Another reason is diversification. IPOs offer investors the chance to enter new industries or sectors that they might not have exposure to. By investing in IPOs, investors can spread their risk across different areas, thereby enhancing the resilience of their investment portfolios. This diversification is crucial for mitigating risks associated with market volatility and sector-specific downturns.

IPOs provide early access to promising companies. Being an early investor in a company that eventually becomes successful can be highly lucrative. It allows investors to participate in the company's growth from the ground up, often resulting in significant capital appreciation over time. This early access can be particularly appealing to those who have a keen eye for identifying potential market leaders.

Market sentiment and trends also play a significant role in attracting investors to IPOs. The buzz and excitement surrounding a company's public debut can create a favourable investment environment. Investors often look to capitalise on this momentum, hoping to benefit from the initial surge in demand for the company's shares.

The process of investing in IPOs can be simplified through the use of digital platforms and tools, making it more accessible to a broader range of investors. This accessibility encourages participation from both seasoned investors and newcomers, further driving interest in IPOs.

Are There Any Disadvantages of Investing in IPOs?

One major concern is volatility. IPOs can experience significant price fluctuations in the initial days of trading, which can lead to substantial losses if the market sentiment shifts unexpectedly. This volatility makes IPO investments risky, especially for those with a lower risk tolerance.

Another drawback is the limited information available about the company. Unlike established public companies, IPOs may not have a long track record of financial performance, making it challenging for investors to conduct thorough due diligence. This lack of historical data can lead to uncertainty and potential misjudgements about the company's future prospects.

Some IPOs impose lock-up periods, restricting investors from selling their shares for a set time after the IPO. This can limit liquidity, preventing investors from quickly exiting their positions if market conditions change. Furthermore, IPOs often come with high costs, including fees and commissions, which can eat into potential profits. These factors combined make IPO investing a complex decision that requires careful consideration.

The Final Word

We have covered the various points in understanding the flesh and bones of the IPO world, from understanding the importance of an IPO to learning how to bid for one. However, an often-overlooked aspect of IPO investing is the role of regulatory changes. These changes can significantly impact the timing and structure of IPOs, influencing investor sentiment and market conditions. Staying informed about regulatory shifts can provide investors with a strategic advantage, allowing them to anticipate changes in the IPO landscape and adjust their strategies accordingly. Moreover, as the market evolves, the use of technology-driven platforms for IPO participation is expected to grow, making the process more accessible and efficient. Investors who embrace these technological advancements may find themselves better positioned to capitalise on opportunities as they arise.

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