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NOTE: PLEASE REFER TO DICTATION GIVEN IN CLASS FOR COMPLETE NOTES
Initial Public Offer (IPO)
1. Definition
IPO is a type of public offering where company invites general public to purchase or subscribe its shares for the
first time. These shares are issued when a company is listed on a stock exchange for the first time. It has to
undergo the process as per SEBI and file a prospectus and enlist underwriters and merchant bankers for the
same. Once the shares are listed, the shares are then exchanged in the open market.
2. Process
i. Thorough planning of an IPO – IPO is usually triggered after a thought of expansion or raising long term
finance by the promoters of the company. All analysis of profits, capital structure, reporting requirements,
etc. is done by the company before going public.
ii. Appointment of Merchant Bankers – A merchant banker will play the role of a lead manager, underwriter,
and advisor to the issuing company and is required by the SEBI rules.
iii. Appointment of other syndicate members and intermediaries – The issuing company appoints a registrar as
per SEBI rules to avail administrative support during the issue process for selecting bankers, centres for
preparing application and allotment forms, and resolving grievances. A scheduled bank registered with SEBI
is appointed as the banker to the issuing company whose main duty is to collect application forms and
money, maintain reports for it and forwarding the application money to the registrar. An underwriter with
a minimum net worth of Rs.20 lacs is appointed to subscribe the shares in case of under-subscription. A
broker is appointed to promote market building making investors aware about the IPO.
iv. Registration of Offer Documents – The issuing company is required to submit the draft prospectus (Red
Herring) with SEBI which then becomes a public document. Merchant banker would fill the reports and
documents with the stock exchange. It has to specify the number of shares being issues (minimum 20%
promoter’s holding will stay locked-in for 3 years) and the price or price band at which the shares are to be
issued or bid for, whatever the case may be.
v. Marketing – Once all documents are registered and approved by SEBI and the stock exchange, the issue and
its related advertising is undertaken to ensure subscription of shares by the public through means of
publishing in newspapers, billboards, emails, etc. The total offer made to the public should be 25% or more
of the total issue amount.
vi. Post-issue – Once the window for subscription closes, the merchant bank has to report to the company
whether there is under or over subscription. Accordingly, underwriters have a time of 60 days to to either
subscribe in case of under-subscription, or company has 30 days to return the excess collection with a
letter of regret in case of over-subscription.
vii. Allotment of shares – Post the issue, shares are to be allotted categorically to QIBs, NIBs, Retails investors,
etc. It is done proportionately and is reported as per SEBI rules to the public.
3. Types
i. Fixed Price Issue – In this method of IPO, the issuing company fixes a the price of the shares before issue.
This price is disclosed in the offer documents alongwith the number of shares to be issued. The quantitative
and qualitative factors that determined the fixed price are specified in the offer documents. The features
are as follows:
a. Fixed Price – The price is not changed at all during the entire process after submission in the offer
documents.
b. Price Discovery – There is no element of price-discovery, and there is no price-demand analysis
done to determine the appropriate price.
c. Undesirable response – If the company cannot understand the public response to the pricing, the
shares may be over-subscribed if underpriced and under-subscribed if overpriced.
d. Full payment – The investor has to pay the full amount of share price during application, unlike in
the other methods.
e. Pro-rata allotment – Allotment is done on a pro-rata basis in cases of both over-subscription and
under-subscription.
ii. Book Building Method – In this method, unlike a fixed price issue, the price band is specified within which
bids are accepted from the public. It is a price discovery mechanism. As per SEBI guidelines, an issuer company
can issue securities to the public though prospectus in the following manner:
a. 100% of the net offer to the public through book building process
b. 75% of the net offer to the public through book building process and 25% at the price determined
through book building. The Fixed Price portion is conducted like a normal public issue after the Book
Built portion, during which the issue price is determined.
The concept of Book Building is relatively new in India. However, it is a common practice in most developed
countries. During the period for which the book for the offer is open, the bids are collected from investors at
various prices, which are within the price band specified by the issuer. The process is directed towards both
the institutional as well as the retail investors. The issue price is determined after the bid closure based on the
demand generated in the process. The process for a Book-Building Issue is as follows:
a. The Issuer who is planning an offer nominates lead merchant banker(s) as 'book runners'.
b. The Issuer specifies the number of securities to be issued and the price band for the bids.
c. The Issuer also appoints syndicate members with whom orders are to be placed by the investors.
d. The syndicate members input the orders into an 'electronic book'. This process is called 'bidding' and is
similar to open auction.
e. The book normally remains open for a period of 5 days.
f. Bids have to be entered within the specified price band with a floor price and a cap price.
g. Bids can be revised by the bidders before the book closes.
h. On the close of the book building period, the book runners evaluate the bids on the basis of the demand
at various price levels.
i. The book runners and the Issuer decide the final price at which the securities shall be issued.
j. Generally, the number of shares are fixed, the issue size gets frozen based on the final price per share.
k. Allocation of securities is made to the successful bidders. The rest get refund orders.
For example, BSE IPO in recent times, had a Book Building IPO, help from Jan 23, 2017 - Jan 25, 2017. The
issue size was 15.42 million Equity Shares of Rs 2 aggregating up to Rs 1,243.43 Crore. Rs. 805 - Rs. 806 Per
Equity Share. Here, Rs. 805 is the floor price and Rs 806 is the cap price. Minimum order quantity was 18
shares per lot.
The features of a book-building method are as follows:
a. Price Discovery – The process depends on price discovery model based on the demand quoted by the
investors.
b. Open book building – It is compulsory for the issuing company to display the demand and bids online
during the building period. The public has full information about the price-demand play.
c. Price Band – A floor price and cap price are specified within which the public can bid for the shares. The
difference can only be upto 20% of the floor price.
d. Cut-off price – During this IPO, a price between the band is determined as the cut-off price. This is decided
by the book-runner and the issuing company. Only retail investors can bid at cut-off price.
4. Advantages & Disadvantages of an IPO:
-Advantages:
i. Enlarging and diversifying the equity base – It dilutes the equity holding and increases the base as
shares are issued to public.
ii. Cheaper source of finance than debt – It is a cheaper source of finance than debt since it bears no
interest payments.
iii. Increasing exposure and enhancing public image – It improves credibility and enhances the
corporate image with the public.
iv. Imporves disclosure – It improves disclosure standards to the investors and enables transparency.
v. Attracting and retaining talent – Once a company is listed through an IPO, it may issue Sweat
Equity or ESOP to talented employees thereby retaining them.
vi. Facilitating acquisition – The company can be valued easily at market price after being listed
through an IPO and makes it easier to acquire.
-Disadvantages:
i. Costly – An IPO is an extremely costly means of raising equity capital because of legal fees,
marketing expenses, banking fees, etc.
ii. Information is made public – A lot of information regarding the company’s finances, operations, is
made public which can be used by competitors, suppliers etc for their own benefit.
iii. Time- consuming process – An IPO takes nearly a quarter of a year to be completed.
iv. Restriction on usage of funds – The funds collected through IPO can not be used to for any
purpose other than that mentioned in the Red Herring Prospectus
v. Loss of control – Since the promoter’s stock is diluted, it leads to loss of control in the decisionmaking of the company.
vi. Reporting Norms – Post-listing, the number of report a company has to generate increases by
manifold and other compliance reporting increases too.
Difference between Fixed Price IPO and Book-building IPO:
Issue
Type
Fixed
Price
Issues
Book
Building
Issues
Offer Price
Demand
Payment
Reservations
Price at which the
securities are offered
and would be allotted
is made known in
advance to the
investors
Demand for the
securities offered
is known only
after the closure
of the issue
100 % advance
payment is required to
be made by the
investors at the time
of application.
A 20 % price band is
offered by the issuer
within which
investors are allowed
to bid and the final
price is determined
by the issuer only
after closure of the
bidding.
Demand for the
securities offered
, and at various
prices, is available
on a real time
basis on the BSE
website during
the bidding
period..
10 % advance
payment is required to
be made by the QIBs
along with the
application, while
other categories of
investors have to pay
100 % advance along
with the application.
50 % of the shares
offered are
reserved for
applications below
Rs. 1 lakh and the
balance for higher
amount
applications.
50 % of shares
offered are
reserved for QIBS,
35 % for small
investors and the
balance for all other
investors.