TYPES OF SHARES ( or ) STOCKS

TYPES OF SHARES :-
The capital of a company can be divided into different units with definite value called shares. Holders of these shares are called shareholders or members of the company. The Indian Companies Act prescribes that a public Ltd company can issue only 2 classes of shares :-

(a) Equity or Common shares or stocks
(b) Preference shares or stocks

(A) COMMON SHARES AS OWNERSHIP SHARES :-
Common stocks also known as Equity securities or Equities, represent ownership shares in a corporation. Each share of common stock entitles its owner to one vote on any matters of corporate governance that are put to a vote at the corporations Annual meeting and to a share in the financial benefits of ownership. ( A corporation sometimes issue two classes of common stock, one bearing the right to vote, the other not. Because of its restricted rights, the non-voting stock might sell for a lower price )

Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure.

Equity shares will get dividend and repayment of capital after meeting the claims of preference shareholders. There will be no fixed rate of dividend to be paid to the equity shareholders and this rate may vary from year to year.

This rate of dividend is determined by directors and in case of larger profits, it may even be more than the rate attached to preference shares. Such shareholders may go without any dividend if no profit is made.

In the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debt holders have been paid in full.

If the company goes bankrupt, the common stockholders will not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets.

This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run.

Either it may be in the secondary market, ( previously functioning shares ) or a new issue such as ( IPO, FPO, ) Initial public offer, Follow on Public Offer, etc. The number of Share holders may be varying daily., for a Specified Stock. The same condition for Other Stocks Also.

The common stock of most large corporations can be bought or sold freely on one or more stock Exchanges.

CHARACTERISTICS OF COMMON STOCK :-
The two most important characteristics of common stock as an investment are its residual claim and Limited Liability features :-

1) Residual claim means that stock holder are the last in line of all these who have a claim on the Assets and income of the Corporation. In a liquidation of the firm’s assets the shareholders have a claim to what is left after all other claimants such as the Tax activities, Employees, Suppliers, Bondholders, and other creditors have been paid. For a firm not in liquidation, shareholders have claim to the part of operating income left over after interest and taxes have been paid. Management can either pay this residual as cash dividends to shareholders or re-invest it in the business to increase the value of the shares.

2 ) Limited Liability means that the most shareholders can lose in the event of failure of the corporation is their Original Investment. Unlike owners of Un- incorporated business , whose creditors can lay claim to the personal assets of the owner ( House, Car, Furniture ) corporate shareholders may at worst have worthless stock. They are not personally liable for the firm’s obligations.

(B) PREFERRED SHARES :-
Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of a liquidation. Also unlike common stock, preference shares pay a fixed dividend that does not fluctuate, although the company does not have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preference shares are that the investor has a greater claim on the company's assets than common stockholders.

Like common stock, preference shares represent partial ownership in a company, although preferred stock shareholders do not enjoy any of the voting rights of common stockholders.

Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before common stockholders.

In general, there are four different types of preferred stock:

a) Cumulative preferred stock,
b) Non-cumulative preferred stock,
c) Participating preferred stock, and
d) Convertible preferred stock.

Preferred stock has features similar to both equity and debt. Like a bond it promises to pay its holder a fixed amount of income each year. Suppose profitable gains are obtained then a Higher rate of Dividend will be given for Equity share holders, whereas only a limited previously given dividend may be given.

In this sense preferred stock is similar to an Infinite-maturity bond that is a perpetuity. It also resembles a bond in that it does not convey voting power regarding the Management of the firm. Preferred stock is an equity investment however.

The firm retains discretion to make the dividend payments to the preferred stock holders. It has not contractual obligation to pay these dividends. Instead preferred dividends are usually cumulative. That is unpaid dividend cumulative and must be paid in full before any Dividend may be paid to holders of common stock.

In Contrast, the firm does have a contractual obligation to make the interest payments on the Debt. Failure to make these payments sets off Corporate Bankruptcy proceedings.

Preferred stock payments are treated as dividend rather than interest, they are not tax deductible expenses for the firm. This disadvantage is somewhat offset by the fact that corporations may exclude 70 % of dividends received from Domestic Corporations in the Computation of their taxable income. Preferred stocks therefore make desirable fixed income investments for some corporations.

Even though preferred stock ranks after bonds in terms of the priority of its claims to the Assets of the firm in the event of Corporate Bankruptcy, preferred stock often sells at lower yields than do Corporate Bonds.

Presumably this reflects the value of the dividend exclusion, because the higher risk of preferred would tend to result in higher yield than those offered by Bonds. Individual Investors, who cannot use the 70 % tax exclusion, generally will find preferred stock yields unattractive relative to these on other available assets.

Preferred stock is issued in variations similar to those of Corporate Bonds. It may be callable by the issuing firm, in which case it is said to be redeemable. Due to an uncertain condition if the company is under a loss, being de-listed, then first a major portion of assets belonging to the company, would be divided to the preference share holders and the debts may be cleared , later the balance amount if any may be divided for the common share holders. It also may be convertible into common stock at some specified conversion ratio. Adjustable rate preferred stock is another variation that, like Adjustable-rate bonds, ties the dividend to current market interest rates.

a) Cumulative Preference Share
If the company does no earn adequate profit in any year, dividends on preference shares may not be paid for that year. But if the preference shares are cumulative such unpaid dividends on these shares go on accumulating and become payable out of the profits of the company, in subsequent years.

Only after such arrears have been paid off, any dividend can be paid to the holder of Equity shares. Thus a cumulative preference shareholder is sure to receive dividend on his shares for all the years our of the earnings of the company.

If the dividend is not paid, it will accumulate for future payment.

b) Non-cumulative Preference Shares
The holders of non-cumulative preference shares no doubt will get a preferential right in getting a fixed dividend it is distributed to quality shareholders. The fixed dividend is to be paid only out of the divisible profits but if in a particular year there is no profit as to distribute it among the shareholders, the non-cumulative preference shareholders, will not get any dividend for that year and they cannot claim it in the next year during which period there might be profits.

If it is not paid, it cannot be carried forward. These shares will be treated on the same footing as other preference shareholders as regards payment of capital in concerned.

Dividend for this type of preferred stock will not accumulate if it is unpaid. Very common in TRuPS and bank preferred stock, since under BIS rules, preferred stock must be non-cumulative if it is to be included in Tier 1 capital.

c) Redeemable Preference Shares

Capital raised by issuing shares, is not to be repaid to the shareholders (except buy back of shares in certain conditions) but capital raised through the issue of redeemable preference shares is to be paid back by the raised thought the issue of redeemable preference shares is to be paid back to the company to such shareholders after the expiry of a stipulated period, whether the company is wound up or not.

As per section (80) 5a, a company after the commencement of the Companies (Amendment) Act, 1988 cannot issue any preference shares which are irredeemable or redeemable after the expiry of a period of 10 years from the date of its issue. It means a company can issue redeemable preference share which are redeemable within 10 years from the date of their issue.

d) Participating or Non-participating Preference Shares
Participating Preferred Stock

These preferred issues offer the holders the opportunity to receive extra dividends if the company achieves some predetermined financial goals. The investors who purchased these stocks receive their regular dividend regardless of how well or how poorly the company performs, assuming the company does well enough to make the annual dividend payments. If the company achieves predetermined sales, earnings or profitability goals, the investors receive an additional dividend.

The preference shares which are entitled to a share in the surplus profit of the company in addition to the fixed rate of preference dividend are known as participating preference shares.

After the payment of the dividend a part of surplus is distributed as dividend among the quality shareholders at a particulate rate. The balance may be shared both by equity and participating preference shareholders at a particular rate.

Thus participating preference shareholders obtain return on their capital in two forms
a) fixed dividend
b) share in excess of profits.

Those preference shares which do not carry the right of share in excess profits are known as non-participating preference shares.

Apart from the above some other preference stocks are also present namely as,

A) CONVERTIBLE PREFERRED STOCK :
Preferred stock (preference shares) that can be converted into common stock (ordinary shares) at the option of the stockholder (shareholder) or as provided in the agreement under which it was issued, at a specified conversion rate.

Holders of this type of security have the right to convert their preferred stock into shares of common stock. This allows the investor to lock in the dividend income and potentially profit from a rise in the common stock while being protected from a fall in the same.


Convertible preferred stock that may be exchanged, at the issuer's option, into convertible bonds that have the same conversion features as the convertible preferred stock.

These are preferred issues that the holders can exchange for a predetermined number of the company's common stock. This exchange can occur at any time the investor chooses regardless of the current market price of the common stock. It is a one-way deal so one cannot convert the common stock back to preferred stock.

B) PRIOR PREFERRED STOCK
Many companies have different issues of preferred stock outstanding at the same time and one of them is usually designated to be the one with the highest priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the dividend payments on the prior preferred. Therefore, prior preferred have less credit risk than the other preferred stocks but it usually offers a lower yield than the others.

C) PREFERENCE PREFERRED STOCK
Ranked behind the company's prior preferred stock (on a seniority basis), are the company's preference preferred issues. These issues receive preference over all other classes of the company's preferred except for the prior preferred. If the company issues more than one issue of preference preferred, then the various issues are ranked by their relative seniority. One issue is designated first preference, the next senior issue is the second and so on.

D) EXCHANGEABLE PREFERRED STOCK
This type of preferred stock carries an embedded option to be exchanged for some other security upon certain conditions.

E) PERPETUAL PREFERRED STOCK
This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder, although there will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date.

F) PUTABLE PREFERRED STOCK
These issues have a "put" privilege whereby the holder may, upon certain conditions, force the issuer to redeem shares.

G) MONTHLY INCOME PREFERRED STOCK
A combination of preferred stock and subordinated debt.

( II ) DEPOSITORY RECEIPTS
A depositary receipt is a negotiable financial instrument issued by a bank to represent a foreign company's publicly traded securities. The depositary receipt trades on a local stock exchange.

Depositary receipts make it easier to buy shares in foreign companies because the shares of the company don't have to leave the home state.

When the depositary bank is in the U.S., the instruments are known as American Depositary Receipts (ADRs). European banks issue European depositary receipts, and other banks issue global depositary receipts (GDRs).

( III ) AMERICAN DEPOSITARY RECEIPT (ADR)
American Depository Receipts, or ADR’s are negotiable security ( certificates ) that represents the underlying securities of a non-US company that are traded in U.S. financial Markets that represent ownership in shares of a Foreign Company. Individual shares of the securities of the foreign company represented by an ADR are called American depositary shares (ADSs).

Each ADR may correspond to ownership of a fraction of a foreign share, one share or several shares of the foreign corporation. ADR’s were created to make it easier for foreign firms to satisfy U.S Security registration requirements. They are the most common way for U.S investors to invest in and trade the shares of foreign corporation.

The stock of many non-US companies trades on US stock exchanges through the use of ADRs. ADRs are denominated, and pay dividends, in US dollars, and may be traded like shares of stock of US-domiciled companies.

The first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges. There are currently four major commercial banks that provide depositary bank services: BNY Mellon, J.P. Morgan, Citi Bank, andDeutsche Bank.

( IV ) EMPLOYEES STOCK OPTION PLAN OR SWEAT EQUITY
An Organization to provide an offer to their serving Employees, may allow for a Specified Amount lesser than the Market value, termed as Employees Stock Option Plan.

An ESOP is nothing but an option to buy the company's share at a certain price. This could either be at the market price (price of the share currently listed on the stock exchange), or at a preferential price (price lower than the current market price).

If the firm has not yet gone public (shares are not listed on any stock exchange), it could be at whatever price the management fixes it at.

WHY WOULD A COMPANY OFFER AN ESOP?
Let's first explain what owning a share entails.
When you invest in shares, you do not invest in the market. You invest in the equity shares of a company. That makes you a shareholder or part owner in the company.

Owning an equity share means owning a share in the company business. Companies offer their employees shares because it is considered that having a stake in the company would increase loyalty and motivation substantially.

WHEN ARE THEY GIVEN?
It depends on company policy and your designation. There are time limits for availing this scheme. For instance, you can acquire the shares after you complete a particular period of employment. This could be a year, even longer.

This is known as the vesting period, and generally ranges from one to five years. If you quit your job before this period is complete, the stock options lapse.

Sometimes, the ESOPs are given in a phased out fashion -- 20% in the second year, another 20% in the third year, etc.

WHEN ARE THEY TAXED? The ESOP is not taxed on acquiring the shares. You are taxed on the profit you make when you sell the shares or transfer them.

Transfer here refers to when you gift it to someone or transfer it to someone else under an irrevocable deed (they now own it, not you).

HOW ARE THEY TAXED?
When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.

The tax you pay on this profit is called the capital gains tax. Capital gains tax is computed on the difference between the sale price and the issue price (the price at which shares are offered to you).

If you sell the shares within a year of allotment (within 12 months of acquiring them), then it is a short-term capital gain. If you sell the shares after a year of allotment (after 12 months of acquiring them), then it is a long -term capital gain.

WHAT MAY HAPPEN IF THEY ARE LISTED ABROAD AND SOLD ABROAD?
This depends on whether you are a resident or non-resident Indian. If you are a non-resident, it will not be taxable, as the gains occur outside India unless the money is received in India.

If you are a resident in India, then you will be taxed on the gains.
Long-term capital gain is taxed at 20%.
Short-term capital gain is added to your overall income and taxed according to your slab rate.

WHAT MAY HAPPEN IF THEY ARE LISTED AND SOLD IN INDIA? The taxability depends on the nature of gain at the time of sale.
If you have a short-term capital gain, you have to pay tax at the rate of 10% (plus surcharge if applicable). Long-term gains are exempt from tax. 

DO I HAVE TO PAY A SECURITY TRANSACTION TAX IF SOLD IN INDIA OR ABROAD?
If you sell your shares on or after October 1, 2004, you need to pay the Securities Transaction Tax in India. Also the STT is leviable in abroad as per their rules.

CAN I AVAIL OF INDEXATION?
You use indexation when you calculate tax taking into account the inflation. This is good because it reduces the amount of capital gain and the amount you end up paying as tax.

Indexation is available only for long-term capital gains. Since the long-term capital gains on shares and options are not taxable now, it is not required.

CAN I INVEST THE PROFIT TO AVOID TAX?
Long-term capital gain on shares are exempt, so this does not arise.
There is no provision to invest the short-term capital gains to avoid tax.

( E ) DIFFERENT VALUE RIGHTS ( DVR ) STOCKS
A DVR share is like an ordinary equity share, but it provides fewer voting rights to the shareholder. So, for instance, while a normal Gujarat NRE Coke shareholder can vote as many times as the number of company shares heshe holds, someone who holds the company’s DVR shares will need to hold 100 DVR shares to cast one vote. The number of DVR shares required to be held will differ from one company to another.

Why are these issued by companies?
Companies issue DVR shares for prevention of a hostile takeover and dilution of voting rights. It also helps strategic investors who do not want control, but are looking at a reasonably big investment in a company. At times, companies issue DVR shares to fund new large projects, due to fewer voting rights, even a big issue does not trigger an open offer.

The Companies Act permits a company to issue DVR shares when, among other conditions, the company has distributable profits and has not defaulted in filing annual accounts and returns for at least three financial years. 

However, the issue of such shares cannot exceed 25 per cent of the total issued share capital. Some companies that have issued DVR shares on our bourses include Tata Motors, Pantaloons and Gujarat NRE Coke. According to reports, Tata Steel has plans to raise $1 billion through various instruments, including DVR shares.

Who should invest in DVR shares?
It offers both retail and institutional investors a variation, especially for those who may not be as particular about voting rights, but may see economic value in the form of higher discount offer that is being made and also for the incremental dividend.

Why should retail investors invest?
These are, ideally, good instruments for long-term investors, typically small investors, who seek higher dividend and are not necessarily interested in taking a voting position. Although DVR shares are listed in the same way as ordinary equity shares, these trade at a discount, as these provide fewer voting rights to the holder. Investors can also take advantage of the price differential of DVR and normal shares. 

When Tata Motors had declared its dividend in 2006, it gave the DVR holders a divided of six per cent and the ordinary shareholders one per cent. For example, the Tata Motors DVR shares were trading at Rs 689.80 on the National Stock Exchange (NSE) and the ordinary ones at Rs 1,255.75 on Wednesday.

What are the disadvantages?
DVR shares are thinly traded scrips, which means these are highly illiquid stocks. On Wednesday, a total of 2,67,000 ordinary shares of Pantaloons were traded on NSE and only 1,154 DVR ones. A total of 44,214 DVR shares of Gujarat NRE Coke were traded on Wednesday and 5,90,000 of the ordinary ones.

OFFER FOR SALE

A public invitation to apply for stock in a company by a sponsoring intermediary, such as bank or broker, to buy new or existing securities based on information contained in a prospectus. It contrasts with an offer for subscription which is an invitation to subscribe direct from the issuer.

A method of bringing a company to the stock market by selling shares in a new issue. The company sponsor offers shares to the public by inviting subscriptions from investors.

A situation in which a company advertises new shares for sale to the public as a way of launching itself on the Stock Exchange

There are two main ways for a company to list new shares

1) By an offer for sale, by fixed price - the sponsor fixes the price prior to the offer, which is a public invitation by a sponsoring intermediary such as an investment bank.

2) By an offer for subscription, ( or direct offer, which is a public invitation by the issuing company itself ) by tender - investors state the price they are willing to pay. A strike price is established by the sponsors after recieving all the bids. All investors pay the strike price.

The offer can be made at a price that is fixed in advance or it can be by tender where investors state the price they are prepared to pay. After all bids are received, a strike price is set which all investors must pay.

A prospectus containing details of the sale must be printed in a national newspaper.

The Securities and Exchange Board of India (SEBI) said on a specific day that any advertisement given by companies going for offer for sale through the stock exchange mechanism should be restricted to such details of the offer that is given to the stock exchange in this regard. "It is clarified that the contents of the advertisement, if any, to be issued ....shall be restricted to the contents of the notice as given to the stock exchange," SEBI said in a circular. The contents of the stock exchange announcement are laid down in an earlier circular.

Accordingly, sellers shall announce the intention of sale of shares at least one clear trading day prior to the opening of offer. This announcement should clearly contain details such as date and time of the opening and closing of the offer, allocation methodology i.e. either on a price priority (multiple clearing prices) basis or on a proportionate basis at a single clearing price, number of shares being offered for sale and floor price

“ When companies have shares to offer for sale it may mean they are launching their IPO and recently became a publicly traded company. ” A method of bringing a company to the stockmarket by selling shares in a new issue. The company sponsor offers shares to the public by inviting subscriptions from investors.

The process of listing for the first time is known as the 'primary market'. The most common way for a company to come to market is by an 'Offer for Sale'.

• The company publishes a prospectus describing its business, who its directors are, what its financial position is, and what profits it thinks it is going to make.
• The prospectus announces the issue of new shares, sets an offer price for the shares, and invites subscriptions.
• Offer prices are often pitched low to make sure the issue is successful.
• Offer for sale by fixed price - the sponsor fixes the price prior to the offer.
• Offer for sale by tender - investors state the price they are willing to pay.

A strike price is established by the sponsors after receiving all the bids. All investors pay the strike price.
A prospectus containing details of the sale must be printed in a national newspaper.

Stagging

Low offer prices encourage investors to 'stag' an issue, applying for more shares than they want and selling them for an instant profit as soon as the market opens. Stagging was particularly good when companies only required payment after shares had been allocated. Now that they usually ask for money with your application, it's less attractive.

Nevertheless, stagging is still a feature of new issues, and you will see it cited as a factor in first day trading. Eg AFX's report on Zen Research said 'The hard disk developer finished the day up 27 from its flotation price of 150 pence to 177, having fallen back from an earlier high of 200 as traders stagged the issue. The stock was the second most traded on the smaller caps, with 22.46 mln transactions'.

Oversubscription
If an issue is oversubscribed, the company will usually allot each subscriber a percentage of the shares they wanted, and return a proportion of the subscription money.

Sometimes the offer stipulates that applications for large numbers of shares will be scaled back or rejected completely. This was what happened with the big UK privatisations, and investors who tried to get round the rule by making multiple applications in the names of children and pets ran the risk of prosecution.

Undersubscription
Most new issues are guaranteed by 'underwriters' - merchant banks who promise to buy any shares not taken up by the public, in return for a fee from the company. This gives the company the comfort of knowing their listing will get off the ground.

Occasionally, the underwriters have to act - as they did when BP floated in 1987 at the time of the crash. The underwriters had to take up huge numbers of unsold shares, at fixed prices, then offload them onto the market at much lower prices and absorb the loss.

FOLLOW ON PUBLIC OFFER

What is an FPO ? 
A Follow-on Public Offer (FPO) is a process in which an already listed com­pany raises addi­tional cap­i­tal from the public also called as further public offer.

A company that is already publicly traded will sometimes sell stock to the public again. This type of offering is called a FOLLOW-ON OFFERing, or a secondary offering. One reason for 
a follow-on offering is the same as a major reason for the initial offering: a company may be growing rapidly, either by making acquisitions or by internal growth, and may simply require additional capital.

When a listed company comes out with a fresh issue of shares or makes an offer for sale to the public to raise funds it is known as FPO. In other words, FPO is the consequent issue to the public after initial public offering (IPO). The word FPO came into news after the YES Bank announcement to raise Rs 2,000 crore through FPO and debt.

Another reason that a company would issue a follow-on offering is similar to the cashing out scenario in the IPO. In a secondary offering, a large existing shareholder (usually the largest shareholder, say, the CEO or founder) may wish to sell a large block of stock in one fell swoop.

The reason for this is that this must be done through an additional offering (rather than through 
a simple sale on the stock market through a broker), is that a company may have shareholders with "unregistered" stock who wish to sell large blocks of their shares. By SEC decree, all stock must first be registered by filing an S-1 or similar document before it can trade on a public stock exchange. Thus, pre-IPO shareholders who do not sell shares in the initial offering hold what is called unregistered stock, and are restricted from selling large blocks unless the company registers them. (The equity owners who hold the shares sold in an offering, whether it be an IPO or a follow-on, are called the selling shareholders.)

In short, both IPO and FPO are process of rais­ing funds from the public.

The basic difference between Initial Public Offer (IPO) and Follow on Public Offer (FPO) is as the names suggest that,

IPO is for the companies which have not listed on an exchange and 

FPO is for the companies which have already listed on exchange but 

want to raise funds by issuing some more equity shares. 

Companies usually go to debt market for raising their short term needs. Either they issue bonds or get loans. But if they have massive expansion plans they may not raise sufficient funds in the debt market and even if they could it costs more. Companies come up with FOLLOW ON OFFER to restructure their business or to raise funds for new business or to expand the existing business.

Similar to an IPO a price band is fixed (usually with the help of Investment banks) for the issue and interested investors can apply for it. Unlike the corporate actions (such as bonus, rights issue which are applicable only to the existing stake holders) FPO is open to all investors. The price band for the FPO depends on the market value of the existing company shares and the reason for raising funds.

In an FPO shares are issued in any of the ways listed below.

1. Promoters dilute their stake by offering some of their shares to the public.
2. Company issue fresh shares.
3. A combination of the above two approaches.

HOW IS IT DIFFERENT FROM AN IPO?
As the name suggests initial public offering (IPO) is the first offer for purchase to public. This is a process when an unlisted company raises funds by offering its shares to the public and consequently gets listed on a stock exchange. 

A company can either issue fresh securities or offer its existing securities to public. However, if the same company comes out with another issue to the public, the second issue would be called an FPO. For instance, ICICI Bank was a listed entity but came out with FPO of around Rs 8,750-crore equity shares in July 2007. 

The issue remained open for subscription between July 19, 2007, and July 22, 2009. Similarly Bharat Earth Movers (BEML), which was listed in National Stock Exchange on November 5, 2003, came out with a public offer of 49 lakh shares in 2007. Shares of BEML were issued at Rs 1,075 after the closure of the FPO.

Under the Fast Track Issues (FTI), a listed company, which meets certain entry norms, can proceed further with FPOs by filling a copy of RHP to regulators. These companies don’t need to file a draft offer document. However, it is mandatory for a private company, which wants to come out with an IPO.

What are the regulatory requirements?
In case, a company wants to come out with FPO and have changed its name within a year, at least 50% of the revenue of the last one-year must have come from the activities defined by the new name. The size of the issue should not be more than five times the pre-issue net worth of the company as mentioned in the balance sheet of the previous financial year.

Nevertheless, a group of companies - private and public sector banks - are exempt from these norms. Also, infrastructure companies whose projects have been appraised and financed by any public financial institution or companies such as IDFC and IL&FS do not need to comply with these norms. Also, the promoter must contribute at least 20% of the post-issue capital or 20% of the issue size.

IPO vs. FPO – Which is better? 
Invest­ment in IPO is more lucra­tive than invest­ing in FPO in terms of returns. How­ever an investor has bet­ter infor­ma­tion in an FPOas against IPO. As the stock is already listed, the respec­tive com­pany has to pro­vide infor­ma­tion based on the mar­ket reg­u­la­tor guide­lines. In my opin­ion, invest­ment in FPOs can be con­sid­ered if the stock is avail­able at a dis­count than the listed price.

THE PROCESS.
The follow-on offering process differs little from that of an IPO, and actually is far less complicated. Since underwriters have already represented the company in an IPO, a company often chooses the same managers, thus making the hiring the manager or beauty contest phase much simpler. Also, no real valuation work is required (the market now values the firm's stock), a prospectus has already been written, and a roadshow presentation already prepared. Modifications to the prospectus and the roadshow demand the most time in a follow-on offering, but still can usually be completed with a fraction of the effort required for an initial offering.

Bond offerings 
When a company requires capital, it sometimes chooses to issue public debt instead of equity. Almost always, however, a firm undergoing a public bond deal will already have stock trading in the market. (It is relatively rare for a private company to issue bonds before its IPO.)

The reasons for issuing bonds rather than stock are various. Perhaps the stock price of the issuer is down, and thus a bond issue is a better alternative. Or perhaps the firm does not wish to dilute its existing shareholders by issuing more equity. Or perhaps a company is quite profitable and wants the tax deduction from paying bond interest, while issuing stock offers no tax deduction. These are all valid reasons for issuing bonds rather than equity. Sometimes in down markets, investor appetite for public offerings dwindles to the point where an equity deal just could not get done (investors would not buy the issue).

The bond offering process resembles the IPO process. The primary difference lies in: 

(1) the focus of the prospectus (a prospectus for a bond offering will emphasize the company's stability and steady cash flow, whereas a stock prospectus will usually play up the company's growth and expansion opportunities), and 

(2) the importance of the bond's credit rating (the company will want to obtain a favorable credit rating from a debt rating agency like S&P or Moody's, with the help of the "credit department" of the investment bank issuing the bond; the bank's credit department will negotiate with the rating agencies to obtain the best possible rating). As covered in Chapter 5, the better the credit rating - and therefore, the safer the bonds - the lower the interest rate the company must pay on the bonds to entice investors to buy the issue. Clearly, a firm issuing debt will want to have the highest possible bond rating, and hence pay a lower interest rate (or yield).

As with stock offerings, investment banks earn underwriting fees on bond offerings in the form of an underwriting discount on the proceeds of the offering. The percentage fee for bond underwriting tends to be lower than for stock underwriting. For more detail on your role as an investment banker in stock and bond offerings, see Chapter 8.

What are the other kinds of issues through which companies raise money?
Apart from IPO and FPO, a company can raise funds through a rights issue and private placement. A rights issue and bonus issue are made to the existing shareholders. However, a rights issue is also a way to raise funds but in a bonus issue new securities are issued to existing shareholders without any consideration.

INITIAL PUBLIC OFFER

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?

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.

3) The company must have track record of distributable profits in at least 3 out of the 
     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,

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

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:

#   purpose of the issue;

#   proposed offering price range;

#   disclosure of any option agreement;

#   underwriter's commissions and discounts; 
     promotion expenses;

#   net proceeds to the issuing company (issuer); 
     balance sheet;

#   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.

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.