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Initial Public Offering

SEBI Requirements for IPO SEBI has laid down certain norms for companies making an offering to the public. The companies should have Net tangible assets of not less than Rs 3 crore

What is an IPO? IPO is an acronym for Initial Public Offering and refers to the first sale of stock by a company to the public. Industries need capital when they decide to embark on a new project or foray into new operations. They have to raise this money from the public in order to fund their new enterprises and to realise their goals of expansion. People are offered shares in return for the investment they make in the industry. This offering to the public can be in the form of equity shares, preference shares or even debentures. An IPO is when a company makes either a fresh issue of securities or an offer for sale of its existing securities to the public for the first time. (It is thus that companies launching an IPO are often said to be going public) This paves the way for listing in a stock exchange in the first case, and trading of the issuers securities in the second.

Offer Document The Offer Document is the prospectus and covers all relevant information that will help the prospective investor to arrive at a decision. The Draft Offer Document is, as the name suggests, the initial draft that has to be filed with the Security and Exchange Board of India (SEBI) at least 21 days before the company wants to go public. SEBI may suggest changes in the Draft Offer Document which the issuer will have to incorporate before filing the Offer Document. The Red Herring Prospectus is a document that does not specify the exact price of each stock on offer, or the total value of the issue. However, the total number of shares on sale as well as the upper and lower price bands have to be mentioned. In the public issue of already listed companies, a prospectus without the price band can be issued and the floor price or a price band can be notified through an advertisement a day prior to the opening of the issue. Specialised intermediaries called Lead Managers (LM) draft and design the offer document, the prospectus, the communication (advert) and the memorandum, stating the salient features of the issue. They also take up the due diligence of companys operations, management, business plans and other legal stuff.

A net worth of Rs 1 crore or more Enough money to distribute as profits for three full years. In cases where a company has changed its name, at least 50% of the revenue for the preceding year should have accrued from the new activity and the size of the new offering cannot exceed 5 times the net worth of the issue made under the previous identity. The issued face value of the securities must be a minimum of Rs10 crore. Primary issuances are governed by SEBI DIP Disclosures and Investor Protection guidelines. The Lead Managers are required to follow due diligence and ensure that all requirements of DIP are fulfilled while submitting the draft offer document to SEBI. Any non- compliance on their part can attract penal action. Price Determination The price of the issue is decided by the company and the LM after mutual consultation. Although SEBI does not have any role in deciding the price, the company and LM are required to disclose parameters considered before fixing the price to the former. There are two types of issues. In the first type, known as a fixed price issue, the company and LM determine a price for its shares and communicate it to prospective investors through the Offer Document.

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In the other, a floor price or a price band (with upper and lower ceilings) is specified. Thereafter, it is left to the wisdom of market forces to determine the final price. This is referred to as a book-built issue. Book-Building is actually a process by which the demand for the securities proposed to be issued is measured and created. This is done by accepting orders from bidders indicating the number of shares they desire and the price that they are willing to pay for the same. The final price for the securities is proposed on the basis of the bids thus obtained. This method opens up a window of opportunity for the market to assess the price of the securities. The spread between the floor price and the price cap quoted by the issuer and the LM should not exceed 20%. Applicants must bid at a price within this band. Only retail investors have the option of bidding at cut-off rates. After the bidding is complete, the cut-off price is arrived at on the lines of Dutch auction (a method of selling in which the price is reduced until a buyer is found). The basis of allotment is then finalised and letters of allotment/refund are issued. Bidding An IPO is kept open for at least 3 working days and not more than 10 working days. In case of book-built issues, the bidding remains open for 3 7 working days. The form for applying/bidding of shares is available from syndicate members, collection centers, the brokers and the bankers to the issue. Investors may also place their bids through online terminals offered by some brokers like ICICIdirect.com. Applications for IPOs in excess of Rs10 crore are to be made compulsorily in the Demat form and
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A bidder, whose application has been rejected, is sent a refund order within 30 days of closure of the issue in case of fixed-price issues. In case of book-built issues, the basis of allotment is finalised by the LM within 2 weeks from the date of closure of the issue. The registrar then ensures that the Demat credit or refund, as applicable, is completed within 15 days of closure of the issue. The listing on stock exchanges is done within 7 days from the finalisation of the issue. Ideally, it takes around 3 weeks after the closure of the book-built issue. It would take around 37 days after closure of the issue for a fixed-price issue. investors have to fill the correct Demat details in the bid/application forms. A bid made in excess of Rs 1 lakh by a retail individual investor will be considered in the HNI (High Net worth Individuals) category. The investor can change or revise the quantity or price in the bid using the form for changing/revising the bid that is available along with the application form. However, the entire process of changing or revising bids must be completed before the date of closure of the issue. Allotment and Closing In a book-built issue, shares are allocated to Retail Individual Investors, Non Institutional Investors and Qualified Institutional Buyers (QIBs) in the ratio of 35: 15: 50. [Those who bid for securities having a total value of less than/equal to Rs1 lakh are termed retail investors. QIBs are those institutional investors who are perceived to possess expertise and the financial muscle to evaluate and invest in the capital markets. They include commercial banks, foreign institutional investors, Mutual funds, etc. Reservation on competitive basis can be made for employees of the company, shareholders of the promoting companies for a new company going public and shareholders of group companies in the case of an existing company. Once an issue closes, bids are classified under different categories such as QIBs, Non-Institutional Buyers, Retail, HNIs... Within each category, bids are then segregated into different buckets based on the number of shares applied for. Often, an issue will be oversubscribed, that is, the number of applications will exceed the number of securities on offer. In such cases, the over-subscription ratios need to be calculated for each category. This is calculated as the total number of shares for which bids have been received against the number of shares reserved for each of the categories in the offer document. The over subscription ratio is then applied to the number of shares applied for by applicants in each bucket to determine the number of shares to be allotted to them. The number of successful allotments is thus determined. This process is followed in case of proportionate allotment. Allotments to QIBs, however, are left to the discretion of the LM.
The writer is a telecommunications engineer and works as an Equity Researcher for a leading stockbroking house.