OFS in IPO Explained: What Is Offer for Sale in India?

OFS in IPO means Offer for Sale, where existing shareholders of a company, who are generally promoters, sell their shares to the public. The company does not sell new shares or receive money from the sale in an Offer for Sale.

New investors should understand the differences between a fresh issue, an OFS, and a combined issue. A fresh issue is made by the company and the money raised is given to the company. An OFS is made by existing shareholders and the money raised is received by the shareholders.

This article provides information about OFS in IPOs, including definitions, examples, and comparisons to fresh issues. The article will also cover bidding by investors, the floor price, cut-off price, allotment of shares, who is eligible to participate in an Offer for Sale, and the differences between a fresh issue and an Offer for Sale.

What Is OFS in IPO?

OFS or Offer for Sale means existing equity shares offered by existing shareholders of a listed company, in a public offer made by such company (referred to as an 'Initial Public Offer' or 'IPO'). The shares offered by existing shareholders through an IPO are already issued shares of the company. These shares are transferred by the selling shareholders to the investors who subscribe to the IPO.

According to the Securities and Exchange Board of India (SEBI) Act, an initial public offer (IPO) is defined as an offer for sale of securities by one or more existing unlisted company’s shareholders to the general public. Further, SEBI's IPO processing documents describe an IPO as a fresh issue, an offer for sale (OFS), or a combination of both.

If a company, for example, decides to raise funds by means of an IPO for 1 crore shares, and 60 lakh shares are offered by the company through an IPO, while 40 lakh shares are offered for sale by the existing shareholders, then from the IPO, an investor can get shares issued by the company and/or shares offered for sale by the existing shareholders.

How Does an Offer for Sale Work in an IPO?

There are a few steps to understand the Offer for Sale process.

1. Existing shareholders decide to sell: Promoters, investors or other eligible shareholders may offer some of their existing shares, subject to applicable regulations and the terms disclosed in the offer document.

2. The OFS is Disclosed: Through the IPO offer document, the selling shareholders and the number of shares sold are disclosed.

3. Bidding for the IPO will commence: Investors will be able to place their bids for the offered shares during this phase of the initial public offering (IPO) process, which is generally called the book-building phase.

4. Bids will be examined to assess demand: The bids placed by investors during the book-building phase of the IPO will provide useful information on the demand for the shares offered in the IPO.

5. The shares will finally be offered to the public at: The price at which the shares offered in the book-building phase of the IPO will be finally allotted.

6. The shares will be allotted: In accordance with the terms and conditions of the IPO, category-wise allotment of shares will be made to successful applicants.

7. The shares allotted to applicants will be listed and traded on the stock exchanges: Upon completion of the offer process, the shares allotted to applicants will be listed on the stock exchanges stated in the offer documents.

Each IPO has a specific structure of allocation, price band, reservation, bid lot, and other terms. Investors should read the offer document relevant to the IPO rather than assuming that the terms and conditions of the IPOs are uniform.

Who Is Selling Shares in an OFS?

Share selling groups for IPOs are not uniform. Companies typically have promoters (owners) with management control. These promoters, along with other investor groups, such as private equity or other institutional investors, may be part of an OFS.

In an IPO offer document, selling shareholders are disclosed along with the number of shares to be sold. The offer document may provide other information such as the type of selling shareholder, for example promoter shareholding, and the weighted average cost price of the shares.

Therefore, it is not always the case that OFS by promoters means complete promoter exit. The selling shareholder may be a promoter group, and the selling shareholder may still hold a large share of the promoter group after the IPO.

Fresh Issue vs OFS in IPO

The biggest difference between a fresh issue and an OFS is who receives the money and whether new shares are issued.

SEBI offer documents regularly disclose fresh issues and OFS portions separately. In an IPO containing both components, the offer document specifies the number or value of shares attributable to each portion and identifies the selling shareholders for the OFS component.

Where Does the Money From an OFS Go?

New IPO investors should understand this point.

Money raised from an OFS does not provide financial capital to the company. The shareholder seller is entitled to the proceeds from the sale of shares, after deducting expenses, taxes and other circumstances.

For illustration, an investor buying 100 OFS shares at ₹500 per share, would result in an outflow of ₹50,000. The proceeds of the share sale would be received by the seller of the shares and would not be available to the company.

If the company raises funds by the issue and sale of 100 shares at ₹500 per share, the proceeds of the share issue would be ₹50,000 and the funds would be available to the company to carry out the activities authorized by the company and stated in the offer document.

Investors need to evaluate the activities for which the funds raised by an IPO would be utilized and also the reason for the sale of the shares by the selling shareholder.

How Does Bidding Work in an OFS IPO?

In book-building, investors indicate the price and quantity of shares they want to buy within the price band stipulated by the company.

Suppose a company lists through an illustrative IPO with a price band of 90-100. Bids can be placed at 95 or 100. The price at which the issue is ultimately alloted is determined by demand and the price at which it is offered.

In a book built IPO, retail investors are allowed to place cut-off bids, if permitted. A cut-off bid means that the retail investor is prepared to accept the price at which the share is alloted, as determined by the exchange.

As described by SEBI, the cut-off option allows retail investors to purchase equity shares at the price determined by the exchange, which may be within the price band allotted to the retail category. The retail application limit, and other conditions, are described in the offer document and may be modified from time to time by SEBI.

What Is the Floor Price in an IPO?

The term ‘floor price’ is used in a book-built IPO process to indicate the lowest permissible price at which bids can be placed. Where a price band is determined for an issue, the floor price represents the minimum price in the band.

Returning to our example, bids for the IPO can be placed in the range from ₹450 to ₹475. Accordingly, normal bids can be placed only from ₹450. Bids placed at a price lower than ₹450 will be rejected.

In book building, the price is determined through a process of demand and supply. SEBI clarifies that the book building process helps determine the fair value of a security. Investors place bids at various prices and the process helps determine the most appropriate price at which the security can be issued.

It is important not to confuse this with the floor price in the separate exchange-based OFS mechanism used by listed companies. An IPO OFS is part of a public issue by an unlisted company, whereas the exchange OFS mechanism is a separate process through which existing shareholders of eligible listed companies can sell shares through an exchange platform.

What Is the Cut-Off Price in an IPO?

The cut-off price is the price determined through the book-building process at which the securities of the IPO are issued. The cut-off price is also referred to as the issue price.

When retail investors opt for the cut-off option, they are willing to buy shares at the last issued price in the offered price band. This is to prevent a situation where an investor places a bid at a price and the final issued price is above the investor’s bid price.

Using the example above, if the price band is set at ₹100 to ₹120 and the final issued price is fixed at ₹116, an investor who placed a bid at ₹110 would have an unsuccessful bid. An investor placing a bid at the cut-off price of ₹116 would have a valid bid and would be evaluated for share allotment along with other investors.

Who Is Eligible For an OFS IPO?

A Fix Public Offer (FPO) combined with an Offer For Sale (OFS) is an offer for subscription by the general public, and investors participate in it by means of the categories and conditions stipulated in the offer document.

The standard categories are Qualified Institutional Buyers (QIBs), Non-Institutional Investors (NIIs) and Retail Individual Investors (RIIs), and, in certain cases, other reserved categories and personnel.

The conditions applicable to retail investors, bid lots, reservation quotas and other parameters may vary from time to time and from offer to offer. Interested investors are advised to go through the offer document and the relevant terms and conditions of the exchange.

Prior to application for an IPO, it is advisable for investors to open a demat account and make necessary application and banking arrangements. For details regarding the same, please go through our article on what is a demat account ?

How Does Allotment Work in an OFS IPO?

The stock exchange will not accept and fill an order for the full quantity of shares requested. The shares will be allotted based on the basis of allotment for the offer.

The reason why retail investors do not get the quantities of shares they apply for in the IPO, is due to the shares being allotted based on the basis of allotment and the number of applications made by other retail investors. Retail investors may not get any shares allotted in very popular IPOs.

Allotment is final and investors are given the allotted shares in their demat accounts. Funds blocked for the unallotted/unsuccessful shares are also released.

A retail investor needs to understand the difference between application, allotment and listing. Just because a retail investor applies for shares in an IPO does not mean the shares will get allotted to them and/or the shares will get listed at a price lower than the IPO price.

OFS in IPO vs Exchange OFS

The term OFS is also used for a separate mechanism in the secondary market. This can cause confusion among beginners.

NSE's separate e-OFS framework describes exchange-based OFS as a mechanism for promoters or other eligible shareholders of listed companies to dilute or offload holdings. Investors participate through registered trading members.

This distinction is useful when searching for an OFS opportunity online because an article about an exchange OFS is not necessarily describing an OFS component of an IPO.

What Must Investors Verify In An IPO With An OFS?

A OFS (Offer for Sale) component is neutral. Determining factors are the rationale behind the equity turnover and the structure of the issue.

1. Verify the fresh issue and OFS: Determine the quantity of the issue that is a fresh offer and the quantity that is sold through the OFS.

2. Identify the sellers: Knowing the sellers helps to understand the reason behind the equity turnover.

3. Understand the end-use of the proceeds: Proceeds of a fresh issue get lapped up by the company and proceeds of the OFS go to the selling shareholders.

4. Review the objectives of the fund raising: Understand how the company intends to utilize the proceeds of the fresh issue.

5. Consider the holdings of promoters and shareholders: Knowing the holdings of the sellers post the IPO is necessary to evaluate whether the promoters retain a considerable stake in the company post the IPO.

6. Conduct a peer-reviewed assessment of valuation: Comparing and justifying the valuation of the company vis-à-vis its peers is equally necessary.

7. Read the offer document: Understand the downside of the business that is not published in the financial press.

8. Verify the final allotment: Understand that just because a price band is set high, doesn't mean that will be the allotment price.

Our guide on how to value a stock in India can help beginners understand why an IPO's offer price should be assessed in relation to the company's financial and valuation information rather than only its popularity.

Does a High OFS Portion Automatically Indicate an Bad IPO?

Not always. A high OFS portion means a large portion of the existing shares will be traded, but doesn't necessarily indicate an IPO is priced poorly.

There may be several reasons for a share sale. Shareholders may want to realize a capital gain, rebalance their portfolio, meet fund obligations, or fulfill other personal objectives.

Generally, investors should be aware that an OFS offer allows a company to raise capital less than a combined offer for sale and fresh issue. This may be an issue if the company intends to use the IPO proceeds to fund growth or other activities.

It is always important to analyze the company and the IPO offer in detail, especially the price band and the floor price. The IPO offering price should also be analyzed.

Simple Example of an IPO with Offer for Sale (OFS)

Let's say there is a company, ABC Technologies.

ABC Technologies does an IPO of 1 crore shares with a price band of 200 to 220 rupees. The IPO consists of 60 lakh shares as a fresh issue and 40 lakh shares by the existing shareholders through offer for sale (OFS).

If the final issue price is fixed at 210 rupees, the gross value of the IPO will be 210 crores. The post issue and ex-offer adjustment and issue costs will be deducted from the 126 crores raised from the fresh issue, and 84 crores will be raised through OFS.

ABC Technologies will not raise capital through the OFS. The shareholders who sold the shares through the OFS will get the proceeds, after deducting the transaction costs.

This example is for illustrative purpose only.

Risks Associated with an OFS IPO

Investing in an OFS IPO does mean that you will not bear the risks associated with equity investing or IPOs.

• Allotment risk: When the demand for shares is high, you may not get any shares or may get less than what you have applied for.

• Listing-price risk: Market price after the listing may be less than the IPO price.

• Valuation risk: An IPO may be over-subscribed and still be offered at a valuation that may not be attractive to some investors.

• Business risk: The actual performance of the company may not be as expected.

• Shareholder-sale risk: An IPO may be offered and may still attract some investors, but other shareholders may be selling their shares as they do not expect the company to perform well.

• Market risk: Equity markets may go down after listing.

SEBI states that an investor has to evaluate the risks of an IPO and invest only after evaluating the offer document. SEBI also states that investors should not consider the demand for an IPO or media articles as a sign of an imminent listing gain.

OFS in IPO: Beginner's Checklist

Before applying to an IPO containing an OFS component, consider this checklist:

• Have you identified the percentage of the IPO that is fresh issue versus OFS?

• Do you know which shareholders are selling their shares?

• Do you understand what the company plans to do with the fresh-issue proceeds?

• Do you know the IPO price band, lot size and applicable investor category?

• Do you understand how the cut-off option works?

• Have you reviewed the company's financial statements and risk factors?

• Have you checked the official offer document rather than relying only on social-media posts or subscription headlines?

• Are you prepared for the possibility that the stock may trade below the IPO price after listing?

For broader IPO education, see our guide to what an IPO is and our article on how to apply for an IPO.