Initial Public Offering

Introduction 

Have you ever wondered how companies keep an inflow of funds, for both long-term and short-term purposes? A company in India can raise money in 3 ways, Debt, Equity, or Hybrid Securities. And also, through Foreign Exchange in the form of foreign direct Investment, or External Commercial borrowing. In today’s blog, the author discusses one of 3 ways funds are raised via Equity, Initial Public Offering, Rights Issue, and Private Placement.

Definition 

There are two kinds of companies, Private and Public, and Listed and Unlisted. Private Companies are usually unlisted and comprise of a few or a small number of shareholders, whereas a Listed Public company has an exponentially larger number of shareholders.

Initial Public Offering, Hereinafter IPO, means an offer of specified securities by an unlisted issuer to the public for subscription and which includes fresh issuance of shares by the company or includes an Offer for Sale (OFS) of specified securities to the public by any existing holder of such securities in an unlisted issuer.

In other words, is a process where the shares of a private company, are listed in the stock market for the public investors to subscribe to them in exchange for equity in the company or is when an unlisted company offers its securities to the public for the first time. This can involve the company issuing new shares or an existing shareholder selling their shares to the public. 

The Rationale or Why IPOs are Offered? 

There can be two kinds of needs to offer IPOs, one to raise funding and the other non-funding needs.

The first and foremost rationale for raising IPO is for its funding needs, such money is used for meeting the ends of the company. A few examples are diversification, Expansion, and Building of new and up-and-coming projects for the company, to finance various capital requirements, building company assets, meet the expenses of the company, etc. 

Non-funding needs include enhancing corporate stature and increasing liquidity to the shareholders, providing exit to the existing shareholders.

Another reason for offering IPOs is to enhance visibility for the company. Companies like Zomato, Nykka, and Paytm gained massive publicity during their IPO process. 

Regulations and Rules 

• Companies Act,1956 

• Provisions relating to the prospectus. 

• Provisions on minimum subscription, allotment, and return of allotment.

• Power relating to the issue and transfer of securities.

• Securities Contract (Regulation) Act,1956

• Securities and Exchange Board of India ( Issue Capital and Disclosure Regulation)

Eligibility of Companies to Raise a IPO

Entities not eligible to make IPO (Regulation 5 of ICDR):

1. If the issuer, any of its promoters, promoter group, or selling shareholders are debarred from accessing the capital market by SEBI;
2. If any of the promoters or directors of the issuer is a promoter or a director of any other company that is debarred from accessing the capital market by SEBI;
3. If the issuer or any of its promoters or directors is a wilful defaulter or a fraudulent borrower;
4. If any of the promoters or directors of the issuer is a fugitive economic offender;
5. If there are any outstanding convertible securities or any other right that would entitle any person with any option to receive equity shares of the issuer except outstanding options granted to the employees under an employee stock option scheme and fully paid-up outstanding convertible securities which are required to be converted on or before the date of filing of the Red Herring Prospectus or the Prospectus.

Eligibility Requirements for an Initial Public Offer (Regulation 6 of ICDR): 

An Issuer shall be eligible to make an initial public offer only if:

1. It has net tangible assets of at least Rs. 3 Crore, calculated on a restated and consolidated basis, in each of the preceding 3 full years (of 12 months each), of which not more than 50% are held in monetary assets. Provided that if more than 50% of the net tangible assets are held in monetary assets, the issuer has utilized or made firm commitments to utilize such excess monetary assets in its business or project. Provided further that the limit of 50% on monetary assets shall not be applicable in case the IPO is made entirely through an offer for sale.
2. It has an average operating profit of at least Rs. 15 Crore, calculated on a restated and consolidated basis, during the preceding 3 years (of 12 months each), with operating profit in each of these preceding 3 years.
3. It has a net worth of at least Rs. 1 Crore in each of the preceding 3 full years (of 12 months each), calculated on a restated and consolidated basis.
4. If it has changed its name within the last 1 year, at least 50% of the revenue, calculated on a restated and consolidated basis, for the preceding 1 full year has been earned by it from the activity indicated by its new name.

An issuer not satisfying the above-mentioned conditions shall be eligible to make an IPO only if the issue is made through the book-building process and the issuer undertakes to allot at least 75% of the net offer to qualified institutional buyers and to refund the full subscription money if it fails to do so.

Other conditions to be fulfilled for IPO (Regulation 7 of ICDR): 

An issuer making an IPO shall ensure that:

1. It has made an application to one or more stock exchanges to seek an in-principle approval for listing of its specified securities on such stock exchanges and has chosen one of them as the designated stock exchange.
2. It has agreed with a depository for the dematerialization of the specified securities already issued and proposed to be issued.
3. All its existing partly paid-up equity shares have either been fully paid up or have been forfeited.
4. It has made firm arrangements of finance through verifiable means towards 75% of the stated means of finance for a specific project proposed to be funded from the issue proceeds, excluding the amount to be raised through the proposed public issue or existing identifiable internal accruals.
5. The amount for general corporate purposes, as mentioned in objects of the issue in the draft offer document and the offer document shall not exceed 25% of the amount being raised by the issuer.

Methods of Raising IPO

1. Fixed Price Issue: In a fixed price issue, the precise price at which the securities are offered is disclosed to the investors. As a result, investors do not influence setting the price. Following the publication of the book construction issue, the majority of Businesses now Favor developing books, and the argument over set prices is moot. 

 

1. Book Building Process: In a Book Building Process, Investors are given access to a price band, not a set price. The process of making a book evaluates the price. When a business uses this technique to raise capital, the share price for the public is determined by examining the offers made by other investors. The process gets its name from the fact that, in this case, the underwriter looks at the prices that the institutional investors are bidding on and then builds a book. Following the bidding procedure, the ultimate cut-off rate is established using the weighted average technique, which takes into account market demand. 

 

Book: accounts/financial statement of a company/ revenue/profits of a company

 

Stakeholders or Intermediaries in an IPO process

• Merchant Banker/Lead Managers: The company appoints one or more registered merchant bankers as lead managers to the issue. Merchant Bankers are responsible for issue management, overall coordination, and interface compliance with the SEBI/NSE/BSE. They also conduct due diligence and assist in the drafting of the offer document.

1. 1. Auditors: They Review and audit financials and prepare financial statements for inclusion in the Offer Document. 

• Registrars: The registrar coordinates with the Issuer and Bankers regarding collections, reconciliation, refunds, etc. The work to Secure allocation approval from Stock Exchanges as well as oversee post-issue coordination collation and reconciliation of information.

• Underwriters: The underwriters are those persons who take the fall in case of the shortfall of the IPO. The supply of the remaining amount/ raise the remaining amount to make the IPO successful. 

1. Credit Rating Agencies: A credit rating agency assesses the financial strength of companies especially their ability to meet principal and interest payments on their debts.
2. Legal Advisors: Legal advisors conduct due diligence on the issuer entity, drafting of RHP, prospectus, offer agreement, underwriting agreement, etc.
3. Compliance officer: The issuer’s compliance officer is responsible for making sure the IPO complies with SEBI regulations and that any non-compliances found during the due diligence process are resolved in advance of the allotment date.
4. Syndicate Members: In a book-built issue, the broking houses are in charge of distributing, collecting, and updating the applications on the stock exchange regularly. the support during the whole bidding procedure

 

IPO PROCESS- BOOK BUILDING ISSUE

Step 1: Decision of the Shareholders to go for an IPO 

Step 2: Appointment of the Intermediaries 

Step 3: Due Diligence 

Step 4: Draft Red Herring Proposal 

Step 5: Filing with SEBI and Stock Exchanges 

Step 6: SEBI Comments 

Step 7: Improved Red Heering Prospectus 

Step 8: SEBI Approval

Step 9:  Price and Allocation 

Step 10: Listing. 

Conclusion

Conclusively, it is established that the initial public offering (IPO) is a milestone in raising business capital. It helps them finance expansion projects, diversify, and satisfy different capital needs, and even provide exit strategies to pre-existing shareholders. When companies transition from private to public ownership, it increases their corporate stature and liquidity for shareholders and grants them access to a wider range of investors. Lastly, this blog has tired to provide an easy overview of this concept without sacrificing the concept’s integrity.

Authored by- Khushi, Guru Nanak Dev University, Amritsar