Quick-Serve Blog

Many times we come across some blog, information or news about new IPO and urging people to go for it. A number of investors, especially, beginners do not know What is an IPO at all? what are the benefits or demerits of going for IPOs. What are the term used? They want to know about listing process, book building process etc. Here we tried to put all this information in questions and answers form. Hope it comes out to be useful for all.

An IPO is defined as an exercise when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public.

The exercise refers the issue of shares to the public by the promoters of the company. The shares are made available to the investors at the face value of the share or with a premium as per the perceived market value of the share by the promoters.

The IPO can be in the form of a fixed price portion or in the form of a book building portion. The IPO paves way for listing and trading of the issuer’s securities.

2 What are primary/secondary market transactions?

Primary market transaction is usually referred to the purchase of shares in an IPO. The purchases are made through applications for the shares on a prescribed form. Once the shares are allotted, the share transactions are carried out in secondary market or stock exchanges.

Secondary market transactions refer to those transactions under which an investor purchases shares from another investor at the prevailing market price or at whatever price the buyer and seller agrees upon.

The primary and secondary markets are governed by a regulatory authority Security and Exchange Board of India (SEBI).

3 What are eligibility norms for making an IPO?

SEBI has laid down eligibility norms for entities planning to enter the primary market through public issues. An unlisted company needs to satisfy following criteria to be eligible for making a public issue:

• Net tangible assets of at least Rs 3 crore for three full years
• Distributable profits in at least three years
• Net worth of at least Rs 1 crore in three years
• If change in name, at least 50 per cent of revenue for preceding one year should be from the new activity
• The issue size should not exceed five times the pre-issue net worth

SEBI also provides alternate routes to the companies not satisfying any of the above parameters, for accessing the primary market.

The alternative conditions are as follows:

• Issue shall be made through book-building route, with at least 50 per cent to be mandatory allotted to the QIBs.
• The minimum post-issue face value capital shall be Rs 10 crore or there shall be a compulsory market-making for at least two years.

4 How can one apply for an IPO?

An investor needs to first obtain an IPO application form through a share broker, an investment consultant or from the collecting banks. The investors are required to fill up the form and remit the amount after calculating the number of shares applied for in the bank, which has been designated as a collecting centre for the particular IPO.

An investor holding a demat account can either apply for the shares directly through the account or can opt for physical delivery of share certificates. There are certain IPOs, which offer only demat form of shares, while others offer both the demat and regular shares. Application forms can be rejected due to incomplete details.

Every week SEBI issues press releases for information of the public, details of offer documents filed with SEBI and observations issued. The required details can be obtained from the ‘Primary Market’ section of the SEBI website. The draft offer document can also be purchased from the SEBI office. The draft offer document/letter of offer remains posted on SEBI website for a period of 21 days from the date of filing the same to SEBI and can also be downloaded from there.

Application forms can also be obtained from the lead manager and brokers to the issue. The application forms are also generally available at collecting bankers. Name and addresses of the lead manager are available in the prospectus/letter of offer.

5 What is book-building process?

SEBI guidelines defines book building as “a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for the securities is assessed on the basis of the bids obtained for the quantum of securities offered for subscription by the issuer”.

This process provides an opportunity to the market to discover price for the securities on offer. In common words, book building is a method for public offer of equity shares of a company. The process is named so because it refers to collection of bids from investors, which is based on a price range. The issue price is fixed after the closing date of the bid.

A company planning an IPO appoints a merchant bank as a book runner. Then the company issues a prospectus that does not mention the price, but provides other details related to the issue size, the company’s operating area and business, the promoters and future plans among other disclosures.
A particular time frame is also fixed as the bidding period. Then the book runner builds an order book that collates bids from various investors. Potential investors are allowed to revise their bids at any time during the bidding period.

At the end of bidding period the order book is closed and consequently the quantum of shares ordered and the respective prices offered are known. The calculation of final price is based on demand at various prices and also involves negotiations between those involved in the issue.

The book runner and the company finalise the pricing and allocation to each syndicate member.

6 What is the main difference between a book-building route and the normal public issue?

Unlike the book-building route, the price is known in advance to investors in case of offer of shares through normal public issue. On the other hand, the demand can be known everyday as the book is built in case of book building, which demand is not known until the close of the issue in case of the normal public issue.

7 What is the minimum number of days for which a bid should remain open in book building?

Book should remain open for a minimum of five days.

8 Can open outcry system be used for book building?

No. As per SEBI, only electronically linked transparent facility is allowed to be used in case of book building.

9 Is the issue price for placement portion and net offer to public the same?

Yes.

10 What is the floor price in case of book building?

Floor price is the minimum price at which bids can be made. The issuer company in consultation with the book-running lead manager fixes the floor price.

11 Can the individual investor use book building facility for making an application?

Yes.

 

13 What proof can a bidder request from a trading member for entering bids?

A bidder can request for a transaction registration slip as proof of his/her having entered the bid. Whenever a bid is entered by trading members into the system, a unique transaction registration slip is automatically generated. Transaction registration slip gives details regarding number of shares bid for, price, the client name among other details.

14 Is it possible to enter bids less than floor price?

No. The system automatically rejects the bids if price is less than floor price.

15 Are there any restrictions on pricing by companies?

The companies can freely price their equity shares. However they have to give justification of the price in the offer document.

16 Who are syndicate members?

Syndicate members are the intermediaries registered with the board and permitted to carry on activity as underwriters. The book-running lead managers to the issue appoint the syndicate members.

17 What is an order book?

It is an ‘electronic book’ that shows the demand for the shares of the company at various prices.

18 What is a red herring prospectus?

A red herring prospectus (RHP) is a preliminary registration statement that must be filed with the regulatory authority describing the IPO and the prospects of the issuing company. There is no price or issue size stated in the red herring, and it is sometimes updated several times before being called the final prospectus.

It is known as a red herring because it contains a passage in red that states the company is not attempting to sell their shares before the registration is approved by the regulatory authority.

19 What is the difference between an offer document, an RHP, a prospectus and an abridged prospectus? What is a “draft offer doc”?

“Offer document” means a prospectus in the case of a public issue or offer for sale which is filed with Registrar of Companies (RoC) and the stock exchanges. An offer document covers all the relevant information required to help an investor to make his/her investment decision.

“Draft offer document” refers to an offer document in a draft stage. The draft offer documents are filed with SEBI at least 21 days prior to the filing of the offer document with the registrar and the exchanges. SEBI may specify necessary changes in the draft offer document and the issuer or the lead merchant banker is required to implement changes in the draft offer document before filing the offer document. The draft offer document is available on the SEBI website for public comments for a period of 21 days from the filing of the draft offer document with SEBI.

A red herring prospectus does not have details of either price or the number of shares being offered or the amount of issue. However, this prospectus mentions the number of shares and the upper and lower price bands. An issuer can also state that the issue size and the number of shares would be determined later. In case of a book-built issues, RHP is a process of price discovery and the price cannot be determined until the bidding process is completed. Hence, such details are not shown in the RHP filed with the RoC. Only on completion of the bidding process, the details of the final price are included in the offer document.

The offer document filed thereafter with ROC is called a prospectus. “Abridged prospectus” refers to a prospectus that contains all the salient features of a prospectus. It accompanies the application form of public issues.
20 What does one mean by ‘lock-in’?

Lock-in refers to a freeze on the shares. SEBI guidelines have stipulated lock-in requirements on shares of promoters primarily to ensure that the promoters, who are controlling the company, shall continue to hold some minimum percentage in the company after the public issue.

21 Who is a promoter?

The promoter is defined as a person (or persons, as the case may be) who is in over-all control of the company, is instrumental in the formulation of a plan or programme pursuant to which the securities are offered to the public and who is named in the prospectus as promoter. A director/officer of the issuer company or person, if they are acting as such merely in their professional capacity are not be included in the definition of a promoter.

‘Promoter group’ includes the promoter, an immediate relative of the promoter (i.e. spouse of that person, or any parent, brother, sister or child of the person or of the spouse).

In case the promoter is a company, a subsidiary or holding company of that company; any company in which the promoter holds 10 per cent or more of the equity capital or which holds 10 per cent or more of the equity capital of the promoter; any company in which a group of individuals or companies or combinations thereof who holds 20 per cent or more of the equity capital in that company also holds 20 per cent or more of the equity capital of the issuer company.

22 What are the requirements regarding promoter’s contribution and lock-in?

In case of an IPO, the promoters have to necessarily offer at least 20 per cent of the post issue capital. In case of public issues by listed companies, the promoters shall participate either to the extent of 20 per cent of the proposed issue or ensure post-issue share holding to the extent of 20 per cent of the post-issue capital.

In case of any issue of capital to the public the minimum contribution of promoters shall be locked in for a period of three years, both for an IPO and public issue by listed companies. In case of an IPO, if the promoters’ contribution in the proposed issue exceeds the required minimum contribution, such excess contribution shall also be locked in for a period of one year. In addition, the entire pre-issue share capital, or paid up share capital prior to IPO, and shares issued on a firm allotment basis along with issue shall be locked-in for a period of one year from the date of allotment in public issue.

23 What is the basis of allotment?

In case of over-subscription in a fixed price issue, the allotment is done in marketable lots and on a proportionate basis. In case of a book building issue, allotment to Qualified Institutional Buyers (QIBs) and Non-Institutional Buyers (NIBs) are done on a discretionary basis. Allotment to retail investors is done on a proportionate basis.

After the closure of the issue, the bids received are aggregated under different categories, such as firm allotment, Qualified Institutional Buyers (QIBs), Non-Institutional Buyers (NIBs) and Retail Individual Investors. The oversubscription ratios are calculated for each of the categories as against the shares reserved for each of the categories in the offer document. Within each of these categories, the bids are segregated into different segments based on the number of shares applied for.

The oversubscription ratio is then applied to the number of shares applied for and the number of shares to be allotted for applicants in each of the buckets is determined. Then, the number of successful allottees is determined. This process is followed in case of proportionate allotment. In case of allotment for QIBs, it is subject to the discretion of the post issue lead manager.

24 Can the public give their comments/complaints on the issuer company or others connected with the issue?

Yes, the objective of making offer document public is to invite public comments. The comments should be given within 21 days of the filing of the draft offer document with SEBI.

25 Within how many days should an investor receive the refund order/allotment advise?

The investor is entitled to receive a confirmatory allotment note (CAN) in case he has been allotted shares within 15 days from the date of closure of a book-built issue. The registrar has to ensure that the demat credit or refund as applicable is completed within 15 days of the closure of the book built issue.

The refund orders/allotment advice is to be despatched within two working days of finalising the basis of allotment. Companies are required to finalise the basis of allotment within 30 days from the closure of the issue in case of a fixed price issue and within 15 days from the closure of the issue in case of a book building issue or else they are liable to pay interest at the rate of 15 per cent per annum

26 In case of non-receipt of the refund order/share certificate/allotment advise, what is the course of action available to the investor?

The investor should complain in writing to the lead manger/registrar/SEBI’s Investor Grievance Cell.

27 Within how many days should the company get its securities listed after the issue?

The post-issue lead manager ensures that all steps for completion of the necessary formalities for listing and commencement of trading at all stock exchanges where the securities are to be listed are taken within 7 working days of finalisation of basis of allotment.

28 Is it mandatory to have a demat account for applying in public issue?

An investor has the option to apply for and receive the shares in physical form. However, it is advisable to get the allotment in demat form as the shares in IPO shall be compulsorily tradable in demat segment in stock exchanges. In case of an IPO of any security of issue size of Rs 10 crore or more, security shall be issued only in dematerialised form.

In book built issues, for QIBs and large investors (applying for more than 1,000 shares) allotment shall be only in demat form and hence they should have a demat account.

29 What are greenshoe option and safety net?

Greenshoe is an option that allows the underwriting syndicate of an IPO to sell additional shares to public if the demand is high.

The name comes from the fact that Green Shoe Company was the first to issue this type of option.

A safety net means investors who subscribe to the IPO of a company can sell those shares to the entity offering safety net at the IPO price. Safety net is actually a put option given to the investors, but not by the company issuing the shares. A put option gives the right but not the obligation to the investors to sell the stock to the entity offering the option at a particular price before a certain period.

Any safety net scheme or buy-back arrangements of the shares proposed in any public issue shall be finalised by the issuer company with the lead merchant banker in advance and should be disclosed in the prospectus.

30 What are fixed price offers?

An issuer company is allowed to freely price the issue. The basis of issue price is disclosed in the offer document where the issuer discloses in detail about the qualitative and quantitative factors justifying the issue price. The issuer company can mention a price band of 20 per cent (cap in the price band should not be more than 20 per cent of the floor price) in the draft offer documents filed with SEBI and actual price can be determined at a later date before filing of the final offer document with SEBI/RoCs.

31 What is a price band?

The RHP may contain either the floor price for the securities or a price band within which the investors can bid. The spread between the floor and the cap of the price band shall not be more than 20 per cent. The price band can be revised also and any such revision is required to be widely disseminated by informing the stock exchanges, by issuing press release and also indicating the change on the relevant website and the terminals of the syndicate members.

In case the price band is revised, the bidding period shall be extended for additional three days, subject to the total bidding period not exceeding thirteen days.

32 Who decides the price band?

The regulators do not play a role in setting the price for issues. The company decides the price or the price band in consultation with merchant bankers. The basis of issue price is disclosed in the offer document. The issuer is required to disclose in detail about the qualitative and quantitative factors justifying the issue price.

33 What is firm allotment?

A company making an issue to public is eligible to reserve some shares on ‘allotment on firm basis’ for certain categories. The shares to be allotted on ‘firm allotment category’ can be issued at a price different from the price at which the net offer to the public is made, provided that the price at which the security is being offered to the applicants in firm allotment category is higher than the price at which securities are offered to public.

34 What is reservation on competitive basis?

Reservation on competitive basis refers to allotment of shares made in proportion to the shares applied for by the concerned reserved categories. Reservation on competitive basis can be made in a public issue to the employees of the company, shareholders of the promoter companies in the case of a new company and shareholders of group companies in the case of an existing company, Indian mutual funds, foreign institutional investors (FIIs), Indian and multilateral development institutions and scheduled banks.

In a book built issue allocation to Retail Individual Investors (RIIs), Non Institutional Investors (NIIs) and Qualified Institutional Buyers (QIBs) is in the ratio of 35: 15: 50 respectively.

35 Is there any preference while doing the allotment?

The allotment to the Qualified Institutional Buyers (QIBs) is made on a discretionary basis. The discretion is left to the merchant bankers who first disclose the parameters of judgment in the Red Herring Prospectus. The merchant bankers are free to set their criteria and mention the same in the Red Herring Prospectus.

36 How is the Retail Investor defined as?

Retail individual investor refers to an investor who applies or bids for securities of or for a value of not more than Rs.1,00,000.

37 What is an e-IPO?

A company can also issue capital to public through the online system of the stock exchange. The appointment of various intermediaries by the issuer includes a prerequisite that such members/registrars have the required facilities to accommodate such an online issue process.

38 What is open book/closed book?

In book-built issues issuers and merchant bankers are required to ensure online display of the demand and bids during the bidding period. This is known as open book system of book building. Under closed book building, the book is not made public and the bidders will have to take a call on the price at which they intend to make a bid without having any information on the bids submitted by other bidders.

39 What is hard/soft underwriting?

Hard underwriting refers to an exercise when an underwriter agrees to buy his commitment at its earliest stage. The underwriter guarantees a fixed amount to the issuer from the issue. If the shares are not subscribed by investors, the issue is devolved on underwriters and they have to bring in the amount by subscribing to the shares.

Soft underwriting refers to a process when an underwriter agrees to buy the shares at later stages as soon as the pricing process is complete. Subsequently, he places those shares with institutional players. The soft underwriter also holds an option to invoke a force majeure (acts of God) clause in case there are certain factors beyond the control that can affect the underwriter’s ability to place the shares with the buyers.

40 What is a cut-off price?

In book-building issues, the issuer is required to indicate either the price band or a floor price in the Red Herring Prospectus. The actual issue price can be any price in the price band or any price above the floor price. This issue price is called “Cut off price”. This is decided by the issuer and lead managers after considering the book and investor demand for the stock.

41 What is differential pricing?

Pricing of an issue where one category is offered shares at a price different from the other category is called differential pricing. According to regulatory guidelines, differential pricing is allowed only if the securities to applicants in the firm allotment category are offered at a price higher than the price at which the net offer to the public is made.

42 Who is qualified institutional buyer (QIBs)?

QIBs are those institutional investors who are perceived to possess expertise and the financial strength to evaluate and invest in the capital markets. A QIB is defined as

• Public financial institution as defined in section 4A of The Companies Act, 1956;
• Scheduled commercial banks;
• Mutual funds;
• Foreign institutional investor registered with SEBI;
• Multilateral and bilateral development financial institutions;
• Venture capital funds registered with SEBI.
• Foreign venture capital investors registered with SEBI.
• State Industrial Development Corporations.
• Insurance companies registered with the Insurance Regulatory and Development Authority (IRDA).
• Provident Funds with minimum corpus of Rs 25 crores
• Pension Funds with minimum corpus of Rs 25 crores

43 Why go public?

Usually it is not possible to buy shares in a private company. A potential investor can approach the owners, but they’re not obliged to sell any shares. However, public companies sell at least a portion of themselves to the public and they also trade on stock exchanges.

Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of director and they must report financial information every quarter. Public companies are regulated by governing bodies. The stock is traded in the open market and any investor, who has got money, can invest in them. The CEO and the owner can not prevent an investor from buying stock.

Going public provides an opportunity to raise cash for the companies, while opening many financial doors as well. Public companies can get better rates when they issue debts because of the increased scrutiny involved. A public company can always issue more stock, as long as there is market demand. Consequently, mergers and acquisitions become easier to execute as stock can be issued as part of the deal.

(Source:-Economic Times)