Companies fall into two broad categories: private and public.
What is an Initial Public Offering (IPO)?
An initial public offering (IPO) or stock market launch is the first sale that a previously private company can sell its shares to “the general public” ( mostly institutional investors at first).
A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it's known as an IPO.
It is a type of public offering. As the result of an initial public offering, a private company turns into a public company. The process is used by either small or large companies to raise expansion capital and become publicly traded enterprises. Many companies that undertake an IPO also request the assistance of an investment banking firm acting in the capacity of an underwriter to help them correctly assess the value of their shares, that is, the share price.
Usually the company issues around 20-30% of its shares (free float), though this varies by industry, company stage, and so on.
Most investors consider it riskier if the company only makes available a low number of shares – but if the company is “hot” enough (see: Facebook, with its 11% offering) they’ll overlook this and dive in head-over-heels anyway.
A privately held company has fewer shareholders and its owners don't have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your jurisdiction. Most small businesses are privately held.
But large companies can be private too. Did you know that IKEA, Domino's Pizza and Hallmark Cards are all privately held? It usually isn't possible to buy shares in a private company. You can approach the owners about investing, but they're not obligated to sell you anything.
Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. This is why doing an IPO is also referred to as "going public."
Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. In the United States, public companies report to the Securities and Exchange Commission (SEC). In other countries, public companies are overseen by governing bodies similar to the SEC( SEBI in India ).
From an investor's standpoint, the most exciting thing about a public company is that the stock is traded in the open market, like any other commodity. If you have the cash, you can invest. The CEO could hate your guts, but there's nothing he or she could do to stop you from buying stock.
We have seen the difference between the Private and Public Limited companies. Public limited company if listed in stock market, the common public can buy or sell those stocks. But private limited companies cannot be listed in stock market.
But private limited company can change to Public limited company. After that it can sell those stocks in stock market for the first time. In this manner the first time selling the stocks to general public is called Initial Public Offer (I.P.O.)
Since many Organizations for the first time paving a way to get stocks for others it can also be called as Primary Market.
After occurrence of Initial Public Offer, the stocks may be traded widely. All type of people can become Owners. These owners (stock holders) can sell their stocks in stock market. Some people may also be found there. It is called as Secondary Market.
In Primary market we buy the stocks from Company,
In Secondary market we buy the stocks from persons like some other people.
An Organizations stocks ( sometimes even Debt Instruments ) in different forms, different stages, different forms of investors, sold is called issue. Public Issues are offered for all types of people. IPO is classified as the first type of Public Issue.
Why Go Public?
Going public raises cash, and usually a lot of it. Being publicly traded also opens many financial doors. Because of the increased scrutiny, public companies can usually get better rates when they issue debt.
As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.
You probably associate IPOs with tech, healthcare, or biotech start-ups, but they apply to a much wider range of companies than that.
You see everything from mature business service companies to energy firms to transportation firms going public, but they get far less attention than hot tech start-ups (see Renaissance Capital for updated lists ).
Being on a major stock exchange carries a considerable amount of prestige. In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn't easy to get listed.
The internet boom changed all this. Firms no longer needed strong financials and a solid history to go public. Instead, IPOs were done by smaller startups seeking to expand their businesses. There's nothing wrong with wanting to expand, but most of these firms had never made a profit and didn't plan on being profitable any time soon.
Founded on venture capital funding, they spent like Texans trying to generate enough excitement to make it to the market before burning through all their cash. In cases like this, companies might be suspected of doing an IPO just to make the founders rich. This is known as an exit strategy, implying that there's no desire to stick around and create value for shareholders. The IPO then becomes the end of the road rather than the beginning.
How can this happen?
Remember: an IPO is just selling stock. It's all about the sales job. If you can convince people to buy stock in your company, you can raise a lot of money.
So, what is an IPO anyway?
How did everybody get so rich so fast?
And, most importantly, is it possible for mere mortals like us to get in on an IPO?
It is a type of public offering. As the result of an initial public offering, a private company turns into a public company. The process is used by either small or large companies to raise expansion capital and become publicly traded enterprises. Many companies that undertake an IPO also request the assistance of an investment banking firm acting in the capacity of an underwriter to help them correctly assess the value of their shares, that is, the share price.
Usually the company issues around 20-30% of its shares (free float), though this varies by industry, company stage, and so on.
Most investors consider it riskier if the company only makes available a low number of shares – but if the company is “hot” enough (see: Facebook, with its 11% offering) they’ll overlook this and dive in head-over-heels anyway.
A privately held company has fewer shareholders and its owners don't have to disclose much information about the company. Anybody can go out and incorporate a company: just put in some money, file the right legal documents and follow the reporting rules of your jurisdiction. Most small businesses are privately held.
But large companies can be private too. Did you know that IKEA, Domino's Pizza and Hallmark Cards are all privately held? It usually isn't possible to buy shares in a private company. You can approach the owners about investing, but they're not obligated to sell you anything.
Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. This is why doing an IPO is also referred to as "going public."
Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. In the United States, public companies report to the Securities and Exchange Commission (SEC). In other countries, public companies are overseen by governing bodies similar to the SEC( SEBI in India ).
From an investor's standpoint, the most exciting thing about a public company is that the stock is traded in the open market, like any other commodity. If you have the cash, you can invest. The CEO could hate your guts, but there's nothing he or she could do to stop you from buying stock.
We have seen the difference between the Private and Public Limited companies. Public limited company if listed in stock market, the common public can buy or sell those stocks. But private limited companies cannot be listed in stock market.
But private limited company can change to Public limited company. After that it can sell those stocks in stock market for the first time. In this manner the first time selling the stocks to general public is called Initial Public Offer (I.P.O.)
Since many Organizations for the first time paving a way to get stocks for others it can also be called as Primary Market.
After occurrence of Initial Public Offer, the stocks may be traded widely. All type of people can become Owners. These owners (stock holders) can sell their stocks in stock market. Some people may also be found there. It is called as Secondary Market.
In Primary market we buy the stocks from Company,
In Secondary market we buy the stocks from persons like some other people.
An Organizations stocks ( sometimes even Debt Instruments ) in different forms, different stages, different forms of investors, sold is called issue. Public Issues are offered for all types of people. IPO is classified as the first type of Public Issue.
Why Go Public?
Going public raises cash, and usually a lot of it. Being publicly traded also opens many financial doors. Because of the increased scrutiny, public companies can usually get better rates when they issue debt.
As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.
You probably associate IPOs with tech, healthcare, or biotech start-ups, but they apply to a much wider range of companies than that.
You see everything from mature business service companies to energy firms to transportation firms going public, but they get far less attention than hot tech start-ups (see Renaissance Capital for updated lists ).
Being on a major stock exchange carries a considerable amount of prestige. In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn't easy to get listed.
The internet boom changed all this. Firms no longer needed strong financials and a solid history to go public. Instead, IPOs were done by smaller startups seeking to expand their businesses. There's nothing wrong with wanting to expand, but most of these firms had never made a profit and didn't plan on being profitable any time soon.
Founded on venture capital funding, they spent like Texans trying to generate enough excitement to make it to the market before burning through all their cash. In cases like this, companies might be suspected of doing an IPO just to make the founders rich. This is known as an exit strategy, implying that there's no desire to stick around and create value for shareholders. The IPO then becomes the end of the road rather than the beginning.
How can this happen?
Remember: an IPO is just selling stock. It's all about the sales job. If you can convince people to buy stock in your company, you can raise a lot of money.
So, what is an IPO anyway?
How did everybody get so rich so fast?
And, most importantly, is it possible for mere mortals like us to get in on an IPO?
Most companies go public to: # Raise capital for expansion efforts or to pay back debt.
# Provide an exit for existing investors – whether the company is PE-owned,
VC- backed, or owned by a small group of individuals or a single person.
# Get an acquisition currency – most private companies’ stock is not highly valued,
so it is much easier to acquire other companies using stock once they’re public.
And raising debt to do deals can be easier once you’re public as well.
# Reward employees – Making employees work crazy hours for 5-10 years is
tough to pull off, but the lure of an IPO that will make them all wealthy is a great
incentive for them to stick around.
# Market themselves – Especially for lesser-known companies in “boring”
industries, an IPO is a great way to increase prestige and attract new investors,
partners, and customers.
And sometimes there are technical reasons as well: in the US, for example, the “500 shareholder rule” used to require any private companies with more than 500 shareholders to publicly disclose their financial statements…
So they might as well just go public and get the other benefits – this was one of the key reasons why Google decided to go public in 2004.
Some companies don’t want to go public (or can’t go public) because:
# They have to give up control and answer to shareholders with quarterly earnings
reports.
# They aren’t VC or PE-backed and therefore don’t need an exit.
# They’re already highly profitable and have no need for cash.
# Compliance costs are much higher as a public company due to legislation like
Sarbanes-Oxley.
# They’re too small – it’s tough to go public if you have under $50 million in
revenue.
Who Decides if the Company Should Go Public?
In most cases, it’s up to the Board and major shareholders. So if a private equity firm owns a company and they need to achieve an exit in year 4 or 5 to get acceptable returns, they might push for the company to go public (or get acquired) around then.
And it has traditionally worked the same way with venture capital firms that often end up controlling tech start-ups.
But since Face book’s CEO owns 28% of its stock and 56% of its voting rights, he has significantly more leeway than the usual founder/CEO – and can make decisions on billion-dollar acquisitions in a weekend without even notifying the Board .
Even with that much control, though, he would not be able to initiate something like an IPO without pulling in everyone else – there’s far too much work to do and too many decisions to be made in the process.
Essentials to Offer I.P.O. :-
SEBI Guidelines specify that only the following companies can make an Initial public Issue in India, They are,
1) The company must have net Tangible Assets of at least Rs 3/- Crores in each of the last
3 years.
2) The company must have a minimum net worth of Rs.1 Crore is at least three out of the
immediately preceding 5 years. The company must satisfy this criteria in the
immediately preceding 2 years.
immediately preceding 5 years. The company must satisfy this criteria in the
immediately preceding 2 years.
3) The company must have track record of distributable profits in at least 3 out of the
previous 5 years.
previous 5 years.
4) In case the company has changed its name in the last one year then at least 50% of the
revenue of last year must have come from an activity suggested by the new name and
finally,
revenue of last year must have come from an activity suggested by the new name and
finally,
5) The issue sizes does not exceed 5 times the pre issue net worth of the company.
For an Un-listed Company :-
If not satisfying the above criteria , it can only make a public issue through Book Building
route, provided 50% of the net offer to the public is reserved for qualified Institutional Buyers (QIB) failing which ,the entire issue proceeds are refunded. Secondly the minimum face value of shares after the issue should be at least Rs.10/-Crore. In April-2007, SEBI also made it mandatory that Un-listed Companies get a grading for their IPO’s from a Credit Rating Company.
For a Listed Company :-
They can make a public issue of the issue size is less than 5 times, Its pre-issue net worth.
If the companies name has been changed , then at least 50% of the revenue of last one year must have come from an activity suggested by the new name.
Not satisfying this criterion , then it can make a public issue only through the Book Building route, provided 50% of the net offer to the public is reserved for Qualified Institutional Buyers(QIB) ,failing which, the entire issue proceeds are refunded.
Companies pricing the issue through the Book Building process can either go for the 75% book building route or the 100% book building route. In the former case , the issue price is decided first and then the remaining 25% shares are sold to retail investors at cut off price.
In this case, the Book runner circulates the Draft Prospectus to potential Institutional Buyers, who are eligible for firm Allotment, and other Intermediaries, who are eligible to act as underwriters. The Book runner maintains a book containing details of the investors, the price they are willing to pay and the number of shares they are willing to buy at that price. Based on this, the Book runner, and the issuing company decide the price at which the issue should be made.
In case the company goes for the 100% Book Building route, the final issue price is
determined through the Bid process. The retail investors need not mention the price at which they would make a bid. They can instead bid at the cut off price. All the investors have a right
to revise the Bid price.
There are several benefits to being a public company, namely:
Bolstering and diversifying equity base
Enabling cheaper access to capital
Exposure, prestige and public image
Attracting and retaining better management and employees through liquid equity participation
Facilitating acquisitions
Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
Reasons for listing
For an Un-listed Company :-
If not satisfying the above criteria , it can only make a public issue through Book Building
route, provided 50% of the net offer to the public is reserved for qualified Institutional Buyers (QIB) failing which ,the entire issue proceeds are refunded. Secondly the minimum face value of shares after the issue should be at least Rs.10/-Crore. In April-2007, SEBI also made it mandatory that Un-listed Companies get a grading for their IPO’s from a Credit Rating Company.
For a Listed Company :-
They can make a public issue of the issue size is less than 5 times, Its pre-issue net worth.
If the companies name has been changed , then at least 50% of the revenue of last one year must have come from an activity suggested by the new name.
Not satisfying this criterion , then it can make a public issue only through the Book Building route, provided 50% of the net offer to the public is reserved for Qualified Institutional Buyers(QIB) ,failing which, the entire issue proceeds are refunded.
Companies pricing the issue through the Book Building process can either go for the 75% book building route or the 100% book building route. In the former case , the issue price is decided first and then the remaining 25% shares are sold to retail investors at cut off price.
In this case, the Book runner circulates the Draft Prospectus to potential Institutional Buyers, who are eligible for firm Allotment, and other Intermediaries, who are eligible to act as underwriters. The Book runner maintains a book containing details of the investors, the price they are willing to pay and the number of shares they are willing to buy at that price. Based on this, the Book runner, and the issuing company decide the price at which the issue should be made.
In case the company goes for the 100% Book Building route, the final issue price is
determined through the Bid process. The retail investors need not mention the price at which they would make a bid. They can instead bid at the cut off price. All the investors have a right
to revise the Bid price.
There are several benefits to being a public company, namely:
Bolstering and diversifying equity base
Enabling cheaper access to capital
Exposure, prestige and public image
Attracting and retaining better management and employees through liquid equity participation
Facilitating acquisitions
Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
Reasons for listing
When a company lists its securities on a public exchange, the money paid by investors for the newly issued shares goes directly to the company (in contrast to a later trade of shares on the exchange, where the money passes between investors).
An IPO, therefore, allows a company to tap a wide pool of investors to provide itself with capital for future growth, repayment of debt or working capital. A company selling common shares is never required to repay the capital to investors.
Once a company is listed, it is able to issue additional common shares via a secondary offering, thereby again providing itself with capital for expansion without incurring any debt.
This ability to quickly raise large amounts of capital from the market is a key reason many companies seek to go public.
Procedure
IPOs generally involve one or more investment banks known as "underwriters". The company offering its shares, called the "issuer", enters a contract with a lead underwriter to sell its shares to the public. The underwriter then approaches investors with offers to sell these shares.
The sale (allocation and pricing) of shares in an IPO may take several forms. Common methods include:
Best efforts contract
Firm commitment contract
All-or-none contract
Bought deal
The Prospectus of an IPO contains the following documents namely :-
1.Offer Document
2.Draft offer Document
3.Red Herring Prospectus
4.Abridged Prospectus
5.Letter of Offer
6. Abridged Letter
OFFER DOCUMENT
Offer document means Prospectus in case of a public issue or offer for sale and Letter of offer in case of a rights issue, which is filed with the Registrar of Companies (ROC) and Stock Exchanges. An offer document covers all the relevant information to help an investor to make his/her investment decision.
DRAFT OFFER DOCUMENT
Draft Offer document" means the offer document in draft stage. The draft offer documents are filed with SEBI, at least 21 days prior to the filing of the offer document with ROC/ SEs. SEBI may specifies changes, if any, in the draft offer document and the issuer or the Lead Merchant banker shall carry out such changes in the draft offer document before filing the offer document with ROC/SEs. 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.
RED HERRING PROSPECTUS
It is a document submitted by a company (issuer) who intends on having a public offering of securities (either stocks or bonds). Most frequently associated with an Initial Public Offering (IPO), this registration statement must be filed with the Securities and Exchange Commission(SEC).
"Red-herring prospectus" means a prospectus that does not have complete particulars on the price of the securities offered and quantum of securities offered.
The red herring statement contains:
An IPO, therefore, allows a company to tap a wide pool of investors to provide itself with capital for future growth, repayment of debt or working capital. A company selling common shares is never required to repay the capital to investors.
Once a company is listed, it is able to issue additional common shares via a secondary offering, thereby again providing itself with capital for expansion without incurring any debt.
This ability to quickly raise large amounts of capital from the market is a key reason many companies seek to go public.
Procedure
IPOs generally involve one or more investment banks known as "underwriters". The company offering its shares, called the "issuer", enters a contract with a lead underwriter to sell its shares to the public. The underwriter then approaches investors with offers to sell these shares.
The sale (allocation and pricing) of shares in an IPO may take several forms. Common methods include:
Best efforts contract
Firm commitment contract
All-or-none contract
Bought deal
The Prospectus of an IPO contains the following documents namely :-
1.Offer Document
2.Draft offer Document
3.Red Herring Prospectus
4.Abridged Prospectus
5.Letter of Offer
6. Abridged Letter
OFFER DOCUMENT
Offer document means Prospectus in case of a public issue or offer for sale and Letter of offer in case of a rights issue, which is filed with the Registrar of Companies (ROC) and Stock Exchanges. An offer document covers all the relevant information to help an investor to make his/her investment decision.
DRAFT OFFER DOCUMENT
Draft Offer document" means the offer document in draft stage. The draft offer documents are filed with SEBI, at least 21 days prior to the filing of the offer document with ROC/ SEs. SEBI may specifies changes, if any, in the draft offer document and the issuer or the Lead Merchant banker shall carry out such changes in the draft offer document before filing the offer document with ROC/SEs. 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.
RED HERRING PROSPECTUS
It is a document submitted by a company (issuer) who intends on having a public offering of securities (either stocks or bonds). Most frequently associated with an Initial Public Offering (IPO), this registration statement must be filed with the Securities and Exchange Commission(SEC).
"Red-herring prospectus" means a prospectus that does not have complete particulars on the price of the securities offered and quantum of securities offered.
The red herring statement contains:
# purpose of the issue;
# proposed offering price range;
# disclosure of any option agreement;
# earnings statements for last 3 years, if available;
# names and address of all officers, directors, underwriters and stockholders owning 10% or
more of the current outstanding stock;
# copy of the underwriting agreement;
# legal opinion on the issue;
# copies of the articles of incorporation of the issuer.
ABRIDGED PROSPECTUS
Abridged Prospectus means the memorandum as prescribed in Form 2A under sub-section (3) of section 56 of the Companies Act, 1956. It contains all the salient features of a prospectus. It accompanies the application form of public issues.
WHAT IS A LETTER OF OFFER?
Letter of offer means the offer document prepared by company for its rights issue and which is filed with the Stock Exchanges. The letter of offer contains all the disclosures as required in term of SEBI(DIP) guidelines and enable shareholder in making an informed decision.
WHAT IS AN ABRIDGED LETTER OF OFFER?
Abridged Letter of offer means the abridged version of the letter of offer. Listed company is required to send the abridged letter of offer to each and every shareholder who is eligible for participating in the rights issue along with the application form. A company is also required to send detailed letter of offer upon request by any Shareholder.
I. BOOK BUILDING
Book building is the process of price discovery. That means there is no fixed price for the shares.
Instead, the company issuing the shares comes up with a price band. The lowest price is referred to as the floor and the highest, the cap.
Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band).
The actual price is then discovered based on these bids. To understand the entire book building process, read Want to bid for shares?
It refers to the process of generating, capturing, and recording investor demand for shares during an IPO (or other securities during their issuance process) in order to support efficient price discovery. Usually, the issuer appoints a major investment bank to act as a major securities underwriter or book runner.
The “book” is the off-market collation of investor demand by the book runner and is confidential to the book runner, issuer, and underwriter. Where shares are acquired, or transferred via a book build, the transfer occurs off-market, and the transfer is not guaranteed by an exchange’s clearing house. Where an underwriter has been appointed, the underwriter bears the risk of non-payment by an acquirer or non-delivery by the seller.
Book building is a common practice in developed countries and has recently been making inroads into emerging markets as well. Bids may be submitted on-line, but the book is maintained off-market by the bookrunner and bids are confidential to the bookrunner. The price at which new shares are issued is determined after the book is closed at the discretion of the bookrunner in consultation with the issuer.
Generally, bidding is by invitation only to clients of the bookrunner and, if any, lead manager, or co-manager. Generally, securities laws require additional disclosure requirements to be met if the issue is to be offered to all investors. Consequently, participation in a book build may be limited to certain classes of investors. If retail clients are invited to bid, retail bidders are generally required to bid at the final price, which is unknown at the time of the bid, due to the impracticability of collecting multiple price point bids from each retail client.
Although bidding is by invitation, the issuer and bookrunner retain discretion to give some bidders a greater allocation of their bids than other investors. Typically, large institutional bidders receive preference over smaller retail bidders, by receiving a greater allocation as a proportion of their initial bid. All bookbuilding is conducted ‘off-market’ and most stock exchanges have rules that require that on-market trading be halted during the bookbuilding process.
The key differences between acquiring shares via a bookbuild (conducted off-market) and trading (conducted on-market) are:
1) bids into the book are confidential vs transparent bid and ask prices on a stock exchange;
2) bidding is by invitation only (only clients of the bookrunner and any co-managers may bid);
3) the bookrunner and the issuer determine the price of the shares to be issued and the allocations of shares between bidders in their absolute discretion;
4) all shares are issued or transferred at the same price whereas on-market acquisitions provide for a multiple trading prices.
It is one of the meger process the bookrunner collects bids from investors at various prices, between the floor price and the cap price. Bids can be revised by the bidder before the book closes. The process aims at tapping both wholesale and retail investors.
The final issue price is not determined until the end of the process when the book has closed. After the close of the book building period, the book runner evaluates the collected bids on the basis of certain evaluation criteria and sets the final issue price.
If demand is high enough, the book can be oversubscribed. In these case the greenshoe option is triggered.
Book building is essentially a process used by companies raising capital through public offerings both initial public offers (IPOs) or follow-on public offers (FPOs) to aid price and demand discovery.
It is a mechanism where, 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.
How does Book Building work?
Book building is a process of price discovery. Hence, the Red Herring prospectus does not contain a price. Instead, the red herring prospectus contains either the floor price of the securities offered through it or a price band along with the range within which the bids can move. The applicants bid for the shares quoting the price and the quantity that they would like to bid at. Only the retail investors have the option of bidding at 'cut-off'. After the bidding process is complete, the 'cut-off' price is arrived at on the lines of Dutch auction. The basis of Allotment (Refer Q. 15.j) is then finalized and letters allotment/refund is undertaken. The final prospectus with all the details including the final issue price and the issue size is filed with ROC, thus completing the issue process.
DUTCH AUCTION
A large IPO is usually underwritten by a "syndicate" of investment banks led by one or more major investment banks (lead underwriter). Upon selling the shares, the underwriters keep a commission based on a percentage of the value of the shares sold (called the gross spread). Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the IPO, take the highest commissions—up to 8% in some cases.
Multinational IPOs may have many syndicates to deal with differing legal requirements in both the issuer's domestic market and other regions. For example, an issuer based in the E.U. may be represented by the main selling syndicate in its domestic market, Europe, in addition to separate syndicates or selling groups for US/Canada and for Asia. Usually, the lead underwriter in the main selling group is also the lead bank in the other selling groups.
Because of the wide array of legal requirements and because it is an expensive process, IPOs typically involve one or more law firms with major practices in securities law, such as the Magic Circle firms of London and the white shoe firms of New York City.
Public offerings are sold to both institutional investors and retail clients of underwriters. A licensed securities salesperson ( Registered Representative in the USA and Canada ) selling shares of a public offering to his clients is paid a commission from their dealer rather than their client. In cases where the salesperson is the client's advisor it is notable that the financial incentives of the advisor and client are not aligned.
In the US sales can only be made through a final prospectus cleared by the Securities and Exchange Commission.
Investment dealers will often initiate research coverage on companies so their Corporate Finance departments and retail divisions can attract and market new issues.
The issuer usually allows the underwriters an option to increase the size of the offering by up to 15% under certain circumstance known as the greenshoe or overallotment option.
ii. Allotment
This is the process whereby those who apply are given shares.
According to the book building process, three classes of investors can bid for the shares:
Qualified Institutional Buyers: QIBs include mutual funds and Foreign Institutional Investors. At least 50% of the shares are reserved for this category.
# names and address of all officers, directors, underwriters and stockholders owning 10% or
more of the current outstanding stock;
# copy of the underwriting agreement;
# legal opinion on the issue;
# copies of the articles of incorporation of the issuer.
ABRIDGED PROSPECTUS
Abridged Prospectus means the memorandum as prescribed in Form 2A under sub-section (3) of section 56 of the Companies Act, 1956. It contains all the salient features of a prospectus. It accompanies the application form of public issues.
WHAT IS A LETTER OF OFFER?
Letter of offer means the offer document prepared by company for its rights issue and which is filed with the Stock Exchanges. The letter of offer contains all the disclosures as required in term of SEBI(DIP) guidelines and enable shareholder in making an informed decision.
WHAT IS AN ABRIDGED LETTER OF OFFER?
Abridged Letter of offer means the abridged version of the letter of offer. Listed company is required to send the abridged letter of offer to each and every shareholder who is eligible for participating in the rights issue along with the application form. A company is also required to send detailed letter of offer upon request by any Shareholder.
I. BOOK BUILDING
Book building is the process of price discovery. That means there is no fixed price for the shares.
Instead, the company issuing the shares comes up with a price band. The lowest price is referred to as the floor and the highest, the cap.
Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band).
The actual price is then discovered based on these bids. To understand the entire book building process, read Want to bid for shares?
It refers to the process of generating, capturing, and recording investor demand for shares during an IPO (or other securities during their issuance process) in order to support efficient price discovery. Usually, the issuer appoints a major investment bank to act as a major securities underwriter or book runner.
The “book” is the off-market collation of investor demand by the book runner and is confidential to the book runner, issuer, and underwriter. Where shares are acquired, or transferred via a book build, the transfer occurs off-market, and the transfer is not guaranteed by an exchange’s clearing house. Where an underwriter has been appointed, the underwriter bears the risk of non-payment by an acquirer or non-delivery by the seller.
Book building is a common practice in developed countries and has recently been making inroads into emerging markets as well. Bids may be submitted on-line, but the book is maintained off-market by the bookrunner and bids are confidential to the bookrunner. The price at which new shares are issued is determined after the book is closed at the discretion of the bookrunner in consultation with the issuer.
Generally, bidding is by invitation only to clients of the bookrunner and, if any, lead manager, or co-manager. Generally, securities laws require additional disclosure requirements to be met if the issue is to be offered to all investors. Consequently, participation in a book build may be limited to certain classes of investors. If retail clients are invited to bid, retail bidders are generally required to bid at the final price, which is unknown at the time of the bid, due to the impracticability of collecting multiple price point bids from each retail client.
Although bidding is by invitation, the issuer and bookrunner retain discretion to give some bidders a greater allocation of their bids than other investors. Typically, large institutional bidders receive preference over smaller retail bidders, by receiving a greater allocation as a proportion of their initial bid. All bookbuilding is conducted ‘off-market’ and most stock exchanges have rules that require that on-market trading be halted during the bookbuilding process.
The key differences between acquiring shares via a bookbuild (conducted off-market) and trading (conducted on-market) are:
1) bids into the book are confidential vs transparent bid and ask prices on a stock exchange;
2) bidding is by invitation only (only clients of the bookrunner and any co-managers may bid);
3) the bookrunner and the issuer determine the price of the shares to be issued and the allocations of shares between bidders in their absolute discretion;
4) all shares are issued or transferred at the same price whereas on-market acquisitions provide for a multiple trading prices.
It is one of the meger process the bookrunner collects bids from investors at various prices, between the floor price and the cap price. Bids can be revised by the bidder before the book closes. The process aims at tapping both wholesale and retail investors.
The final issue price is not determined until the end of the process when the book has closed. After the close of the book building period, the book runner evaluates the collected bids on the basis of certain evaluation criteria and sets the final issue price.
If demand is high enough, the book can be oversubscribed. In these case the greenshoe option is triggered.
Book building is essentially a process used by companies raising capital through public offerings both initial public offers (IPOs) or follow-on public offers (FPOs) to aid price and demand discovery.
It is a mechanism where, 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.
How does Book Building work?
Book building is a process of price discovery. Hence, the Red Herring prospectus does not contain a price. Instead, the red herring prospectus contains either the floor price of the securities offered through it or a price band along with the range within which the bids can move. The applicants bid for the shares quoting the price and the quantity that they would like to bid at. Only the retail investors have the option of bidding at 'cut-off'. After the bidding process is complete, the 'cut-off' price is arrived at on the lines of Dutch auction. The basis of Allotment (Refer Q. 15.j) is then finalized and letters allotment/refund is undertaken. The final prospectus with all the details including the final issue price and the issue size is filed with ROC, thus completing the issue process.
DUTCH AUCTION
A large IPO is usually underwritten by a "syndicate" of investment banks led by one or more major investment banks (lead underwriter). Upon selling the shares, the underwriters keep a commission based on a percentage of the value of the shares sold (called the gross spread). Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the IPO, take the highest commissions—up to 8% in some cases.
Multinational IPOs may have many syndicates to deal with differing legal requirements in both the issuer's domestic market and other regions. For example, an issuer based in the E.U. may be represented by the main selling syndicate in its domestic market, Europe, in addition to separate syndicates or selling groups for US/Canada and for Asia. Usually, the lead underwriter in the main selling group is also the lead bank in the other selling groups.
Because of the wide array of legal requirements and because it is an expensive process, IPOs typically involve one or more law firms with major practices in securities law, such as the Magic Circle firms of London and the white shoe firms of New York City.
Public offerings are sold to both institutional investors and retail clients of underwriters. A licensed securities salesperson ( Registered Representative in the USA and Canada ) selling shares of a public offering to his clients is paid a commission from their dealer rather than their client. In cases where the salesperson is the client's advisor it is notable that the financial incentives of the advisor and client are not aligned.
In the US sales can only be made through a final prospectus cleared by the Securities and Exchange Commission.
Investment dealers will often initiate research coverage on companies so their Corporate Finance departments and retail divisions can attract and market new issues.
The issuer usually allows the underwriters an option to increase the size of the offering by up to 15% under certain circumstance known as the greenshoe or overallotment option.
ii. Allotment
This is the process whereby those who apply are given shares.
According to the book building process, three classes of investors can bid for the shares:
Qualified Institutional Buyers: QIBs include mutual funds and Foreign Institutional Investors. At least 50% of the shares are reserved for this category.
Retail investors: Anyone who bids for shares under Rs 50,000 is a retail investor. At least 25% is reserved for this category. The balance bids are offered to high net worth individuals and employees of the company.
The bids are first allotted to the different categories and the over-subscription (more shares applied for than shares available) in each category is determined.
Retail investors and high net worth individuals get allotments on a proportional basis. Assuming you are a retail investor and have applied for 200 shares in the issue, and the issue is over-subscribed five times in the retail category, you qualify to get 40 shares (200 shares/5).
Sometimes, the over-subscription is huge or the issue is priced so high that you can't really bid for too many shares before the Rs 50,000 limit is reached. In such cases, allotments are made on the basis of a lottery.
Say, a retail investor has applied for five shares in an issue, and the retail category has been over-subscribed 10 times. The investor is entitled to half a share.
Since that isn't possible, it may then be decided that every 1 in 2 retail investors will get allotment. The investors are then selected by lottery and the issue allotted on a proportional basis.
That is why there is no way you can be sure of getting an allotment. To understand the entire allotment process, read Want to bid for shares?
iii. Draft Offer Document
Any company making a public issue is required to file its prospectus with the Securities and Exchange Board of India [ Images ], the market regulator.
A prospectus is the document that contains all the information you need about the company.
It will tell you why the company is coming is out with a public issue, its financials and how the issue will be priced.
This is called a Draft Offer Document.
This is first filed with SEBI which may specify changes, if any, to be made.
Once the changes are made, it is filed with the Registrar of Companies or the Stock Exchange.
It must be filed with SEBI at least 21 days before the company files it with the RoC/ Stock Exchange.
During this period, you can check it out on the SEBI web site .
iv. Red Herring Prospectus
This is a prospectus that will have all the information as a draft offer document, except details of the price or number of shares being offered or the amount of issue.
That is because it is used in book building issues only, where the details of the final price are known only after bidding is concluded.
So a Red Herring prospectus is an offer document used only in book building issues. All issues these days are through the book building route.
v. Underwriters
An underwriter to the issue could be a banker, broker, merchant banker (see below) or a financial institution. They give a commitment to underwrite the issue.
Underwriting means they will subscribe to the balance shares if all the shares offered at the IPO are not picked up.
Suppose there is an issue is for Rs 100 crore (Rs 1 billion) and subscriptions are received only for Rs 80 crore (Rs 800 million). It is then left to the underwriters to pick up the balance Rs 20 crore (Rs 200 million).
If underwriters don't pay up, SEBI will cancel their licenses.
vi. Lead Manager
Just because the prospectus has been filed with SEBI, it doesn't mean it recommends the issue or guarantees its contents.
That responsibility rests with the lead managers to the issue, who are supposed to do due diligence on the issue. In plain language that means certifying the issue is in accordance with the regulations, proper disclosures have been made and the facts in the prospectus are correct.
They are also called merchant bankers or investment bankers and are in charge of the issue process. Their functions are:
# To act as intermediaries between the company seeking to raise money and the investors.
They must possess a valid registration from SEBI enabling them to do this job.
# They are responsible for complying with the formalities of an issue, like drawing up the
prospectus and marketing the issue.
# If it is a book building process, the lead manager is also in charge of it. In such a case, they
are also called Book Running Lead Managers.
Post issue activities, like intimation of allotments and refunds, are their responsibility as well.
The actual work of drawing up the list of allottees, crediting the shares to their demat accounts and ensuring refunds is done by the Registrars to the Issue. These are financial institutions appointed to keep a record of the issue and ownership of company shares.
In the case of complaints like non-receipts of shares or refunds, investors must complain to the lead managers, who take up the matter with the registrars.
The names of all the lead managers and the registrar to the issue, with their addresses, phone numbers and e-mail addresses, are displayed prominently on the cover of every prospectus.
On a closing note
Don't forget there are no guarantees in subscribing to IPOs.
The lead manager may have certified the facts as disclosed in the prospectus are right. Prominent financial institutions may agree to underwrite the issue. The issue may end up being oversubscribed.
But the responsibility for investing in an issue rests fairly and squarely on you, the investor.
So make sure you have studied the company and the issue thoroughly before you make the decision to invest.
Auction
A venture capitalist named Bill Hambrecht has attempted to devise a method that can reduce the inefficient process. He devised a way to issue shares through a Dutch auction as an attempt to minimize the extreme underpricing that underwriters were nurturing. Underwriters, however, have not taken to this strategy very well which is understandable given that auctions are threatening large fees otherwise payable.
Though not the first company to use Dutch auction, Google is one established company that went public through the use of auction. Google's share price rose 17% in its first day of trading despite the auction method. Brokers close to the IPO report that the underwriters actively discouraged institutional investors from buying to reduce demand and send the initial price down. The resulting low share price was then used to "illustrate" that auctions generally don't work.
Perception of IPOs can be controversial. For those who view a successful IPO to be one that raises as much money as possible, the IPO was a total failure. For those who view a successful IPO from the kind of investors that eventually gained from the underpricing, the IPO was a complete success. It's important to note that different sets of investors bid in auctions versus the open market—more institutions bid, fewer private individuals bid. Google may be a special case, however, as many individual investors bought the stock based on long-term valuation shortly after it launched its IPO, driving it beyond institutional valuation.
How many days is the issue open?
As per Clause 8.8.1, Subscription list for public issues shall be kept open for at least 3 working days and not more than 10 working days. In case of Book built issues, the minimum and maximum period for which bidding will be open is 3-7 working days extendable by 3 days in case of a revision in the price band. The public issue made by an infrastructure company, satisfying the requirements in Clause 2.4.1 (iii) of Chapter II may be kept open for a maximum period of 21 working days. As per clause 8.8.2., Rights issues shall be kept open for at least 30 days and not more than 60 days.
Pricing of IPO
The underpricing of initial public offerings (IPO) has been well documented in different markets (Ibbotson, 1975; Ritter 1984; Levis, 1990; McGuinness, 1992; Drucker and Puri, 2007). While issuers always try to maximize their issue proceeds, the underpricing of IPOs has constituted a serious anomaly in the literature of financial economics.
Many financial economists have developed different models to explain the underpricing of IPOs. Some of the models explained it as a consequence of deliberate underpricing by issuers or their agents. In general, smaller issues are observed to be underpriced more than large ones (Ritter, 1984; Ritter, 1991; Levis, 1990).
Historically, some of IPOs both globally and in the United States have been underpriced. The effect of "initial underpricing" an IPO is to generate additional interest in the stock when it first becomes publicly traded. Through flipping, this can lead to significant gains for investors who have been allocated shares of the IPO at the offering price.
However, underpricing an IPO results in "money left on the table"—lost capital that could have been raised for the company had the stock been offered at a higher price. One great example of all these factors at play was seen withtheglobe.com IPO which helped fuel the IPO mania of the late 90's internet era. Underwritten byBear Stearns on November 13, 1998, the stock had been priced at $9 per share, and famously jumped 1000% at the opening of trading all the way up to $97, before deflating and closing at $63 after large sell offs from institutions flipping the stock. Although the company did raise about $30 million from the offering it is estimated that with the level of demand for the offering and the volume of trading that took place the company might have left upwards of $200 million on the table.
The danger of overpricing is also an important consideration. If a stock is offered to the public at a higher price than the market will pay, the underwriters may have trouble meeting their commitments to sell shares. Even if they sell all of the issued shares, if the stock falls in value on the first day of trading, it may lose its marketability and hence even more of its value.
Underwriters, therefore, take many factors into consideration when pricing an IPO, and attempt to reach an offering price that is low enough to stimulate interest in the stock, but high enough to raise an adequate amount of capital for the company. The process of determining an optimal price usually involves the underwriters ("syndicate") arranging share purchase commitments from leading institutional investors.
On the other hand, some researchers (e.g. Geoffrey C., and C. Swift, 2009) believe that IPOs are not being under-priced deliberately by issuers and/or underwriters, but the price-rocketing phenomena on issuance days are due to investors' over-reaction (Friesen & Swift, 2009).
Some algorithms to determine underpricing: IPO Underpricing Algorithms
Issue price
A company that is planning an IPO appoints lead managers to help it decide on an appropriate price at which the shares should be issued. There are two ways in which the price of an IPO can be determined: either the company, with the help of its lead managers, fixes a price (fixed price method) or the price is arrived at through the process of book building.
Note: Not all IPOs are eligible for delivery settlement through the DTC system, which would then either require the physical delivery of the stock certificates to the clearing agent bank's custodian, or a delivery versus payment (DVP) arrangement with the selling group brokerage firm.
Types of IPO
There are many types of IPO, illustrating the different management and owner compensation contracts in firms.
The plain vanilla IPO is undertaken by a privately held company, mostly owned by management, who want to secure additional funding and determine the company’s fair market value.
A venture capital-backed IPO refers to a company in which management has sold its shares to one or more groups of private investors in return for funding and advice. This provides an effective incentive scheme for venture capitalists to implement their exit strategy after they have successfully transformed a firm in which they invested so that it is financially viable in the market.
In a reverse-leveraged buyout, the proceeds of the IPO are used to pay off the debt accumulated when a company was privatized after a previous listing on an exchange. This process enables owners who own majority shares to privatize their publicly trading firms, which are undervalued in the market, thus realizing financial gains after the public was informed of the high intrinsic value of the private firm.
A spin-off IPO denotes the process whereby a large company carves out a stand-alone subsidiary and sells it to the public. A spin-off may also offer owners of the parent firm and hedge funds the opportunity to capitalize mispricing in both the subsidiary and parent if the market is not efficient enough. An interesting example in the United States was the spin-off of uBid by Creative Computers in 1998, which enabled arbitragers to capitalize the mispricing between the two listed companies.
The IPO Process
Overview
The first task of management is to select the underwriters who will be responsible for the new issue. This is done roughly three months before the IPO date. The underwriters provide the issuing firm with procedural and financial advice. Later they will buy the stock and then sell it to the public.
The company, with the aid of lawyers, accountants, and underwriters, submits aregistration statement to a regulatory body (such as the Securities and Exchange Commission (SEC) in the United States) for approval of the public offering. The registration statement is a detailed document about the company’s history, business, and future plans. Specifically, the SEC requires information on the details of the company (form S-1), its financial history (form S-2), and expected cash flows (form S-3). The company must be able to back up the information provided to the SEC.
In the United States, about six weeks prior to the IPO issue the SEC reviews and approves the content of the disclosure to the public; this becomes the preliminary prospectus and is also called the “red herring.” In December 2006, the SEC set new rules on what information must be included about a public company’s executive compensation, including the level of executive pay, the benchmark used, and what quantitative or qualitative methods are employed in determining that pay.1 The prospectus is a legal document describing the securities to be offered to participants and buyers. It is advised on and distributed by the underwriters, and provides information such as the types of stock to be issued, biographies of officers and directors with detailed information about their compensation, any litigation in place, and any othermaterial information.
After publication of the prospectus the company, with the help of the underwriting syndicate, prepares for roadshows to meet potential investors—primarily institutional investors in major cities like New York, San Francisco, Boston, Chicago, and Los Angeles. Roadshows may sometimes be arranged for overseas investors. After the SEC approves registration of the IPO, the underwriters and the company will agree on the amount and price of the issue. On the day prior to the IPO issue the exact price of the shares to be issued is announced by the underwriter. After the IPO, the lead underwriter provides stock liquidity and research coverage.
The IPO date is followed by a “lockup” period, the duration of which varies across different issues and markets, but is in the region of 180 days for a typical issue. After this “insiders,” who include the underwriters, are allowed to sell their shares. Insiders may or may not hold on to stock they own, depending on their motives and objectives. However, the lockup period appears to exert no control on those who bought shares at the market-offered IPO price, although there are regulatory restrictions on the types of clients to whom the firm can sell stock.
Selection of Underwriters
The board of a firm planning to launch an IPO will first meet with potential candidates for underwriters among investment banks and then select the lead underwriter. The choice of underwriter is based on criteria that include: a preliminary valuation of the firm based on its financial information; and the characteristics of the underwriter, such as previous IPO experience, strengths and weaknesses, client network, research capabilities, and support for post-IPO issues. Discounted cash flow analysis and earnings multiples (such as theprice/earnings ratio) are typically used to come up with the preliminary value of the company.
Citigroup was ranked first among underwriters in 2007, arranging $617.6 billion of offerings, and JPMorgan Chase was second with $554.1 billion. Deutsche Bank was ranked third and Merrill fourth in underwriting volume.2 Citigroup has been top of the list for the past eight years. As a result of the global recession that began in 2008 the underwriting volume has declined, while fees have increased.
Types of Underwriting
The management of the IPO firm selects the underwriters and decides on the type of underwriting it wants. There are two types of underwriting: firm commitment, and best efforts. If the underwriter enters a firm commitment with the company, the underwriter is confident about the issue and is willing to buy all the shares if there is insufficient demand. In a firm commitment offering, the underwriters will buy the IPO shares at a discount in the range 3.5–7.0% and then sell them on to the public at the full offer price.
In a best efforts case, the investment bank will only do as much as it reasonably can to sell the shares and will return unsold equity to the firm. This practice is common for less liquid securities. However, if there is excess demand, the bank will ask for a “greenshoe” option, allowing it to buy additional stock from the IPO firm. Typically, a lead underwriter asks other investment banks to form an underwriting syndicate to take care of the IPO issue before final approval by the SEC. The syndicate serves to expand the marketing of the company’s stock issue and to reduce the overall risk of the lead bank. The syndicate members are involved in the underwriting either through a commitment to sell the shares or just in marketing of the shares.
Underwriters may face legal consequences if a new issue goes wrong. Therefore, they have to present accurate and fair facts about the firm to investors, because otherwise they may be sued for misrepresentation, or for failing to carry out due diligence. Some underwriters may allocate stocks of popular new issues to their important corporate clients; this is known as “spinning,” and is deemed to be unethical and illegal.
Underwriters charge different spreads, and domestic and overseas spreads may differ. The average underwriting fee (spread) runs between about 3.3% and 7% in the United Kingdom and the United States (Brealey, Myers, and Allen, 2008).
Selection of an Exchange
Different exchanges have different listing requirements. In general, they require minimum levels of pretax income, net tangible assets, and number of stockholders. For example, a New York Stock Exchange listing requires an income of either US$2.5 million before federal income taxes for the most recent year or US$2 million pretax for the each of the preceding two years. The firm must have been profitable in the two years before a listing.
The NASDAQ (National Association of Securities Dealers Automated Quotations), the largest electronic screen-based equity securities trading market in the United States, has lower listing requirements than the NYSE. Other markets, such as the NASDAQ Small Cap Market and the American Stock Exchange, offer even lower listing requirements(www.inc.com/guides/finance/20713.html). Thus, an IPO firm needs to assess its own strengths and weaknesses in order to pick the right exchange on which to list its shares.
A firm also needs to select a trading symbol for use on the exchange. For example, Microsoft trades as MSFT. A fee, which varies for each exchange, has to be paid for the services provided.
Subscription Procedure
IPO shares are distributed in different ways to investors. One approach is an open auction, where investors are invited to submit bids stating the number of shares they wish to purchase and the price they will pay for them. The highest bidders get the securities. The Google IPO of US$1.7 billion in 2004 and the Morningstar IPO of US$140 million in 2005 used this open auction method.
The bookbuilding method is the most commonly used in the United States today and is gaining popularity and dominance across the globe (Degeorge, Derrien, and Womack, 2007). During the roadshows, the investment bankerasks institutional investors and individual clients about their intention to buy the shares. Each bid indicates the number to be purchased, and may include a limiting price. Such information is recorded in a “book,” from which the name bookbuilding is derived. These indications of interest provide valuable information, because all bids are compiled to ascertain the market demand for the security. Although these bid indications are not binding, the investment banker can utilize the information to set the final offer price, which is made known on the day before the actual issue (Cornelli and Goldreich, 2003).
The appeal of the bookbuilding method, despite its higher underwriting costs, is that investment banks provide better promotion and research coverage of the IPO than other IPO issuing procedures. Thus, the networking of the bank with clients helps to enhance the image of the issuing firm. Chief financial officersappear to prefer this approach to IPOs despite the higher cost.
IPO Cost and Pricing
Underpricing
Besides the substantial underwriting cost and direct costs of lawyers, printers, accountants, etc., the IPO firm has to bear notional losses due to the underpricing of the issue—i.e., the IPO price is less than the true price of the stock. If the offering price is less than the true value of the issue, original stockholders effectively provide a bargain to the new investors. The finance literature shows that investors that buy at the issue price on average realize high returns (for example, 18%) over the following days. This high return from underpricing is common across the world—especially in China, which provides the highest return of 257% (Loughran, Ritter, and Rydqvist, 1994).
Underpricing, which is most likely to be seen with the bookbuilding method, can be justified as follows. First, a low offer price makes it probable that shares will later be traded at a higher price in the market, thus enhancing the firm’s ability to raise capital in future. That is, underpricing ensures that the IPO is successful and that those who want to buy the issue will follow the same underwriter among those in the market. Second, it is a way to avoid the winner’s curse—the feeling of investors that they have paid too much. Simply, underpricing makes it more likely that an IPO will be successful. It appears that stockholders of the IPO firm focus more on likely gains in wealth from later stock price increases than on any short-term loss from underpricing (Loughran and Ritter, 2002).
New Price and Stock Issue
Suppose that an IPO firm has 10 million shares with a current valuation of $100 million, that it wants to raise $70 million for the issue, and that it has to pay $4.9 million for the direct cost of issuance, which is in general about 7% of the issue value (Hansen, 2001). The post-issue price, Pnew, which includes underpricing, and the number of new shares to be issued, N, will be determined simultaneously. That is, the dollar amount of the new issue will cover the fund required and the direct cost to be paid, while the augmented value of the firm will include the
old and new assets of the firm. Pnew and N can be determined as follows:
Pnew × N = $70,000,000 (new fund) + $4,900,000 (issue cost)(1)
(10,000,000 + N) × Pnew = $100,000,000 (old assets) + $70,000,000 (new assets)(2)
Solving these two equations (1) − (2) yields the new price of the IPO, Pnew = $9.51. The number of new shares to be issued, N = 7,875,920.
Making It Happen
An IPO is a time-consuming process.
The success of an IPO depends on the successful selling of the firm to the investment banks,
to the regulator, to the analysts, and to the public.
During the six-month IPO process the firm’s operations need to be on autopilot cruise control as management will be totally tied up during this time.
Can I know the number of shares that would be allotted to me?
In case of fixed price issues, the investor is intimated about the CAN/Refund order within 30 days of the closure of the issue. In case of book built issues, the basis of allotment is finalized by the Book Running lead Managers within 2 weeks from the date of closure of the issue. The registrar then ensures that the demat credit or refund as applicable is completed within 15 days of the closure of the issue. The listing on the stock exchanges is done within 7 days from the finalization of the issue.
How do I know if I am allotted the shares?
And by what timeframe will I get a refund if I am not allotted?
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.
How do I interpret the IPO Grades?
The grades are allocated on a 5-point scale, the lowest being Grade 1 and highest Grade 5.
IPO GRADING
Grade Fundamentals
1. Poor
2. Below Average
3. Average
4. Above average
5. Strong.
Is grading optional?
No, IPO grading is not optional. A company which has filed the draft offer document for its IPO with SEBI, on or after 1st May, 2007, is required to obtain a grade for the IPO from at least one CRA ( Community Reinvestment Act ).
Based on the given below points grading may be assigned for an IPO, such as,
a) Promoters, their credibility and Track record.
b) Past performance of the company.
c) Products of the company and future potential of the Products.
d) Technology tie up, if any and the reputation of the collaborators.
e) Project cost, means of financing and Profitability projections.
f ) Risk factors.
Rating are given by a Credit rating Agency.
What are the dos and don'ts for bidding / applying in the issue?
The investors are generally advised to study all the material facts pertaining to the issue including the risk factors before considering any investment. They are strongly warned against any 'tips' or relying on news obtained through unofficial means.
Is this IPO a good investment?
When you go through the executive summary of an IPO, our research team provides its opinion on the issue based on an analysis of the company's financials, promoters' background and other qualitative issues. This can help in guiding your investment decision.
Depending upon the nature the different types of IPO,s which a company can issue are,
1. Initial Public Offer
2. Offer for Sale
3. Follow on Offer
4. Rights Issue
5. Preferential Issue
The next kind of popularly known Public Issue is called as FPO ( FOLLOW ON PUBLIC OFFER ).An Organization, already functioning in the stock market, again re-collecting money in the form of stocks is called FPO.
