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“INITIAL PUBLIC OFFER – (IPO)”

MEANING

 An initial public offering (IPO) occurs when a company first sells common shares to investors
in the public. Generally, the company offers primary shares this way, although sometimes
secondary shares are also sold as IPOs.
 Broadly speaking, companies are either private or public. Going public means a company is
switching from private ownership to public ownership.
 Going public raises cash and provides many benefits for a company.

DEFINITION

An IPO (initial public offering) is a first and one-time only sale of publicly tradable stock
shares in a company that has previously been owned privately. An IPO is also sometimes known
as "going public." Technically, an IPO is the offering to sell but virtually all IPOs result in all the
stock offered being sold. IPOs are generally managed by companies that specialize in handling
IPOs and have experience in determining what the likely IPO offering price should be. If the IPO
manager determines that the stock will not sell at an offering price that is acceptable to the
company, the application for an IPO is usually withdrawn until a better time. As soon as all
shares of an IPO have been sold, the stock is now tradable through stock exchanges or
specialists that trade in the stock and the stock price may go up or down.

HISTORY

The term initial public offering (IPO) slipped into everyday speech during the tech bull
market of the late 1990s. Back then, it seemed you couldn't go a day without hearing about a
dozen new dotcom millionaires in Silicon Valley who were cashing in on their latest IPO. The
phenomenon spawned the term silicon ire, which described the dotcom entrepreneurs in their
early 20s and 30s who suddenly found themselves living large on the proceeds from their
internet companies' IPOs.

INVESTORS are still wary of equities in the 1990s, to blame are the excesses in the
primary market in the 1990s. Of the thousands of IPOs (initial public offerings) and offers for sale
made between 1994 and 1996, less than a hundred were from companies with track record.
Even in this shortlist, only a few managed to complete planned projects and deliver value to
investors. The rest just frittered the money away.

The primary market of the mid-1990s was merely used as a channel to move public
funds into private hands. The Securities and Exchange Board of India (SEBI) was late to wake
up to the excesses, but when it did, it improved the disclosure framework, tightened the
prerequisites for an IPO, and towards the end of the decade, introduced book-building.

( This route brought to market quality, wealth-creating IPOs such as Hughes Software, I-
flex solutions, Maruti, Bharti Tele-Ventures, TV Today and Divi's Labs, to name a few. Yet the
corporate sector has still not fully lived down the consequences of the excesses of the mid-
1990s.)

CURRENT POSITION OF INDIAN IPO MARKET


India is being lauded as the savior of the ailing global IPO market with $3.3 billion worth
of proceeds from eight deals. This makes India the largest IPO market in the world so far this
year.

1. According to Thomson Financial, the bulk of the volumes came from the biggest IPO deal
so far this year — Reliance Power's $3 billion IPO on January 21, 2008.

2. On January 15, 2008, Reliance Power attracted $27.5 billion of bids on the first day of its
IPO, equivalent to 10.5 times the stock on offer, thereby, creating India's IPO record. Its
upper cut off price was Rs. 450. The proposed IPO was to fund the development of its six
power projects across the country.

3. Emaar MGF’s IPO, at $1.6 billion is estimated to be the second largest IPO in the world
so far this year, behind Reliance Power's $3 billion IPO.

4. Thomson Financial data reveals that India accounts for 49.1% of global IPO proceeds at
the moment, compared to just 3.7% same time last year. Significant, given that global IPOs
declined 36.1% over the last one year.

5. The Indian capital market has performed quite well in 2007. It raised US$8.3
billion through 95 Initial Public Offers (IPOs). According to the Ernst & Young report,
"Globalization - Global IPO Trend Report 2007" India was the fifth largest market in the
world in terms of the number of IPOs and the seventh largest in terms of the proceeds for
the year.

6. It was the real estate sector which took the maximum advantage of the bullish
stock market trends in 2007. According to the industry body Assocham, real estate players
raised the maximum amount of funds from the capital market through IPOs last year. Realty
firms picked up around 42.7% of the total funds generated through IPOs. Of the Rs.34,119
crore raised in the primary market in the period starting from January 1, 2007 to mid-
December, about Rs.14,591 crore was raised by the realty firms.

7. An initial public offering (IPO) is the first sale of stock by a company to the public.
FINANCIAL YEAR AMOUNT RAISED THROUHG IPO
2002-03 Rs 1039 crore
2003-04 Rs 17807 crore
2004-05 Rs 21432 crore
2005-06 Rs 23,676 crore
2006-07 Rs 24,994 crore
2007-08 Rs 52,253 crore

PRIMARY MARKET AND SECONDARY MARKET

When shares are bought in an IPO it is termed primary market. The primary market does
not involve the stock exchanges. A company that plans an IPO contacts an investment banker
who will in turn called on securities dealers to help sell the new stock issue.
This process of selling the new stock issues to prospective investors in the primary
market is called underwriting.

When an investor buys shares from another investor at an agreed prevailing market
price, it is called as buying from the secondary market.

The secondary market involves the stock exchanges and it is regulated by a regulatory
authority. In India, the secondary and primary markets are governed by the Security and
Exchange Board of India (SEBI).

KINDS OF PUBLIC OFFERINGS

1. Primary offering:- New shares are sold to raise cash for the company.

2. Secondary offering:- Existing shares (owned by VCs or firm founders) are sold, no new
cash goes to company. A single offering may include both of these initial public offering.

SOME MOTIVATIONS

 Additional source of capital.


 Increase debt capacity (give “breathing room” for debt).
 Stock prices give measure of performance.
 Allows managers to be compensated with options, or have incentives otherwise directly tied
to shareholder value.
 Potentially more information about firm (analyst following), makes borrowing cheaper.

ADVANTAGES AND DISADVANTAGES OF AN IPO

Making a public offering of stock ("going public") is a financing option for well-established
small firms. In addition to its potential of generating large amounts of growth capital, public
offerings also provide a way for owners to profit more immediately from their success and help
overcome some of the tax issues faced when passing the business to the next generation. When
business owners speak of going public, they are usually talking about an initial public offering
(IPO), in which stock is registered with the Singapore Stock Exchange (SGX) and offered to the
public through an investment banker or brokerage firm. Shares of the company are then traded
publicly on the stock market. Due to its expense, extensive filing requirements, and equity
considerations, relatively few small companies ever undertake an IPO. The decision to take a
company public in the form of an Initial Public Offering (IPO) should not be considered lightly.
There are several advantages and disadvantages to being a public company, which should
thoroughly be considered. This memorandum will discuss the advantages and disadvantages of
conducting an IPO and will briefly discuss the steps to be taken to register an offering for sale to
the public. The purpose of this memorandum is to provide a thumbnail sketch of the process.
The reader should understand that the process is very time consuming and complicated and
companies should undertake this process only after serious consideration of the advantages and
disadvantages and discussions with qualified advisors.

Advantages:
1. Increased Capital:-
A public offering will allow a company to raise capital to use for various corporate
purposes such as working capital, acquisitions, research and development, marketing, and
expanding plant and equipment.

2. Liquidity:-
Once shares of a company are traded on a public exchange, those shares have a
market value and can be resold. This allows a company to attract and retain employees by
offering stock incentive packages to those employees. Moreover, it also provides investors
in the company the option to trade their shares thus enhancing investor confidence.

3. Increased Prestige:-
Public companies often are better known and more visible than private companies,
this enables them to obtain a larger market for their goods or services. Public companies
are able to have access to larger pools of capital as well as different types of capital.

4. Valuation:-
Public trading of a company's shares sets a value for the company that is set by the
public market and not through more subjective standards set by a private valuator. This is
helpful for a company that is looking for a merger or acquisition. It also allows the
shareholders to know the value of the shares.

5. Increased wealth:-
The founders of the company often have the sense of increased wealth as a result of
the IPO. Prior to the IPO these shares were illiquid and had a more subjective price. These
shares now have an ascertainable price and after any lockup period these shares may be
sold to the public, subject to limitations of federal and state securities laws.

Disadvantages:
1. Time and Expense:-
Conducting an IPO is time consuming and expensive. A successful IPO can take up
to a year or more to complete and a company can expect to spend several hundreds of
thousands of dollars on attorneys, accountants, and printers. In addition, the underwriter's
fees can range from 3% to 10% of the value of the offering. Due to the time and expense of
preparation of the IPO, many companies simply cannot afford the time or spare the expense
of preparing the IPO.

2. Disclosure:-
The Securities and Exchange Commission (SEC) disclosure rules are very
extensive. Once a company is a reporting company it must provide information regarding
compensation of senior management, transactions with parties related to the company,
conflicts of interest, competitive positions, how the company intends to develop future
products, material contracts, and lawsuits. In addition, once the offering statement is
effective, a company will be required to make financial disclosures, public companies
required to file quarterly statements containing unaudited financial statements and audited
financial statements annually. These statements must also contain updated information
regarding nonfinancial matters similar to information provided in the initial registration
statement. This usually entails retaining lawyers and auditors to prepare these quarterly and
annual statements. In addition, a company must report certain material events as they arise.
This information is available to investors, employees, and competitors.

3. Decisions based upon Stock Price:-


Management's decisions may be effected by the market price of the shares and the
feeling that they must get market recognition for the company's stock.

4. Regulatory Review:-
The Company will be open to review by the Securities and Exchange Commission
(SEC) to ensure that the company is making the appropriate filings with all relevant
disclosures.

5. Falling Stock Price:-


If the shares of the company's stock fall, the company may lose market confidence,
decreased valuation of the company may effect lines of credits, secondary offering pricing,
the company's ability to maintain employees, and the personal wealth of insiders and
investors.

6. Vulnerablility:-
If a large portion of the company's shares are sold to the public, the company may
become a target for a takeover, causing insiders to lose control. A takeover bid may be the
result of shareholders being upset with management or corporate raiders looking for an
opportunity. Defending a hostile bid can be both expensive and time consuming. Once a
company has weighed the advantages and disadvantages of being a public company, if it
decides that it would like to conduct an IPO it will have to retain a lead underwriter to sell the
securities, an attorney to assist in the preparation of a registration statement, and auditors to
prepare financial statements.

UNDERSTANDING “ISSUES”

This portion tries to cover the basic concepts and questions related to issues (issues in
the meaning of issuance of securities). The aim is towards understanding the various types of
issues, eligibility norms, exemptions from the same. The disclosure requirements regarding the
issuance of securities are covered in detail in the SEBI (Disclosure and Investor Protection)
Guidelines, 2000.

KINDS OF ISSUES

Primarily, issues can be classified as a Public, Rights or preferential issues (also known
as private placements). While public and rights issues involve a detailed procedure, private
placements or preferential issues are relatively simpler. The classification of issues is illustrated
below:

Public issues can be further classified into Initial Public offerings and further public
offerings. In a public offering, the issuer makes an offer for new investors to enter its
shareholding family. The issuer company makes detailed disclosures as per the DIP guidelines
in its offer document and offers it for subscription. The significant features are illustrated below:

1. Initial Public Offering (IPO):-


It is when an unlisted company makes either a fresh issue of securities or an offer for
sale of its existing securities or both for the first time to the public. This paves way for listing
and trading of the issuer’s securities.

2. Further public offering (FPO):-


It is when an already listed company makes either a fresh issue of securities to the
public or an offer for sale to the public, through an offer document. An offer for sale in such
scenario is allowed only if it is made to satisfy listing or continuous listing obligations.

3. Rights Issue (RI):-


It is when a listed company which proposes to issue fresh securities to its existing
shareholders as on a record date. The rights are normally offered in a particular ratio to the
number of securities held prior to the issue. This route is best suited for companies who
would like to raise capital without diluting stake of its existing shareholders unless they do
not intend to subscribe to their entitlements.

4. Private placement:-
It is an issue of shares or of convertible securities by a company to a select group of
persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a
public issue. This is a faster way for a company to raise equity capital. A private placement of
shares or of convertible securities by a listed company is generally known by name of
preferential allotment. A listed company going for preferential allotment has to comply with
the requirements contained in Chapter XIII of SEBI (DIP) Guidelines pertaining to preferential
allotment in SEBI (DIP) guidelines include pricing, disclosures in notice etc, in addition to the
requirements specified in the Companies Act.

5. Free-pricing abused:-
As controls over pricing of equity were abolished in 1992, prudence took a backseat
as companies set about raising funds at fancy prices; the pricing was justified with helpful
projections of profitability dished out even by ICICI, IDBI, IFCI, Kotak Mahindra and Enam
Securities, leave alone the plethora of lesser-known investment banking outfits. The earnings
projections were vastly out of tune with reality. There was no element of the risk of business
cycle built into them; in many cases, it appeared as if the price had been fixed, and the
revenue and earnings numbers generated to justify it.
That the IDBI's stock traded at the offer price for just a couple of days over an
eight-year period and, subsequently, well below that price, tells the tale of abuse of free-
pricing. Not surprisingly, this put investors off; they had patronised such IPOs in a big way as
the first few offers in the free-pricing mode — of IFCI, Bank of Baroda, Infosys and Satyam
Computer — delivered value. Corporate greed was penalised, as investor apathy ensured
that between 1998 and 2001, the number of IPOs/offers for sale could be counted on the
fingers of one hand.
.
6. A colossal misconception:-
This period was also witness to a popular notion that equity was the cheapest source
of the funding, as the premium element was perceived as carrying no cost. What companies
failed to recognize in this process — they were also encouraged by investment banks
seeking more IPO opportunities — was that their capital cost could only be the same as the
investor's expected rate return.

By assuming and assigning a zero-cost to the premium element, companies


converted what is, inarguably, the most expensive source of finance to the cheapest one.
This led to an overhang on equity across Corporate India, with funds being mobilised in the
domestic and global markets through the issuance of global depository receipts. As this
understanding of the cost was not clued to reality, it soon fell apart.

7. Capacity overhang:-
The primary market boom of the mid-1990s also ensured excess of a different kind: A
fad for capacity creation across a range of commodities, with the possible exception of
aluminum and copper. Cement and steel were good examples. Buoyed by high cement and
steel prices, and expectations of consistent double-digit growth in demand that was
attributed to liberalization of the economy, several firms set up cement and steel capacities.

Binani Zinc, Sanghi Polesyter and the Rajan Raheja group and the DLF group
(both cited backward integration to construction as the reason for their cement foray) set up
large-sized cement units. Jindal Vijayanagar, Essar Steel, Bhushan Steel, Ispat Industries
and Lloyds Steel completed the steel story. The effect of the overcapacity still exerts
pressure on profitability. For instance, in cement, a better balance between demand and
supply is expected only two years from now.

This binge effectively ensured that even in the small number of companies where
projects were implemented — without exception marked by time and cost-overrun —
investors have had nothing to show by way of wealth accretion. Only the IPOs of the past
two-and-half years have changed that. If the ongoing bullish phase is used to perpetrate
excesses, the consequences would not be any different. Corporate India needs to walk a
different path now, both for its sake as well as in the interest of investors.

8. Qualified Institutions Placement:-


It is a private placement of equity shares or securities convertible in to equity shares
by a listed company to Qualified Institutions Buyers only in terms of provisions of Chapter
XIIIA of SEBI (DIP) guidelines. The Chapter contains provisions relating to pricing,
disclosures, currency of instruments etc.

IPO GRADING
IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the
initial public offering (IPO) of equity shares or any other security which may be converted into or
exchanged with equity shares at a later date. The grade represents a relative assessment of the
fundamentals of that issue in relation to the other listed equity securities in India. Such grading is
generally assigned on a five-point point scale with a higher score indicating stronger
fundamentals and vice versa as below.
IPO grade 1: Poor fundamentals
IPO grade 2: Below-average fundamentals
IPO grade 3: Average fundamentals
IPO grade 4: Above-average fundamentals
IPO grade 5: Strong fundamentals

IPO grading has been introduced as an endeavor to make additional information


available for the investors in order to facilitate their assessment of equity issues offered through
an IPO.

1. IPO grading can be done either before filing the draft offer documents with SEBI or
thereafter. However, the Prospectus/Red Herring Prospectus, as the case may be, must
contain the grade/s given to the IPO by all CRAs approached by the company for grading
such IPO.

2. Further information regarding the grading process may be obtained from the Credit
Rating Agencies.

3. The company desirous of making the IPO is required to bear the expenses incurred for
grading such IPO.

4. A company which has filed the draft offer document for its IPO with SEBI, on or after 1 st
May, 2007, is required to obtain a grade for the IPO from at least one CRA.

5. IPO grade/s cannot be rejected. Irrespective of whether the issuer finds the grade given
by the rating agency acceptable or not, the grade has to be disclosed as required under the
DIP Guidelines.

6. However the issuer has the option of opting for another grading by a different agency. In
such an event all grades obtained for the IPO will have to be disclosed in the offer
documents, advertisements etc.

7. IPO grading is intended to run parallel to the filing of offer document with SEBI and the
consequent issuance of observations. Since issuance of observation by SEBI and the
grading process, function independently, IPO grading is not expected to delay the issue
process.

8. The IPO grading process is expected to take into account the prospects of the industry in
which the company operates, the competitive strengths of the company that would allow it to
address the risks inherent in the business(es) and capitalise on the opportunities available,
as well as the company’s financial position.

9. While the actual factors considered for grading may not be identical or limited to the
following, the areas listed below are generally looked into by the rating agencies, while
arriving at an IPO grad Business Prospects and Competitive Position.
i. Industry Prospects

ii. Company Prospects

Financial Position.
Management Quality.
Corporate Governance Practices.
Compliance and Litigation History.
New Projects—Risks and Prospects.

It may be noted that the above is only indicative of some of the factors considered in the
IPO grading process and may vary on a case to case basis.

10. IPO grading is done without taking into account the price at which the security is
offered in the IPO. Since IPO grading does not consider the issue price, the investor needs
to make an independent judgment regarding the price at which to bid for/subscribe to the
shares offered through the IPO.

11. All grades obtained for the IPO along with a description of the grades can be
found in the Prospectus. Abridged Prospectus, issue advertisement or any other place
where the issuer company is making advertisement for its issue. Further the Grading letter
of the Credit Rating Agency which contains the detailed rationale for assigning the particular
grade will be included among the Material Documents available for Inspection.

12. An IPO grade is NOT a suggestion or recommendation as to whether one should


subscribe to the IPO or not. IPO grade needs to be read together with the disclosures made
in the prospectus including the risk factors as well as the price at which the shares are
offered in the issue.

13. The grades are allocated on a 5-point scale, the lowest being Grade 1 and
highest Grade.

14. IPO Grading is intended to provide the investor with an informed and objective
opinion expressed by a professional rating agency after analyzing factors like business and
financial prospects, management quality and corporate governance practices etc. However,
irrespective of the grade obtained by the issuer, the investor needs to make his/her own
independent decision regarding investing in any issue after studying the contents of the
prospectus including risk factors carefully.

15. SEBI does not play any role in the assessment made by the grading agency. The
grading is intended to be an independent and unbiased opinion of that agency.

16. The grading is intended to be an independent and unbiased opinion of a rating


agency. SEBI does not pass any judgment on the quality of the issuer company. SEBI’s
observations on the IPO document are entirely independent of the IPO grading process or
the grades received by the company.

RATING IPO - POWERFUL GUIDANCE TOOL

SEBI's proposal to make the IPO assessment available to investors is a step in the right
direction.
Though the move to make IPO assessment mandatory has drawn some critical
comments, the need for a tool to help investors make better-informed decisions and judge the
quality of issues hitting the market is undisputed.

An IPO assessment brings four major pluses.


 Firstly, it improves information content through a professional and independent assessment.
 Secondly, it is relief for individual investors from information overload.
 Thirdly, it provides disincentives for weak companies to come to the market in the hope of
raising easy capital.
 And fourthly, it brings about greater level of investor sophistication.

ARRANGING AN IPO

1. Select Underwriter:-
 Provides procedural, financial advice.
 Ultimately buys issue from company (at “issue price”).
 Ultimately sells it to public (at “offer price”).

2. Prepare Registration Statement :-


For approval of SEC (in accord with Securities Act of 1933). Formal summary that
provides information on an issue of securities.

3. Prepare Prospectus:-
Streamlined version of registration statement, for consideration by potential investors.

4. Set price:-
 Road show:-
Talks organized to introduce company to potential investors, before the IPO.

 Bookbuilding:-
“Book Building” means a process undertaken by which a demand for the securities
proposed to be issued by a body corporate is elicited and built up and the price for such
securities is assessed for the determination of the quantum of such securities to be issued
by means of a notice, circular, advertisement, document or information memoranda or
offer document.

5. Selling the shares:-


 Best efforts offering:-
IPO method in which underwriter promises to sell as much as possible, give best
effort, not commit to selling all of issue.

 Firm commitment offering:-


Method in which underwriter buys the whole issue, bears all risk.

 Syndicate:-
Group of underwriters formed to sell a particular issue.

 Spread:-
Difference between public “offer price” and price paid by underwriter (“issue
price”). Biggest part of underwriter compensation.

PROCEDURE OF SALE OF IPO’S

IPOs generally involve one or more investment banks 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 (that is, the allocation and pricing) of shares in an IPO may take several forms.
Common methods include:
 Dutch auction
 Firm commitment
 Best efforts
 Bought deal
 Self Distribution of Stock

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. 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 as many as three 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, 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.

Usually, the offering will include the issuance of new shares, intended to raise new
capital, as well the secondary sale of existing shares. However, certain regulatory restrictions
and restrictions imposed by the lead underwriter are often placed on the sale of existing shares.
Public offerings are primarily sold to institutional investors, but some shares are also allocated to
the underwriters' retail investors. A broker selling shares of a public offering to his clients is paid
through a sales credit instead of a commission. The client pays no commission to purchase the
shares of a public offering; the purchase price simply includes the built-in sales credit.

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.

FACTORS REQUIRED TO APPLY FOR AN IPO

 Track record of the promoters


 Financials position of that company
 Read Prospectus very carefully
 Issue price

IPO RISKY FOR PUBLIC

IPOs can be a risky investment. For the individual investor, it is tough to predict what the
stock or shares will do on its initial day of trading and in the near future since there is often little
historical data with which to analyze the company. Also, most IPOs are of companies going
through a transitory growth period, and they are therefore subject to additional uncertainty
regarding their future value.

DRAWBACKS OF IPO

 It is true that IPO raises huge capital for the issuing company. But, in order to launch an IPO,
it is also necessary to make certain investments.

 Setting up an IPO does not always lead to an improvement in the economic performance of
the company. A continuing expenditure has to be incurred after the setting up of an IPO by
the parent company.

 A lot of expenses have to be incurred in the form of legal fees, printing costs and accounting
fees, which are connected to the registering of an IPO.

 The rules and regulations involved to set up public offerings and this entire process on the
other hand involve a number of complexities which sometime require the services of experts
in relevant fields.

ELIGIBILITY CRITERIA

Net Tangible assets of Rs. 3.00 Crore in each of the preceding 3 years. And Track
record of Distributable profits at least 3 out of 5 preceding years and The Company has a
Networth of Rs. 1.00 Crore in preceding 3 years and the proposed issue should not exceed 5
times of its Pre-issue networth. Book building process and 50% of the offer to QIBs or 15%
participation in project by F/Is or Schedule Banks;10% of the Project cost from appraiser;10% of
the Issue to QIBs and Minimum post issue face capital of Rs.10 Crores or Market making for 2
years and Minimum number of allottees atleast 1000 Minimum number of allottees atleast 1000.

SEBI GUIDELINES

1. Filing of prospectus:-
Prospectus to be filed with SEBI Through Merchant Banker At least 30 days <
filing with ROC SEBI may suggest changes < 30 days SEBI to consider only after approval
from St.Ex Issuer is obligated ,SEBI is not obligated.

2. Application for Listing:-


No IPO without application for listing application for Listing: No IPO without
application for listing.

3. Dematerialization of shares:-
Agreement with Depository Present shares also to be in dmat public may opt either
physical or dmat shares.
4. “Qualified Institutional Buyer” shall mean:-
 Public financial institution as defined in section 4A of the Companies Act, 1956.
 Scheduled commercial banks.
 Mutual funds.
 Foreign institutional investor registered with SEBI.
 Multilateral and bilateral development financial institutions.
 Venture capital funds registered with SEBI.
 Foreign venture capital investors registered with SEBI.
 State industrial development corporations.
 Insurance companies registered with the Insurance Regulatory and Development
Authority (IRDA).
 Provident funds with minimum corpus of Rs. 25 crores.
 Pension funds with minimum corpus of Rs. 25 crores).

4. Exemption from Eligibility Norms:-


Banking Co. including Pvt. Banks Subject to licensing by RBI. New Bank
being set up on acquisition or takeover of a bank. An infrastructure Company,
whose project is appraised by F/I, IL & FS and IDFC.

5. IPO Grading:-
No IPO unless; (as on the date of filing the prospectus with ROC): Grading for IPO
has been obtained from at least one agency Grading and the rationale have been included in
the prospectus Grading expenses to be borne by the issuer.

6. Present shares to be fully paid-up:-


No IPO, if there are any shares partly paid up as on the date of IPO the Shares to be
fully paid up or forfeited.

7. Pricing of the Securities:-


Listed Co’s- Free price/ Unlisted Co.s- Free price Infrastructure co. - Free price
Subject to the Disclosure norms issued by SEBI Banks to obtain approval from RBI.

8. Price Band:-
Price Band to be 20% Max price can be 20% above the floor price Board of directors
may be authorized to fix the price.

9. Denomination of shares:-
Denomination of the shares is not restricted In case the issue price is <Rs.500, the
Face Value shall be Rs.10/- The Face Value may be less, where the issue price is Rs.500 or
more. Full disclosure of the face value, in offer document.

10. Promoter Contribution and Lock-in:-


20% of the post issue share cap is to be held by promoters.

11. Securities not included in the above:-


Where the equity has been acquired during the preceding 3 years and; preceding 3
years and;
 where the consideration is not cash - where the consideration is not cash
or
 where the shares are given through bonus issue from revaluation reserve

CONCLUSION

IPO is used by a company to raise its funds. The extra amount obtained from public may be
invested in the development o f the company, although it costs a little to a company but it gives a
way to get more money for long term investments.

Book building
Introduction
To keep pace with the globalization and liberalization process, the government of India
was very keen to bring the capital market in line with international practices through
gradual deregulation of the economy. It led to liberalization of capital market in the
country with more expectations from primary market to meet the growing needs for funds
for investment in trade and industry. Therefore, there was a vital need to strengthen the
capital market which, it felt, could only be achieved through structural modifications,
introducing new mechanism and instruments, and by taking steps for safeguarding the
interest of the investors through more disclosures and transparency. As such, an important
mechanism named as Book building in the system of initial public offerings (IPOs) was
recognized by SEBI in India after having the recommendations of the committee under
the chairmanship of Y. H. Malegam in October, 1995. SEBI guidelines recognized book
building as an alternative mechanism of pricing. Under this approach, a portion of the
issue is reserved for institutional and corporate investors.

SEBI guidelines, 1995 defines book building as “a process undertaken by which a


demand for the securities proposed to be issued by a body corporate is elicited and built
up and the price for such securities is assessed for the determination of the quantum of
such securities to be issued by means of a notice, circular, advertisement, document or
information memoranda or offer document.”

Book building process is a common practice used in most developed countries for
marketing a public offer of equity shares of a company. However, book building is a
transparent and flexible price discovery method of initial public offerings (IPOs) in which
price of securities is fixed by the issuer company along with the Book Running Lead
Manager (BRLM) on the basis of feedback received from investors as well as market
intermediaries during a certain period.

Need of Book Building


The abolition of the Capital Issue Control Act, 1947 has brought a new era in the primary
capital markets in India. Controls over the pricing of the issues, designing and tenure of
the capital issues were abolished. The issuers, at present, are free to make the price of the
issues. Before establishment of SEBI in 1992, the quality of disclosures in the offer
documents was very poor. SEBI has also formulated and prescribed stringent disclosure
norms in conformity to global standards. The main drawback of free pricing was the
process of pricing of issues. The issue price was determined around 60-70 days before the
opening of the issue and the issuer had no clear idea about the market perception of the
price determined. The traditional fixed price method of tapping individual investors
suffered from two defects: (a) delays in the IPO process and (b) under-pricing of issue. In
fixed price method, public offers do not have any flexibility in terms of price as well as
number of issues. From experience it can be stated that a majority of the public issues
coming through the fixed price method are either under-priced or over-priced. Individual
investors (i.e. retail investors), as such, are unable to distinguish good issues from bad
one. This is because the issuer Company and the merchant banker as lead manager do not
have the exact idea on the fixed pricing of public issues.
Thus it is required to find out a new mechanism for fair price discovery and to help the
least informed investors. That’s why, Book Building mechanism, a new process of price
discovery, has been introduced to overcome this limitation and determine issue price
effectively. Public offers in fixed price method involve a pre issue cost of 2-3% and carry
the risk of failure if it does not receive 90% of the total subscription. In Book Building
such cost and risks can be avoided because the issuer company can withdraw from the
market if demand for the security does not exist.

Malegam Panel’s Recommendations:


The introduction of book-building in India in 1995 was on account of the
recommendations of an expert committee appointed by SEBI under Chairmanship of YH
Malegam “to review the (then) existing disclosure requirements in offer documents.” Two
of the terms of reference being “the basis of pricing the issue” and “whether substantial
reduction was possible in the time taken for processing applications by SEBI.” The
committee has submitted its report with several recommendations and the SEBI accepted
the same in November 1995. The book-building route should be open to issuer
companies, subject to certain terms and conditions. Some of them are presented below:
1. The option should be available only to issues exceeding Rs. 100 crore;
2. The book-building issuer companies could either reserve the securities for firm
allotment or avail themselves of the book-building process;
3. Draft prospectus to be submitted to SEBI could exclude information about the offer
price;
4. A book runner to be nominated from among the lead merchant bankers, charged with
specific responsibilities and the name is to be submitted to the SEBI’s approval
5. The requirement of 25 percent of the securities to be offered to the public will be
continued.
There have been several amendments/revisions to the above guidelines; the first one in
December 1996 made available the option of book-building to all corporate bodies which
were otherwise eligible to make an issue of capital to the public, and in case of under
subscription, the spill-over from the public portion could be permitted to the placement
area and vice-versa.
In 1997, the restriction of the facility to 75 % of the issue was thought to severely
constrain the benefits arising out of price and demand discovery, and the facility was
extended to 100 percent of the issue, available only if the issue amount was Rs. 100 crore
and above, compulsorily offering an additional 10 percent of the issue to the public
through prospectus, and reserving at least 15 percent of the issue size to individual
investors applying up to ten tradable lots. Further, audited financial ratios had to be
disclosed, namely, EPS, P/E, average return on net worth for the last three years and net
asset value based on last year’s balance sheet. However, there were no takers for the 100
percent book-building facility. Based on suggestions made by leading merchant bankers,
the following amendments were made to the guidelines in 1999:
1. The issuer may be allowed to disclose either the issue size or the number of securities
to be offered to the public;
2. Allotment should be in demat mode only; and
3. Reservation of 15 percent of issue amount for individual investors need to the public at
a fixed price.
Some of the earliest mega issues through the book-building route were those of Larsen
&Toubro, ICICI, TISCO and others.
Book Building and Fixed Price Option in the IPOs
A company may raise capital in the primary capital market through initial public offers
(IPOs), rights issues and private placement. IPOs, the largest sources of funds in the
primary capital market, to the company are basically an invitation by a company to the
public to subscribe to its securities offered through prospectus.
In fixed price process in IPOs, allotments of shares to all investors are made on
proportionate basis. Institutional investors normally are not interested to participate in
fixed price public issues due to uncertainty of allotment and lack of opportunity cost. On
the other, they like to participate largely in book built transactions as in this process the
costs of public issue and the time taken for the completion of the entire process are much
lesser than the fixed price issues.
In Book Building the price is determined on the basis of demand received or at price
above or equal to the floor price whereas in fixed price option the price of issues is fixed
first and then the securities are offered to the investors. In case of Book Building process
book is built by Book Runner Lead Manager (BRLM) to know the everyday demand
whereas in case of fixed price of public issues, the demand is known at the close of the
issue.

How is Book Built in India?


The main parties who are directly associated with book building process are the issuer
company, the Book Runner Lead Manager (BRLM) and the syndicate members. The
Book Runner Lead Manager (i.e. merchant banker) and the syndicate members who are
the intermediaries are both eligible to act as underwriters. The steps which are usually
followed in the book building process can be summarized below:
1. The issuer company proposing an IPO appoints a lead merchant banker as a
BRLM.
2. Initially, the issuer company consults with the BRLM in drawing up a draft
prospectus (i.e. offer document) which does not mention the price of the issues,
but includes other details about the size of the issue, past history of the company,
and a price band. The securities available to the public are separately identified as
“net offer to the public”.
3. The draft prospectus is filed with SEBI which gives it a legal standing.
4. A definite period is fixed as the bid period and BRLM conducts awareness
campaigns like advertisement, road shows etc.
5. The BRLM appoints a syndicate member, a SEBI registered intermediary to
underwrite the issues to the extent of “net offer to the public”.
6. The BRLM is entitled to remuneration for conducting the Book Building process.
7. The copy of the draft prospectus may be circulated by the BRLM to the
institutional investors as well as to the syndicate members.
8. The syndicate members create demand and ask each investor for the number of
shares and the offer price.
9. The BRLM receives the feedback about the investor’s bids through syndicate
members.

10. The prospective investors may revise their bids at any time during the bid period.

11. The BRLM on receipts of the feedback from the syndicate members about the bid
price and the quantity of shares applied has to build up an order book showing the
demand for the shares of the company at various prices. The syndicate members
must also maintain a record book for orders received from institutional investors
for subscribing to the issue out of the placement portion.

12. On receipts of the above information, the BRLM and the issuer company
determine the issue price. This is known as the market-clearing price.
13. The BRLM then closes the book in consultation with the issuer company and
determine the issue size of (a) placement portion and (b) public offer portion.
14. Once the final price is determined, the allocation of securities should be made by
the BRLM based on prior commitment, investor’s quality, price aggression,
earliness of bids etc. The bid of an institutional bidder, even if he has paid full
amount may be rejected without being assigned any reason as the Book Building
portion of institutional investors is left entirely at the discretion of the issuer
company and the BRLM.
15. The Final prospectus is filed with the registrar of companies within 2 days of
determination of issue price and receipts of acknowledgement card from SEBI.
16. Two different accounts for collection of application money, one for the private
placement portion and the other for the public subscription should be opened by
the issuer company.
17. The placement portion is closed a day before the opening of the public issue
through fixed price method. The BRLM is required to have the application forms
along with the application money from the institutional buyers and the
underwriters to the private placement portion.
18. The allotment for the private placement portion shall be made on the 2nd day from
the closure of the issue and the private placement portion is ready to be listed.
19. The allotment and listing of issues under the public portion (i.e. fixed price
portion) must be as per the existing statutory requirements.
20. Finally, the SEBI has the right to inspect such records and books which are
maintained by the BRLM and other intermediaries involved in the Book Building
Book building process
Regulatory Framework
The Book Building guidelines were first introduced by SEBI in 1995 (clarification XIII,
dated 12.10.95) for optimum price discovery of corporate securities. The SEBI, from time
to time modifies the guidelines in order to upgrading the existing mechanism. The SEBI
in its press release dated 7th September, 1998 prescribed the fresh guidelines for book
building mechanism after thorough modification and it was again modified in
2001(Circular No.2, dated 6.12.2001) and 2003(Circular No. 11, dated 14.08.2003).

Some of the guidelines of SEBI are:


1. In January 2000, SEBI has issued a compendium of guidelines, circulars and
instructions to merchant bankers relating to issue of capital, including those on the
book-building mechanism. The compendium includes a model time frame for
book-building: “After the price has been determined on the basis of bidding,
statutory public advertisements for a continuous three days containing, inter alia,
the price as well as a table showing the number of securities and the amount
payable by an investor, based on the price determined, shall be issued and the
interval between the advertisement and issue opening date should be a minimum
of five days.”
2. The draft prospectus to be circulated has to indicate the price band within which
the securities are being offered for subscription. The bids have to be within the
price bands. Bidding is permissible only if an electronically- linked transparent
facility is used. An issuing company can also fix a minimum bid size. An initial
bid can be changed before the final rate is determined.
3. The Prospective bidders were advised to read the “Red herring prospectus”
carefully. According to the Act, a “Red herring prospectus” means a prospectus
that does not have complete particulars on the price and the quantum of securities
offered.
4. The year 2000, Amendment to the Act gave legal cloak to the book-building route
by allowing circulation of the information memorandum and the red herring
prospectus. According to the Act, a process is to be undertaken prior to the filing
of a prospectus by which a demand for the securities proposed to be issued by a
company is elicited, the price and the terms of the issue of such securities are
assessed by means of a notice, circular, advertisement or document. Incidentally,
the working group on the Comprehensive Companies Bill, 1997 (since lapsed) had
advocated introduction of book-building. It defined the term as “an international
practice that refers to collecting orders from investment bankers and large
investors based on an indicative price range. In capital markets, with sufficient
width and depth, such a pre-issue exercise often allows the issue to get a better
idea of the demand and the final offer price of an intended public offer.”

5. SEBI (Disclosure and Investor Protection) Guidelines, 2000 contains provisions


for book building under chapter XI that includes guidelines for 75 per cent bookbuilding
process, 100 per cent book-building process, disclosure requirements,
allocation/allotment procedure and maintenance of books and records.
According to the SEBI, a public issue through Book Building route should consist of two
portions:
(a) The Book Building portion and
(b) The fixed price portion.
The fixed price portion is conducted like normal public issues (conventionally followed
earlier) after the book built portion during which the issue price is fixed after the bid
closing date. Basically, an issuer company proposing to issue capital through book
building shall comply with the guidelines prescribed by SEBI. However, the main theme
of SEBI guidelines regarding book building can be presented at a glance in the following
manner:
1. 75% Book Building process: Under this process 25% of the issue is to be sold at a
fixed price and the balance 75% through the Book Building process.
2. Offer to public through Book building process: The process specifies that an issuer
company may make an issue of securities to the public through prospectus in the
following manner:
a. 100% of the net offer to the public through book-building process, or
b. 75% of the net offer to the public through book-building process and 25%
of the net offer to the public at the price determined through book building
process.
100% of the net offer to the public through 100% Book Building process
T
he net offer to the public, under this process shall be fully underwritten by the syndicate
members/book running lead managers. The syndicate members are to enter into an
underwritten agreement with the BRLMs indicating the number of securities which they
would like to subscribe at the pre-determined price and BRLMs shall in turn enter into an
underwritten agreement with the issuer company. If the syndicate members are not able to
fulfill their underwritten obligations, the BRLMs shall be responsible for bringing in the
amount involved. The bid remains open for at least five days. The date of opening as well
as closing of the bidding, the names and addresses of BRLMs, syndicate members,
bidding terminals for accepting the bids must be mentioned in the advertisement.
Recent Changes in Book- Building Mechanism:
The Securities and Exchange Board of India on March 29, 2005 announced sweeping
changes in the IPO norms. They are as follows:
1. Increased allocation for retail investors in book-built issue from 25 per cent to 35
per cent and has also changed the definition of the retail category.
2. The market regulator has now permitted retail investors to apply for Rs. 1 lakh
worth of shares in a book-built issue against Rs. 50,000 earlier. For this purpose,
SEBI has redefined the retail individual investor as one who applies or bids for
securities of or for a value not exceeding Rs. 1 lakh.
3. It has reduced the non institutional category, popularly known as high net worth
individuals (HNI), allocation from 25 per cent to 15 per cent.
4. Institutional investors include foreign financial institutions (FII) banks, mutual
funds and Indian financial institutions like LIC or IDBI.
5. The changes have been made in the SEBI (DIP) Guidelines, 2000 on the basis of
recommendations made by SEBI’s primary market advisory committee.
6. The new norms will be applicable to all public issues whose draft offers
documents are filed with SEBI on or after April 4, 2005.
7. SEBI has decided to reduce the bidding period from the current 5 to 10 days
(including holidays) to 3 to 7 working days.
8. It has also provided more flexibility for listed companies to disclose price
band/floor price for public issues one day before bid opening.
9. SEBI has decided to give an option to listed issuers to either disclose price band in
RHP/application form/abridged prospectus (current practice) or to disclose the
price band/ floor price at least one day before bid opening.
10. It is proposed to amend the guidelines to improve contents and ensure uniformity
in data display on the websites of the stock exchanges. The date will be made
available for a further period of three days after the closure of the bids/issue.

Limitations of Book Building Mechanism


Retail investors are not free from certain disadvantages compared to institutional
investors in Book Building, which does not provide an appropriate price discovery
mechanism. It is the main reason why small investors have stayed away from the market.
It needs changes to make it more suitable to the Indian context and the conditions
prevailing in the Indian capital market.
In the IPOs through the Book-Building route, it would be difficult to find dubious issues
of the kind that put off investors. The book-building system has various limitations. Some
of them are as are as follows:
1. Book-building is appropriate for mega issues only. In the case of the potential
investors, the companies can adjust the attributes of the offer according to the
preferences of the potential investors. It may not be possible in big issues since the
risk-return preference of the investors cannot be estimated easily;
2. The issuer company should be fundamentally strong and well known to the
investors;
3. The book-building system works very efficiently in matured market conditions. In
such circumstances,
4. The investors are aware of the various parameters affecting the market price of the
securities. But, such conditions are not commonly found in practice;
6. There is a possibility of price rigging on listing as promoters may try to bail out syndicate
members.

Green Shoe Option


In most of the cases, it is experienced that IPO through Book Building method in India
turns out to be overpriced or underpriced after their listing of them and ultimately the
small investors become a net looser. If the IPO is overpriced it creates a bad feeling in
investor’s mind as initial returns to them may be negative at that point of time. On the
other side, if the prices in the open market fall below the issue price, small investors may
start selling their securities to minimize losses. Therefore, there was a vital need of a
market stabilizer to smoothen the swings in the open market price of a newly listed share,
after an initial public offering.
Market stabilization is the mechanism by which stabilizing agent acts on behalf of the
issuer company, buys a newly issued security for the limited purpose of preventing a
declining in the new security’s open market price in order to facilitate its distribution to
the public. It can prevent the IPO from huge price fluctuations and save investors from
potential loss. Such mechanism is known as Green Shoe Option (GSO) which is an
internationally recognized for market stabilization. So, GSO can rectify the demand and
supply imbalances and can stabilize the price of the stock. It owes its origin to the Green
Shoe Company which used this option for the first time throughout the World.
ICICI Bank has, used Green Shoe Option in first time in case of its public issue through
the book building mechanism in India. As such, such important mechanism i.e. GSO in the
system of initial public offerings (IPOs) using book building method was recognized by SEBI
in India through its new guidelines on 14.08.2003 (vide
SEBI/CFD/DIL/DIP/Circular No.11). In case an initial public offer of equity shares is
made by an issuer company through the book building mechanism, the Green Shoe option
(GSO) can be used by such company for stabilizing the post listing price of its shares,
subject to the guidelines prescribed by SEBI.
According to SEBI guidelines, “a company desirous of availing the GSO shall in the
resolution of the general meeting authorizing the public issue, seek authorization also for
the possibility of allotment of further shares to the ‘stabilizing agent’ (SA). The company
shall appoint one of the lead book runners, amongst the issue management team, as the
“stabilizing agent” (SA), who will be responsible for the price stabilization process, if
required. The SA shall enter into an agreement with the issuer company, prior to filing ofoffer
document with SEBI, clearly stating all the terms and conditions relating to this
option including fees charged / expenses to be incurred by SA for this purpose. The SA
shall also enter into an agreement with the promoter(s) who will lend their shares,
specifying the maximum number of shares that may be borrowed from the promoters,
which shall not be in excess of 15% of the total issue size. The stabilization mechanism
shall be available for the period disclosed by the company in the prospectus, which shall
not exceed 30 days from the date when trading permission was given by the
exchange(s)”.
Conclusion
Book Building process aims at fair pricing of the issue which is supposed to emerge out
of offers made by various investors. One question may arise whether book b uilding is the
right mechanism for fair pricing discovery in IPOs? The answer may be in the negative
because a floor price is fixed for the Book Building below which no bid can be accepted.
Since investors participate through Book Building process in making fair pricing of IPOs
where there is no ceiling price, there should not be any floor price. In addition to this,
unlike international market, India has not reached the stage of development of the
institutional framework to experiment with the book building process because retail
investors (i.e. individual investors) are still now an integral part of Indian capital market.
If the interests of the small investors are not safeguarded appropriately, this may be very
dangerous to the primary capital market. Although only two book built issues — Hughes
software and HCL Technologies have given proper returns to the shareholders in 1999
and Maruti Udyog in 2003 but the other four book built issues of Shree Rama Multitech,
Cadila, Cinevista and Mascot system were trading at huge discounts to their issue priceranging
between 35-50%.

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