Ipo Investment In India: A Guide To Going Public

Initial Public Offerings (IPOs) are a significant milestone for companies, as they mark the first time a private company offers its shares to the public. IPOs are an important step in a company's growth, providing access to funds through the public capital market. They also increase a company's credibility and publicity. IPOs are often used to raise capital for growth and expansion, and they allow early investors and company founders to sell their shares and realise a return on their investments. However, going public comes with increased regulatory and reporting requirements, as companies are now accountable to shareholders and the broader investing public. As such, the decision to go public involves careful consideration of the company's financial position, growth strategy, and readiness for public ownership.

Fixed Price Offerings

An Initial Public Offering (IPO) is when a private company sells its shares to the public for the first time. This allows the company to raise funds by selling ownership stakes to individuals and institutional investors. There are two common types of IPOs: fixed-price offerings and book-building offerings.

A fixed-price offering is a straightforward approach to setting the price of shares before they are offered to the market. This method involves the company determining a fixed price per share, which remains constant throughout the IPO process. To establish this price, the company collaborates with financial experts like merchant bankers and underwriters.

Indian businesses have traditionally favoured fixed-price offerings for capital raising. Investors appreciate this type of IPO due to its transparency. They know the exact price per share they will pay, providing reassurance to those who prioritise predictability in their investments.

Under a fixed-price offering, the company going public determines a fixed price at which its shares are offered to investors. The investors know the share price before the company goes public. Demand from the markets is only known once the issue is closed. To partake in this IPO, the investor must pay the full share price when making the application.

The process of an IPO involves several steps. First, the company decides to go public and appoints investment banks as underwriters. Extensive due diligence, including financial audits and legal compliance checks, is conducted. The company then files a Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India.

The company selects the stock exchange where it will list its shares and applies to the chosen exchange. Together with the underwriters, the company conducts a roadshow to promote the IPO to potential investors. Based on investor demand and market conditions, the offering price is determined.

The final prospectus, known as the Red Herring Prospectus (RHP), is issued with the offer price range. Shares are allocated to various investor categories, including Qualified Institutional Buyers (QIBs), Non-Institutional Investors, and Retail Individual Investors. Bidders can apply for shares within the specified price range.

On the IPO day, the company's shares become available for trading in the secondary market, and investors can buy and sell shares at market prices. Post-IPO, the company is required to provide regular financial and operational updates to the stock exchanges and investors.

Book Building Offerings

Book building is a crucial process in determining the share price of a company going public through an IPO. It is a method for setting the price based on investor interest and demand. Here's a detailed overview of book-building offerings:

Process of Book Building

The book-building process typically involves the following steps:

• Appointment of Intermediaries: The company going public appoints lead managers or book runners, usually investment banks, to manage the book-building process. These intermediaries assist in determining the offer price, marketing the issue, and allocating securities.
• Filing of Draft Offer Document: The company files a draft offer document with the regulatory authority, providing details about the company, its operations, financial performance, and the proposed offering.
• Marketing and Roadshows: The lead managers conduct marketing activities and roadshows to generate investor interest and educate potential investors about the offering.
• Bidding Period: Investors submit bids for the securities during the specified bidding period, indicating the quantity they wish to purchase and the price they are willing to pay.
• Price Discovery: Based on the bids received, the lead managers assess investor demand and determine the final offer price within the specified price range.
• Allocation of Securities: Once the offer price is finalised, securities are allocated to investors based on their bids, with preference given to institutional investors and high-net-worth individuals.
• Listing and Trading: After the allotment process is completed, the securities are listed on the stock exchange, allowing investors to trade them in the secondary market.

Advantages of Book Building

Book building offers several benefits over traditional fixed-price offerings:

• Price Discovery: Book building helps determine the optimal price for securities by assessing investor demand, ensuring competitive pricing and maximising the company's proceeds.
• Efficient Capital Allocation: By allowing investors to indicate their willingness to pay, book building ensures efficient capital allocation, allocating securities to investors who value them the most.
• Flexibility: Book building provides flexibility in adjusting the offering price within a predetermined range based on investor demand, accommodating market conditions and maximising investor participation.
• Reduced Price Fluctuations: As the offering price is determined through investor consensus, book building can mitigate price volatility in the secondary market post-listing.
• Enhanced Transparency: The process provides investors with insights into demand dynamics and pricing considerations, enabling informed investment decisions.

Disadvantages of Book Building

While book building has advantages, it also presents certain challenges:

• Limited Transparency for Retail Investors: Retail investors may have limited access to information and understanding compared to institutional investors, leading to a perceived lack of transparency.
• Potential for Price Manipulation: Sophisticated investors or underwriters could potentially manipulate the bidding process, disadvantaging other investors and leading to inaccurate pricing.
• Exclusion of Small Investors: Retail investors, particularly those with limited resources or expertise, may feel excluded from effectively participating in the book-building process, impacting their ability to acquire shares at a fair price.
• Higher Costs and Fees: Engaging underwriters and investment banks for book building can result in higher costs for the issuing company compared to fixed-price offerings.
• Market Volatility and Uncertainty: Variations in investor bids and rapid market changes during the IPO period can lead to pricing uncertainty and impact investor confidence and post-IPO performance.
• Complexity in Pricing: Analysing a wide range of bids from different investors can result in delays or disagreements, potentially affecting the overall success of the IPO.
• Risk of Underpricing or Overpricing: Despite efforts to set a fair price, there is still a risk of underpricing or overpricing, which can influence the company's valuation and investor perceptions post-listing.

Types of Book Building

There are two main subtypes of book building:

• Accelerated Book Building: This type is preferred when a company needs quick access to capital and is usually completed within one to two days. It involves direct communication with a select group of institutional investors and targets swift capital raising.
• Partial Book Building: This process combines fixed-price offerings and book-building elements. A portion of the shares is offered at a fixed price, while the remaining shares are subject to the book-building process, allowing for a balance between secured funding and market-driven pricing.

Eligibility for IPO listing in India

The eligibility criteria for a company to issue an IPO in India are determined by the Securities and Exchange Board of India (SEBI) and the National Stock Exchange (NSE). Here are the key requirements:

SEBI Eligibility Criteria:

• The company should have a minimum net worth of Rs. 1 crore in each of the last three years.
• The company should have at least Rs. 3 crore in net tangible assets annually, with no more than 50% in cash or equivalents, unless the IPO is through an Offer for Sale (OFS).
• If the company has changed its name, 50% of the previous year's revenue must be generated under its new name.
• The company should have an average pre-tax operating profit of at least Rs. 15 crore for three out of the last five years.
• The IPO issue size must not exceed five times the company's total net worth before the issue.

NSE Eligibility Criteria:

• At least one promoter of the company should have a minimum of three years of experience in the industry.
• The company must submit annual reports for the last three financial years to the NSE.
• For issues less than Rs. 500 crore, the company must have a positive net worth.
• The company should have a post-paid-up equity of more than Rs. 10 crore.
• The company's market capitalisation should be more than Rs. 25 crore.

Additional Requirements:

• The company must apply to one or more exchanges and select one as its desired exchange.
• Arrangements must be made with a depository (CDSL or NSDL) to handle the dematerialisation process before and after the IPO.
• Promoters need to keep their shares in demat form before filing the DRHP.
• The company must deposit 1% of the issue amount as a deposit with the selected stock exchange before the issue.
• The company must have no bankruptcy proceedings admitted by the National Company Law Tribunal (NCLT) or Board for Industrial and Financial Reconstruction (BIFR).
• The company must have been seeking IPO applications for at least three years or be a partnership firm converted into a company.

Reasons for companies to offer IPOs

There are several reasons why companies decide to offer IPOs. Here are some of the most common ones:

• Capital Infusion: IPOs are an effective way for companies to raise capital by selling ownership stakes to individuals and institutional investors. This capital can then be used for business expansion, debt reduction, or other corporate purposes.
• Liquidity for Investors: An IPO allows existing shareholders, including founders and early investors, to monetise their investments by selling their shares to the public.
• Enhanced Visibility: Going public increases a company's visibility and credibility in the market, which can positively impact its business relationships and growth prospects. It also helps the company establish goodwill and gain better market visibility.
• Funding Operations: By selling shares to the public, companies can quickly raise capital to fund operational activities, pay for new infrastructure, or cover expansion costs.
• Facilitate Trading of Assets: Going public makes it easier for a company to trade its assets.
• Monetise Private Stakeholders' Investments: An IPO provides an opportunity for private stakeholders to monetise their investments and exit the business.
• Improve Transparency and Credibility: Publicly traded companies are required to disclose financial and operational information regularly, which can enhance their credibility and transparency.
• Attract and Retain Talent: Going public can help attract and retain skilled employees by offering them liquid stock equity participation.
• Lower Cost of Capital: IPOs can give companies access to lower costs of capital for both equity and debt financing.

The IPO process in India

Step 1: Hire an Investment Bank

The first step in the IPO process is for the company to seek guidance from a team of underwriters or investment banks. These financial experts will study the company's financial situation, work with its assets and liabilities, and plan to cater to the company's financial needs. An underwriting agreement will be signed, detailing the deal, the amount to be raised, and the securities to be issued.

Step 2: Prepare RHP and Register with SEBI

The company, along with the underwriters, will file a registration statement and a Draft Red Herring Prospectus (RHP). The RHP includes financial data, industry and business descriptions, management details, probable price estimates per share, risk reports, business plans, and other disclosures as per the SEBI Act and Companies Act. This document must be submitted to the local Registrar of Companies (ROC) before the offer is opened to the public for bidding. After submission, the company can apply for the IPO to SEBI.

Step 3: Verification by SEBI

The market regulator, SEBI, then verifies the disclosure of facts by the company. If the application is approved, the company can announce a date for its IPO.

Step 4: Application to a Stock Exchange

The company must decide on the stock exchange where it will list its shares and apply accordingly.

Step 5: Roadshows

Before the IPO opens to the public, the company's executives will typically travel across the country for about two weeks, marketing the upcoming IPO to potential investors. This phase involves advertising and promoting the IPO to attract potential investors.

Step 6: IPO Pricing

The company can now initiate the pricing of the IPO. This can be done through either a Fixed Price IPO or a Book Binding Offering. In the former, the company's stock price is announced in advance, while in the latter, a price range of 20% is announced, and investors place their bids within this bracket.

Step 7: Allotment of Shares

Once the IPO price is finalised, the company, along with the underwriters, will determine the number of shares allotted to each investor. In cases of over-subscription, partial allotments will be made. The IPO stocks are usually allotted to the bidders within 10 working days of the last bidding date.

Other Considerations

Throughout the IPO process, companies must also consider factors such as preventing company insiders or internal investors from participating. This is to maintain a balance in the demand and supply of shares and protect retail investors from manipulated offer prices.

Frequently asked questions