Initial Public Offering

INITIAL PUBLIC OFFER (IPO)

Initial public offer deals with the new securities which were not previously available to the investing public, i.e., the securities that are offered to the investing public for the first time. The market, therefore, makes available a new block of securities for public subscription. In other words, IPO deals with rising of fresh capital either for cash or for Consideration other than cash.

* FUNCTIONS OF IPO

The main function of IPO is to facilitate transfer of resources from savers to the users. The savers are individuals, commercial banks, insurance companies etc. The users are public limited companies and the government. IPO plays an important role of mobilizing the funds from the savers and transfer them to borrowers for production purposes, an important requisite of economic growth.

The main function of IPO can be divided into a triple service functions:
1. Origination
2. Underwriting
3. Distribution

* ORIGINATION

Origination refers to the work of investigation, analysis and processing of new project proposals. Origination starts before an issue is actually floated in the market.

There are two aspects in this function:

i) A careful study of the technical, economic and financial viability to ensure soundness of the project. This is a preliminary investigation undertaken by the sponsor of the issue.

ii) Advisory services which improve the quality of capital issues and ensure its success
The advisory service includes:
1. Type of issue
2. Magnitude of issue
3. Time of floating a new issue
4. Pricing of an
5. Methods of issue
6. Techniques of selling the securities.

* UNDERWRITING

Underwriting is an agreement whereby the underwriter promises to subscribe to a specified number of shares or debentures or a specified amount of stock in the event of public not subscribing to the issue. If the issue is fully subscribed, then there is no liability for the underwriter. If a part of share issue remains unsold, the underwriter will buy the shares. Thus, underwriting is a guarantee for the marketability of shares.

* METHODS OF UNDERWRITING

An underwriting agreement may take any of the following three forms:

1. Standing behind the issueUnder this method, the underwriter guarantees the sale of a specified number of shares within a specified period. If the public do not subscribe to the specified amount of issue, the underwriter buys the balance in the issue.

2. Outright purchaseThe underwriter in this method makes outright purchase of shares and resells them to the investors.

3. Consortium methodUnderwriting is jointly done by a group of underwriters in this method. The underwriters form a syndicate for this purpose. This method is adopted for large issues.

* ADVANTAGES OF UNDERWRITING

Underwriting assumes a great significance as it offers the following advantages to the issuing company.
1. The issuing company is relieved from the risk of finding buyers for issue offered to the public. The company is assured of raising adequate capital.

2. The company is assured of getting the minimum subscription within the stipulated time, astatutory obligation to be fulfilled by the issuing company.

3. Underwriters undertake the burden of highly specialized function of distributing securities.

4. They provide expert advice with regard to timing of security issue, the pricing issue, the size and type of securities to be issued.

5. Public confidence on the issue is enhanced when underwritten is done by reputedunderwriters.

* DISTRIBUTION
Distribution is the function of sale of securities to ultimate investors. This service is performed by brokers and agents who maintain a regular and direct contact with the ultimate investors.

* METHODS OF FLOATING NEW ISSUE

The various methods which are used in the floatation of securities in the initial public offering are
1. Public issue
2. Offer for sale
3. placement
4. rights issue

* PUBLIC ISSUE

Under this method the issuing company directly offers to the general public/institutions a fixed number of shares at a stated price through a document called prospectus. This is the most common method follow by the joint stock companies to raise capital through the issue of securities.The prospectus must state the following:
1. Name of the company

2. Address of the registered office of the company

3. Existing and proposed activities

4. Location of the industry

5. Names of directors

6. Authorized and proposed issue capital to the public

7. Dates of opening and closing the subscription list

8. Minimum subscription

9. Names of brokers/underwriters/bankers/managers and registrars to the
issue.

10. A statement by the company that it will apply to stock exchange for
quotation of its shares.

* Merits of issue through prospectus

1. Sale through prospectus has the advantage of inviting a large section of the investing public through advertisement.

2. It is a direct method and no intermediaries are involved in it.

3. Shares, under this method, are allotted to a large section of investors on a non discriminatory basis. This procedure helps in wide dispersion of shares and to avoidconcentration of wealth in few hands.

* OFFERS OF SALE

The method of offer of sale consist outright sale of securities through the intermediary of issue houses or share brokers. In other words the share is not offered to the public directly. This method consist of two stages: The first stage is direct sale by the issuing company to the issue house and brokers at an a agreed price. In the second stage, the intermediaries resell the above securities to the ultimate investors. The issue houses or stock brokers purchase the securities at a negotiated price and resell at a higher price. The difference in the purchase and sale price is called turn or spread. It is otherwise called Bought Out Deals (BOD).

* ADVANTAGES

Bought out deal enables an issuer with good project to obtain funds with a minimum cost without the fear of under subscription.The advantage of this method is that the company is relieved from the problem of printing and advertisement of prospectus and making allotment of shares.

Offer of sale is not common in India. This method is used generally in two instances:

1. Offer by a foreign company of a part of it to Indian investors.

2. Promoters diluting their stake to comply with requirements of stock exchange at the time of listing of shares.

* PLACEMENT

Under this method, the issue houses or brokers buy the securities outright with the intention of placing them with their clients afterwards. Here the brokers act as almost wholesalers selling them in retail to the public. The brokers would make profit in the process of reselling to the public. The issue houses or brokers maintain their own list of clients and through customer contact sell the securities. There is no need for a formal prospectus as well as underwriting agreement.

* ADVANTAGES

Placement has the following advantages:

1. Timing of issue is important for successful floatation of shares. In a depressed marketconditions when the issues are not likely to get public through prospectus, placementmethod is a useful method of flotation of shares.

2. This method is suitable when small companies issue their shares.

3. It avoids delays involved in public issue and it also reduces the expenses involved inpublic issue.

4. There are no entry barriers for a company to access the private placement market.

5. A private placement deal can be successfully executed much faster than a public offering.

* RIGHTS ISSUE

Rights issue is a method of raising funds in the market by an existing company. A right means an option to buy certain securities at a certain privileged price within a certain specified period. Rights shares are offered to the existing shareholders in a particular proportion to their existing share ownership. The ratio in which the new shares or debentures are offered to the existing share capital would depend upon the requirement of capital.

* ADVANTAGES OF RIGHT ISSUE

The cost of issue is minimum. There is no underwriting, brokerage, advertising and printing of prospectus expenses.

1. It ensures equitable distribution of shares to all existing shareholders and so control of company remains undisturbed as proportionate ownership in the company remains the same.

2. It prevents the directors from issuing new shares in their own name or to their relatives at a lower price and get controlling right.

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INITIAL AND FOLLOW ON PUBLIC OFFERINGS

One of the foremost reasons as to why companies go public is to raise capital to support their future growth. Once a company gets listed on the bourses, it has to comply with several regulations making it more accountable, efficient, etc. At the same time, it comes in the eye of the investor community at large, which raises its chance of being acquired or merged in the future, which could be valuable for its shareholders. Additionally, the shares of a listed company also act as a currency for the company and could potentially be a medium of payment for future acquisitions or amalgamations.

KEY DOCUMENTS INVOLVED IN THE PUBLIC ISSUE PROCESS

Draft Offer DocumentAny company coming out with a public issue is required to file its preliminary prospectus with SEBI, the market regulator. This preliminary prospectus is termed as the ‘Draft Offer Document’. It contains all the information that you may want to know about the company before subscribing to its issue - its management, business model, future plans, financials, risk factors involved, etc. SEBI does not approve or vet the draft offer document. SEBI's role is to ensure that the disclosures made in this document are generally adequate to enable the investors to make an informed decision regarding the offer. SEBI conveys its comments, if any, on the draft document, which results in the issuing company making the suggested additional disclosures in it before it is dispatched to the investors.Red Herring ProspectusOnce SEBI passes the draft offer document, it gets converted into the Red Herring prospectus. This contains all the information that you need to know about the company before subscribing to its issue - its management, business model, future plans, financials, risk factors involved, etc. In addition, the red herring prospectus contains the issue details – i.e. the size of the issue, the number of shares on offer, the offer price band and the duration of the issue.

PLAYERS INVOLVED IN THE PUBLIC ISSUE PROCESS

UnderwriterEach and every issue has an underwriter. An underwriter could be a bank, a brokerage house, a merchant banker or a financial institution. An underwriter gives the issuer a commitment that it will buy all the public issue shares which are not subscribed to during the offer period. For instance, the issue of Company ABC Ltd. consists of 1 crore shares. If at the end of the issue, subscription from all investors amounts to only 80 lakh shares, then, the underwriter is under obligation to buy the balance shares. An issue can have more than one underwriter.Lead ManagerAs in the case of the underwriter, lead managers could be banks, brokerage houses, merchant bankers or financial institutions. It is the responsibility of the lead managers to ensure that the issue is in accordance with SEBI’s regulations, proper disclosures have been made and the facts in the red herring prospectus are correct. Further, they act as intermediaries between the issuing company and the investors. The responsibility of creating the draft offer document and the red herring prospectus lies with them. Further, the responsibility of marketing the issue lies with them. Post-issue activities such as intimating the subscribers about the number of shares that have been allotted to them and ensuring that the refunds reach investors who do not receive allotments also fall under their domain.RegistrarThe actual work of drawing up the list of investors who will receive allotment, crediting shares to their demat accounts and ensuring that the refunds are disbursed, lies with the registrar to the issue. A registrar is a financial institution appointed by the issuing company to keep a record of the issue and the ownership of the company’s equity.

PRICING OF A PUBLIC ISSUE

Pricing a public issue of a company is a challenge for even the very best and the most experienced in the business. It involves a trade-off between satisfying promoter expectations of obtaining good valuations for the company and giving the investors the opportunity to enjoy some returns. While aggressively priced issues (i.e. issues that are priced on the higher side) have shown a tendency to fail even in bull markets, issues that are priced keeping the investors in perspective have yielded gains for all concerned.

METHODS OF PUBLIC ISSUE PRICING

There are two popular methodologies available for pricing issues. They are the fixed price method and the book building method. Some issues are priced using a combination of both.

Fixed Price method

In this case, the company concerned, with the help of the lead managers, identifies and makes public the price at which it is ready to sell its shares to the investing public. Thus, only if investors feel that the price is right would they subscribe to the issue.

Book Building method

Book building is a method whereby shares of a company are offered at a price that is determined by the demand for shares of that company. The company indicates a price band (i.e., the minimum and the maximum offer price at which it will issue shares). The price at which the investors can subscribe to the issue must be within this price range. All the investors’ price and quantity bids, which are submitted during the offer period, are maintained in an ‘order book’ by one of the lead managers who is called the ‘book runner’. A cut off price is then determined on the basis of which the issue will be fully subscribed. The investors whose price bids are lower than the cut off price are refunded their application money. Those who have bid at the cut off price or above are allotted shares at the cut off price and the company refunds any money paid by investors as application money that is in excess of the cut off price.

Fixed Price + Book Building

A company can issue its shares using a combination of the book building process and a fixed price process in a single issue. SEBI guidelines mandate that an issuer going in for a combination of both a fixed price and a book built issue may make a maximum of 75 percent of the net offer to the public through the book building process and a minimum of 25 per cent through a fixed price process.