What is Initial Public Offering (IPO)


If a newborn firm or a firm which is already in existence, but it has no shares which are listed on the stock exchange and chooses to call upon the public to buy its shares, it is called as an IPO (Initial Public Offering). The main motive of a company to come out with an IPO is to raise capital for the firm’s activities. Prior to the IPO, shares which were held by promoters or private investors are now offered to public. So, to the extent of the shares they offer to the public, their stakes reduces. In other case, new shares are issued and those of promoters stay with them. However in both circumstances, share of promoter in the total capital of the firm shall come down.

Lets take a hypothetical example. A company has 10 shares and offered 5 in an IPO. So, stake of the promoters reduces from 100% to 50%. If company issues 5 additional shares, then in this case, stake of promoter will come down to 67% from 100%.

Key Reasons for going public:

  1. To raise funds for financing capital expenditure needs like expansion, diversification etc.
  2. To finance increased working capital requirement.
  3. As an exit route for existing investors(Offer for Sale)
  4. For Debt Financing

Ways in which Company may raise capital:

1. Public Issue: This involves sale of securities to members of the public. It is one of  the most significant way of issuing securities.

2. Rights Issue: This is a method of raising further funds from existing shareholders/ debenture holders by offering additional securities to them on a preemptive basis.

3. Private Placement: Just as the term hints, it involves selling securities privately to a group of investors.

Primary Market and Secondary Market

Primary Market

If a firm is in need of funds, it would consider approaching a bank. But banks might not be willing to provide large amounts for longer duration if the returns are not fixed. In such situation best way to raise money is by offering shares to public. When shares are bought in an IPO it is termed primary market. The primary market does not involve the stock exchanges.

The key objective of primary market is to transfer funds from savers to entrepreneurs looking forward to establish or to expand/diversify their business.

Secondary Market

When an investor buys shares from another investor at an agreed prevailing market price, it is called as buying from the secondary market. The secondary market involves the stock exchanges and it is regulated by a regulatory authority. In India, the secondary and primary markets are governed by the Security and Exchange Board of India (SEBI).

Principal Steps in a Public Issue:

Principal Steps in a Public Issue:

Source: swaritadvisors.com

Pre Issue:

1. Approval of Board

An approval of BOD (Board of Directors) of company is required for raising capital from the public.

2. Appointment of Lead Manager/s

The lead manager/s is a merchant banker who controls and arranges for the issue in consultation with the firm. Selection of lead manager should be done with proper care.

3. Appointment of other Intermediaries:

There are many intermediaries which simplify the Public Issue process. Their key tasks and way of functioning is mentioned below:

a. Co-managers and advisers: A co-manager coordinates the tasks of the lead manager and an advisor gives counseling. The lead manager may appoint co-managers and advisers, if the need is felt.

b. Underwriters: An underwriter agrees to subscribe to a given no. of shares in the event the public do not subscribe them. The underwriter, basically, takes assurance for public subscription and in turn receives underwriting commission. Some of the eminent underwriters in India are the public financial institutions, commercial banks, insurance companies, private merchant bankers, and brokers.

c. Bankers: The bankers to the issue accumulate funds on behalf of the firm from the applicants. Guidelines from SEBI have specified the minimal banking arrangements which should be made to collect applications. The bankers chosen for the issue are typically the ones (i) with whom the company has its cash credit accounts (ii) who provide term loans to the company and (iii) who underwrite and/or manage the issue.

d. Brokers and Principal Brokers: The brokers to the issue aid in its subscription. While you appoint the brokers to the issue, the following points should be kept in mind: (i) Only members of recognized stock exchanges can be appointed as brokers. (ii) The no. of brokers appointed has to bear a reasonable relationship to the size of the issue. A firm shall, if required, appoint a principal broker to share the work of the brokers.

e. Registrars: The registrars to the issue carry out a wide range of activities beginning from the period subscription is closed to the time allotment is made: collection of application forms from the banks, inspection of application forms, categorization and tabularization of data, finalizing of the basis of allotment, issuing and dispatching allotment letters, share/debenture certificates, and refund orders. Registrars can be chosen on the basis of experience, proficiency, reliability and expense.

4. Preparation of the Prospectus: The prospectus is a manuscript to share information about the firm and the proposed security issue, to the public. Its contents, administered mostly by law, are very wide ranging. The draft prospectus containing the disclosures has to be vetted by SEBI before a public issue is made. In certain cases, requirement of vetting is waived. Once vetted, the draft prospectus and the application form (along with Articles and Memorandum of Association) should be directed to the concerned stock exchange, where the issue is proposed to be listed, to obtain sanction.

5. Filling of the Prospectus with the Registrar of Companies/SEBI

Once the prospectus is sanctioned by the concerned stock exchanges and approvals obtained from the bankers, auditors, legal advisors, registrars, underwriters and others, the prospectus, signed by the directors, should be filed with the Registrar of Companies(ROC) along with requisite documents as required by Companies Act, 1956.

6. Printing and Dispatch of Prospectus and Application Form

Once the prospectus is filed with ROC, the firm must print the prospectus and the application form. Also, the firm can come out with a publicity brochure that is generally a short, alluring pamphlet drawing attention to the distinct features of the issue.

The quantities in which the prospectus, application form, and publicity brochure are printed should suffice needs of brokers, underwriters and bankers to the issue. They must be forwarded to stock exchanges and brokers so that they obtain them at least 21 days before the first announcement in the newspapers. Brokers, who serve as link between the firm and probable investors, collect the prospectus, application form, and brochure in large quantities, and then mail them to their clients. The firm might share the cost of mailing incurred by brokers on some basis.

7. Filing of Initial Listing Application

Within a period of 10 days that the prospectus has been filled, the initial listing application should be directed to the concerned stock exchanges, along with the initial listing fees.

8. Promotion of the Issue

The promotional campaign normally begins with the filing of the prospectus with the ROC and terminates with the discharge of statutory announcement of the issue. In order to promote the issue the firm orchestrates conferences for brokers, press, and potential investors. Here the firm looks for getting enough publicity. Advertisements are also released in newspapers and periodicals to develop interest amongst probable investors.

9. Statutory Announcement

The Statutory Announcement of the issue should be made after receiving the consent of the lead stock exchange. This should be published at least 10 days prior to the opening of the subscription list.

Post Issue:

1. Collection of Applications

The statutory announcement as well as the prospectus mentions when the subscription would open, when it would close, and the banks where the applications can be made. When the subscription is kept open, the bankers to the issue gather application money on behalf of the firm and the managers to the issue, along with assistance of the registrars to the issue, monitor the situation. Information is collected regarding the no. of applications received in various categories, the no. of shares applied for, and the amount received. When the application information points that the issue is over subscribed, the firm must consider a decision, in consultation with the managers and registrars to the issue, about closing the subscription. Nonetheless it can’t be done before the minimum period prescribed by the stock exchanges.

2. Processing of Applications

The application forms received by the bankers are transferred to the registrars of the issue to process them further that consist of following:

  1. Checking the applications to ensure if the proper amount has been received, whether the applicant’s name is rightly mentioned, if particulars such as address, age, occupation etc. have been  given, whether the application has been signed properly, and whether the applicant is authentic
  2. Serially numbering the applications
  3. To code the applications for items such as the name of applicant, broker, underwriter, occupation etc.
  4. To prepare list of applications along with all the relevant details.

3. Establishing the Liability of Underwriters

If the issue is under subscribed, the liability of the underwriters needs to be determined which is done in the following way:

  1. Segregate the applications that bear the stamp of an underwriter and those that do not bear the stamp of an underwriter. Find out the no. of shares acquired by each underwriter and carry the no. of shares relating to applications which do not bear the stamp of an underwriter to a general pool.
  2. Compare the no. of shares acquired by each underwriter with his underwriting commitment. If an underwriter acquires more shares than his underwriting commitment, transmit the surplus to the general pool. If an underwriter acquires lesser shares than his underwriting commitment, find out his shortfall.
  3. Credit the total no. of shares in the general pool to the underwriters with shortfall in proportion to their underwriting commitments and then find out the net shortfall of each underwriter who couldn’t acquire enough shares. This represents the underwriter’s liability.

4. Allotment of Shares

According to SEBI Guidelines, one half of the net public offers must be reserved for applications upto 1000 shares and the balance one half for larger applications. For each of these segments, the “proportionate” system of allotment has to be followed.

14. Listing of the Issue

The detailed listing application should be submitted to the concerned stock exchanges along with the listing agreements and the listing fee. The allotment formalities should be completed within 30 days after subscription list is closed or such extended period as permitted by the lead stock exchange.

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