Initial Public Offerings


An Initial Public Offering (IPO) is a significant financial event where a private company transitions into a public company by offering its shares to the general public for the first time. In an IPO, the company aims to raise capital by selling a portion of its ownership (equity) to investors in the form of shares. This process involves a series of steps, including thorough financial and legal scrutiny, regulatory approvals, and determining the initial offering price. Once the IPO is complete, the company’s shares become tradable on a stock exchange, providing liquidity for existing shareholders and allowing new investors to buy and sell shares. IPOs are often seen as a way for companies to access additional funding for expansion, acquisitions, or other strategic initiatives, while also increasing their visibility in the financial markets.

Key Players in the IPO Ecosystem

  1. Issuer:

    • The company seeking to go public and list its shares on Indian stock exchanges.
  2. SEBI (Securities and Exchange Board of India):

    • The regulatory authority overseeing IPOs, ensuring compliance with guidelines and safeguarding investor interests.
  3. Underwriters and Book Running Lead Managers (BRLMs):

    • Financial institutions facilitating the IPO process, managing the issue, and determining the offer price.
  4. Stock Exchanges (e.g., BSE and NSE):

    • Platforms where the company’s shares are listed and traded after the IPO.
  5. Investors:

    • Individual and institutional investors participating in the IPO to acquire shares of the company.

Types of IPO

There are two common types of IPO. They are-

1) Fixed Price Offering

Fixed Price IPO can be referred to as the issue price that some companies set for the initial sale of their shares. The investors come to know about the price of the stocks that the company decides to make public. 

The demand for the stocks in the market can be known once the issue is closed. If the investors partake in this IPO, they must ensure that they pay the full price of the shares when making the application.  

2) Book Building Offering

In the case of book building,  the company initiating an IPO offers a 20% price band on the stocks to the investors. Interested investors bid on the shares before the final price is decided. Here, the investors need to specify the number of shares they intend to buy and the amount they are willing to pay per share. 

The lowest share price is referred to as floor price and the highest stock price is known as cap price. The ultimate decision regarding the price of the shares is determined by investors’ bids.

Why Companies needs IPO

Companies pursue Initial Public Offerings (IPOs) for reasons such as:

  1. Capital Raise: IPOs enable companies to raise funds for expansion, debt repayment, or strategic initiatives.

  2. Market Valuation: Establishing a market value for the company’s shares based on investor demand.

  3. Liquidity for Shareholders: Providing liquidity for existing shareholders, including founders and early investors.

  4. Currency for Acquisitions: Using shares as currency for mergers and acquisitions.

  5. Enhanced Visibility: Increasing visibility, credibility, and attractiveness to customers and employees.

  6. Employee Benefits: Offering stock options and equity-based benefits to attract and retain talent.

  7. Access to Public Markets: Maintaining ongoing access to public markets for future capital needs.

  8. Diversification of Ownership: Broadening ownership and reducing dependence on a small group of private investors.

Regulations of IPOs

Initial Public Offerings (IPOs) are regulated by various financial authorities to ensure transparency, fairness, and investor protection. In the context of India, the regulatory framework for IPOs is overseen by the Securities and Exchange Board of India (SEBI). Here are key regulations governing IPOs:

  1. SEBI Guidelines:

    • SEBI issues comprehensive guidelines that outline the process and requirements for companies planning to go public. These guidelines cover aspects such as eligibility criteria, disclosures, and the role of intermediaries.
  2. Eligibility Criteria:

    • SEBI sets specific eligibility criteria that companies must meet to undertake an IPO. This includes financial stability, profitability track record, and compliance with regulatory norms.
  3. Drafting of Offer Document:

    • Companies planning an IPO must prepare a Draft Red Herring Prospectus (DRHP), a detailed document containing information about the company, its financials, and the proposed use of funds. This document is scrutinized by SEBI for accuracy and completeness.
  4. SEBI Approval:

    • The DRHP is submitted to SEBI for approval. SEBI reviews the document and provides necessary feedback. Once satisfied, SEBI grants its approval for the IPO.
  5. Pricing Mechanism:

    • SEBI regulates the pricing mechanism for IPOs, ensuring that it is fair and transparent. The pricing can be determined through methods like book building or fixed price, with SEBI overseeing the process.
  6. Role of Intermediaries:

    • SEBI regulates various intermediaries involved in the IPO process, including merchant bankers, underwriters, and registrars. These entities must adhere to SEBI’s guidelines and codes of conduct.
  7. Market Conduct:

    • SEBI establishes rules to prevent market manipulation and insider trading during the IPO period. Stringent measures are in place to maintain the integrity of the IPO process.
  8. Listing Requirements:

    • Stock exchanges, under the purview of SEBI, have specific listing requirements that companies must meet to be listed on the exchange post-IPO. This includes corporate governance standards and ongoing disclosure obligations.
  9. Investor Protection:

    • SEBI places a strong emphasis on protecting the interests of investors. The regulator ensures that companies provide accurate and complete information in the offer document, enabling investors to make informed decisions.
  10. Continuous Disclosure:

    • Companies listed after an IPO must adhere to continuous disclosure requirements. This includes regular financial reporting, updates on material events, and compliance with corporate governance norms.

Eligibilty norms for making an IPO

  1. Profitability Track Record:

    • The company must have a positive consolidated profit after tax in at least three of the immediately preceding five years. Alternatively, it should have a positive cash accrual in at least three of the immediately preceding five years.
  2. Net Worth:

    • The minimum net worth for the last 3 years should be positive.
  3. Positive Cash Accruals:

    • The company must have positive cash accruals from operations in at least three out of the immediately preceding 5 years.
  4. Net Tangible Assets:

    • The net tangible assets of the company should be positive, as per the latest audited financial statements.
  5. Minimum Issue Size:

    • The minimum issue size for the IPO should be in accordance with the regulations, and the post-issue paid-up capital should be at least ₹10 crores.
  6. Promoter’s Contribution:

    • The promoters are required to contribute at least 20% of the post-issue capital.
  7. No Default:

    • The company, its promoters, and group companies should not have any defaults in payment of interest and principal to debenture or statutory dues to any statutory authority.
  8. Regulatory Compliance:

    • The company must be in compliance with SEBI regulations and other applicable laws.
  9. Utilization of Funds:

    • The company should disclose the specific purposes for which it intends to use the funds raised through the IPO.
  10. Appointment of Intermediaries:

    • The company needs to appoint SEBI-registered intermediaries, such as merchant bankers, registrars, and others, for the IPO process.
  11. Lock-in Requirements:

    • Promoters’ contribution and pre-issue capital will be subject to a lock-in period.

Exceptions from Eligibilty Norms

Certain categories may be eligible for exceptions to standard IPO eligibility norms in India:

  1. Startups and Innovators:

    • Innovators Growth Platform (IGP) offers tailored norms for startups.
  2. Sector-Specific Relaxations:

    • Certain industries may receive relaxations to encourage listings.
  3. Companies in CIRP:

    • Firms undergoing insolvency resolution may get specific relaxations.
  4. DVR Issuers:

    • Companies with Differential Voting Rights may have different eligibility criteria.
  5. ITP-Listed Companies:

    • Companies listed on Institutional Trading Platforms may have eased norms when moving to the main board.
  6. SMEs:

    • SMEs listing on SME Exchanges have separate, often more lenient, eligibility criteria.

While these categories may have relaxed norms, regulatory authorities maintain basic investor protection and market integrity principles. Companies should review specific SEBI guidelines for their eligibility criteria.

Terms Associated with IPO

  1. Issuer:

    • The company going public and offering its shares to the public for the first time.
  2. Underwriter:

    • Financial institutions responsible for assessing the company’s value and facilitating the IPO process.
  3. Fixed Price IPOs:

    • IPOs where the offer price is predetermined and disclosed in advance.
  4. Price Band:

    • A range within which investors bid for shares during the book-building process.
  5. DRHP (Draft Red Herring Prospectus):

    • The preliminary prospectus filed with regulatory authorities before the IPO, excluding the offer price.
  6. Under Subscription:

    • When the demand for shares in an IPO is less than the number of shares offered.
  7. Over Subscription:

    • When the demand for shares in an IPO exceeds the number of shares offered.
  8. Green Shoe Option:

    • An option allowing underwriters to issue additional shares in case of oversubscription.
  9. Book Building:

    • A price discovery method where the offer price is determined based on investor demand during the bidding process.
  10. Flipping:

    • The practice of selling allocated IPO shares shortly after the stock is listed to take advantage of immediate price gains.

Benefits of IPO

  1. Capital Infusion for Growth.
  2. Liquidity for Existing Shareholders.
  3. Establishment of Market Valuation.
  4. Employee Incentives through ESOPs.
  5. Enhanced Ability for Mergers and Acquisitions.
  6. Increased Visibility and Credibility.

Disadvantages of IPO

  1. High Costs and Complexity.
  2. Exposure to Market Pressures and Volatility.
  3. Dilution of Ownership and Control.
  4. Extensive Disclosure Requirements.
  5. Vulnerability to Market Fluctuations.
  6. Short-Term Focus on Quarterly Expectations.
  7. Ongoing Regulatory Compliance Obligations.
  8. Legal Risks, including Potential Lawsuits.
  9. Time-Consuming Process.
  10. Impact on Market Perception and Reputation.

While an Initial Public Offering (IPO) opens doors to capital and visibility, companies must carefully balance the benefits with the complexities. Strategic planning and a commitment to transparency are key to navigating the challenges and ensuring sustained success in the public markets.

G Akshay Associates