NFO vs. IPO: What SMEs Need to Know about Allotment Processes

The financial road before us can be opened through alternatives provided by specific mechanisms for investments. These mechanisms are called New Fund Offer for mutual funds and Initial Public Offer for equity shares offered by companies. The small and medium enterprises (SMEs) and individual investors may look at the distinctions, objectives, and allotment mechanisms corresponding to these two ways of raising capital.

Understanding the NFO Full Form and Its Context in Mutual Funds

NFO is an acronym that stands for New Fund Offer, which denotes the opening of a new mutual fund scheme to investors by the Asset Management Company (AMC). During the NFO period, the AMC sells units of the Mutual Fund to the investors at a fixed price, generally of ₹10 per unit, for a specified period. Upon the expiry of the NFO period, the scheme opens for subscription and redemption at the Net Asset Value (NAV).

What Is an IPO, and What Is the Difference Between an IPO and an NFO?

An IPO refers to the initial public offering of a company's equity, while an NFO pertains to the launching of a mutual fund scheme to the public. The investor in an IPO thereby becomes a partial owner of the company, whereas the investor in a mutual fund scheme becomes a unitholder of a trust that invests in financial instruments.

NFO vs. IPO: Key Differences in Allotment Processes

NFOs and IPOs present choices relevant to SMEs and investors pondering over the various modes of investment or raising capital. One major area of interest is the contrast in allotment processes.

Allotment in NFOs

As compared to the issuance of the IPO, investors apply for units during the offer period in NFOs; upon the termination of the offer period, all valid applications are processed by the fund and allocated units by the company at the issue price. Typically, NFO allotments do not face an oversubscription. This is because AMCs are permitted to create an unlimited number of units as per the regulations of the fund, and hence making allotting units to any investor applying on time an easy process.

Allotment in IPOs

Notably, allotment in the IPO process considers the number of shares issued against the number of applications received. When demand exceeds supply, this therefore makes the Issue an Oversubscription. Depending on their classification, shares might be accorded proportionately or based on a lottery.

Importance for SMEs

The Regulatory Framework

NFOs and IPOs alike are under the regulation of SEBI, which is the Securities and Exchange Board of India. In the case of NFOs, the mutual fund houses have to file the offer document and get approval from SEBI to launch it. An IPO, in its turn, has a Red Herring Prospectus drafted and it registers itself with stock exchanges for the purpose of listing.

SEBI also mandates the method of allotment to enhance transparency and fairness. In either mode, an escrow mechanism is in place to protect investors' funds, with specified timelines for refund or allotment.

Post-Allotment Differences

Post-allotment, investors shall receive the mutual fund units allotted from an NFO in a demat or physical format, as per their choice, and redeem them after the scheme opens for redemption. Whereas, under closed-end arrangements, redemption would be at maturity upon redemption of shares.

On the other hand, in the case of IPOs, upon allotment, shares would be credited to the investor's demat account, upon which they can sell shares on the stock exchange at a price determined by market forces.

Conclusion

NFOs and IPOs serve completely different purposes in the financial ecosystem. The NFO full form—New Fund Offer—applies to mutual funds, while IPO—Initial Public Offering—applies to the equity market.