Decoding Initial Public Offering (IPO)

Indian multinational restaurant aggregator and food delivery start-up, Zomato offered India’s biggest Initial Public Offering (IPO) for the year 2021 and converted itself into a public limited company from a private company on the 14th of July, 2021. The total size of the IPO is Rs 9,375 crore, out of which the fresh issue of equity shares is worth Rs 9,000 crore[1]. A lot of other big companies including Paytm, PolicyBazaar, Aditya Birla Sun Life AMC and the government-owned insurance and investment corporation, Life Insurance Corporation (LIC) are in line for conversion to a public company by raising an IPO in the near future. This stride by Zomato and other multinational companies has created an inquisitiveness in the minds of people and has raised umpteen questions about the process of conversion of a public company into an IPO and its working thereon. Through this article, we aim to demystify the ambiguity surrounding the topic.

WHAT IS AN INITIAL PUBLIC OFFERING

In uncomplicated terms, an initial public offering (IPO) is the first time when a private company issues its shares to the public i.e. when it decides to go public[2]. Some common reasons for such a conversion are to meet the capital requirements for growth and expansion in a cost-efficient manner, boost liquidity and profitability for the owners and early investors, and to enhance credibility since public companies are regulated by the Securities and Exchange Board of India (SEBI). Moreover, this conversion is a great way for a company to publicize its products and services to a new set of customers in the market.

1. Underwriters/Investment Banks

The process of initial public offering typically begins with the company hiring an underwriter, a person who assumes the risk of a company or an investment bank to evaluate and assume any present or future risk that will arise as a result of the conversion. They further sign an underwriting agreement containing details of the deal, the securities being issued and the amount to be raised.

2. Prospectus

If the company has securities of value of more than Rs 50 lakhs[3], the underwriters file the registration statement and IPO prospectus. The registration statement contains the details of the company's business plan, fiscal data and utilization of the funds raised. The IPO prospectus is an offer document filed before the Securities and Exchange Board of India (SEBI). The IPO prospectus is further classified into Draft Red Herring Prospectus and Red Herring Prospectus.

The Draft Red Herring Prospectus is a preliminary document that contains the details of the nature of business, financial information, use of funds, risk factors and management. It is submitted to SEBI to get approval for the IPO. Red Herring Prospectus is an extended version of the Draft Red Herring Prospectus. It contains requisite information related to business operations of the company, purpose of issue, usage of the capital raised, promotion expenses, copy of underwriting agreement[4] purpose of issue and other financial information. It further provides the investors with the requisite information related to the arena of ambiguity and risk for the potential investors.

3. Approval/Rejection by SEBI

SEBI then provides the company with its observations in relation to the prospectus filed and also verifies the information contained in it. If the facts are verified, SEBI issues an observation letter. The validity period of the observation letter is twelve months only which means that the company has to open its issue within the period of twelve months starting from the date of issuing the observation letter[5].

4. Advertising and Publicity

Once the observation letter is issued, the company then makes an application to the stock exchange for floating its initial issue. But before this initial offer reaches the public, the executives of the company advertise the forthcoming IPO and try to create awareness in the market to attract potential investors.

5. Pricing

The company then proceeds with the pricing of IPO based on Fixed Price Issue where the price is fixed and the reasoning behind choosing that price is stated in the offer document or Book Built Issue where the investors bid on the basis of the price range announced. The company also announces the IPO Cap Price which is the maximum bid price and IPO Floor Price which is the minimum bid price. The buyers place their biddings in between the price range so announced. Post the completion of the bidding process which lasts for 3 to 5 working days, the company determines the final price of the issue i.e.; the Cut-off price.

6. Application and Allotment of Shares

The application form and prospectus are released on the scheduled date which is accessible to the public and investors in any bank or brokerage firm. The IPO is usually available for 5 working days. The interested investors are required to submit their forms within this time period. The company then determines the number of shares to be allotted. The investors are allotted full securities except in situations where there is an oversubscription where the allotment is partial.

IPO RUSH

A considerable number of companies dealing in diverse goods or services have gone public this year. As of July 2021, thirty companies have filed IPO papers and at least 10-15 more are lined up to initiate the process to go public[6]. Around Rs. 55, 000 Crore is expected to be released by the companies that have already filed for the IPO and another Rs 25,000 crore is expected to be raised by the companies aiming to go public[7]. Six months into this year and the companies have already raised the highest amount through the IPO route in over a decade[8] despite the ongoing pandemic. In a way, there has been an IPO rush in the country. The rationale behind such a rush can be attributed to the exuberant stock market activity and opening up of the economy that is leading to benchmark indices at the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) and are likely to grow further following a declining trend in coronavirus cases and an uptick in economic activity going forward.

It is also believed that the companies are aiming at capitalizing in this good earning season, excess liquidity in the market, the rise in indices and good investor sentiment[9]. Opting for an IPO and listing the company on the stock exchange widens a company’s access to gain risk capital by the public. It also gets easier to attract companies once a company is listed and has achieved recognition in the market. Not just this, even banks are comparatively less hesitant when it comes to providing loans to a public company. When a private company is converted into a public limited company, employee stock option plans can be easily set up and the company can smoothly carry out or be a part of any merger or acquisition.

CONCLUSION

Going public has its own share of pros and cons. The biggest leverage that a company gets ongoing public is going back to the public markets to raise more cash i.e., a follow-on offering. On an average, around one-third of the total IPO issuers return to the public market within five years and raise about three times as much capital as they did in the IPO[10]. Since there is already a buyer’s market, cashing out either completely or partially is plausible. However, there is another side to such a conversion which is gawky. For a public company, having a few poor quarters leads to the stock price becoming depressed, thus making it easier and cheaper for anyone to have significant control over the company. Going public also implies being transparent and it gets easier for people to view the success as well as the failures of a company. It also leads to being accountable for every act, not just to the shareholders but to the general public. There is also a constant pressure of living up to the market standards and constantly staying on the charts.

Many economists regard 2021 to be the year of IPOs in India. However, in order to make its IPO a successful exit strategy, a company has to keep in mind certain prominent factors. Regardless of the large-scale publicity of the company by the executives, it is the underwriters and investment banks who play a significant role in determining the success rate of the company’s Initial Public Offer (IPO). Thus, it is important for a company to make a prudent selection of underwriters and investment banks in order to make its Initial Public Offer (IPO) a successful exit strategy. The underwriters and investment banks must have an understanding of the industry the company belongs to. They should have in-depth knowledge about the company, its target customers and its competition.

ABOUT THE AUTHOR

This blog has been authored by Suruchi Bajpai & Shreeya Khasnis, who are Final Year students at ILS Law College, Pune.

[PUBLICATION NO. TLG_BLOG_21_15]

Decoding Initial Public Offering (IPO)

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