This article is written by Advocate Shamika Vaidya pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.com. Here she discusses the Initial Public Offering.

Introduction

A private company is proscribed from having more than 200 shareholders. Private companies get listed so that it can extensively raise funds from the public. A listed company can trade its shares on the stock exchanges. Companies, like Reliance Power, have raised 11,560 crores in the past from Initial Public Offering. Many Private Equity /Venture Capital Investors who hold a considerable stake in the company looks forward to a company to go public for profitable exits as well. Nevertheless, there are a set of compliances that vis-a-vis follows this advantage

Pursuant to the Initial Public Offering, a company is converted into a public listed company and the shares of the company are traded on the stock exchanges. Through an IPO a company offers its shares to the public for the first time.

In an IPO, companies put forward the price/price band at which they would offer the securities to the public and the later then subscribes to the securities. The intermediaries appointment, compliances, disclosures are stated in the Securities Exchange Board of India (Issue of Capital and Disclosure Requirements), 2018.

There are two ways through which a company can undertake an IPO;

1. Book Building Process
2. Fixed Price Issue

Book Building Issue

• In the event a company is able to satisfy the requisite requirements as stated in the ICDR regulations, it can undertake an IPO through the book building process subject to certain conditions.
• In a book building issue, a price band is disclosed to the investors. The price is discovered through the process of book building.

Fixed Price Issue  

• Unlike the book building process, in a fixed price issue the investors are informed about the exact price at which the securities are offered. Therefore, the investors have no say in the price determination.
• Pursuant to the introduction of the book building issue most of the companies prefer the book building route and fixed price issue has become obsolete.

Eligibility for a company to undertake an IPO

• Regulation 6(1) of the ICDR states the minimum financial threshold to be eligible for the Initial Public Offering.

Net Tangible Asset         Three crore

Operating Profit               Fifteen crore

Net worth                         One crore

• The company should be satisfying the above threshold in the last three preceding years.
• In case, the company has changed its name in one last year, fifty percent of the revenue has to be earned from the activities by its new name.

• The net tangible assets held in the monetary asset cannot be more than fifty percent. In case it exceeds fifty percent, the excess monetary assets have to be utilized or committed to be utilized in business or projects.

• An issuer is not eligible to make an initial open offer if the issuer, its promoter group, promoters, directors or selling shareholders are debarred from accessing the capital market or if the promoters or directors are willful defaulters or fugitive economic offenders subject to certain conditions.
• If there are outstanding convertible security or any right which would entitle a person to receive equity shares on exercising the option.

Promoters’ holding

• The holding of the promoter of the issuer should be twenty-five percent of the post issue capital.
• In case, the promoter’s holding is less than 20% then alternative investment funds, foreign venture capital funds, scheduled commercial banks or public financial institutions or insurance companies can contribute to meet the shortfall.
• Having said that, these funds and institutes can contribute a maximum of ten percent of the post issue capital.
• If the promoters have to subscribe to the equity shares in order to meet the minimum promoter contribution then he has to keep his contribution in an escrow account with a scheduled commercial bank.
• The promoters have to fulfill the requirement at least a day prior to the date of opening of the issue.
• Regulation 15 (1) states the securities that are ineligible for the minimum promoters contribution.

Lock in periods

• The contributions in the minimum promoter contribution by the promoter along with AIF, VCF and other institutes who are eligible to contribute a maximum of 10% are subjected to a lock-up period of three years.
• Promoter holdings that are in excess than the minimum requirement are subjected to a lock-in period of one year pursuant to the allotment date.
• The lock-in period of the people other than the promoter of the pre-issue capital is locked in for the period for one year.
• This does not apply to equity shares allotted to the employees subject to some conditions
• Equity shares held by VCF, AIF Category I & II and Foreign Venture Capitalist are exempted from lock-in. Nonetheless, they are locked in for a period of one year from the date of purchase.
• Securities held by promoters that are locked in can be transferred to other promoters or any person from the promoters group.   

Intermediaries Involved

The following intermediaries are appointed during the Initial Public Offer;

1. Merchant Banker
2. Underwriters
3. Credit rating Agencies
4. Legal Advisors
5. Banker to the issue
6. Book Running Lead Managers
7. Stock Brokers
8. Registrar to the Issue
9. Compliance Officer
10. Syndicate Members  

Merchant Banker

• The company has to appoint one or more registered merchant bankers as lead managers to the issue. Merchant Bankers are entrusted with the responsibility of issue management.
• They have to perform their role in accordance with SEBI (Merchant Banker) Regulations, 1992. At the inception of the issue, the issue manager has to enter into an agreement with the issuer as provided by the regulation. The contents of the agreement are explicitly mentioned in Schedule II.  
• Regulation 64 casts an obligation on the lead manager pursuant to satisfying himself about the aspects of the issue. Form H Format of due diligence certificate filed by the lead manager for IDR issue.

Underwriters

• One of the concerns for the issuers is the inherent risk for in public offers. There is no way to gauge the outcome of the process as several variables are involved. The concept of underwriting was evolved recognizing the importance of risk mitigation.
• The obligations and eligibility of the underwriters are governed by the SEBI (Underwriters) Regulations 1993.
• An underwriting Agreement is entered between the Issuer Company and underwriter wherein the underwriter buys shares from the issuer in case the issue is not able to reach the mandatory subscription threshold for its success.

Credit Rating Agencies

• A credit rating agency assesses the financial strength of companies especially their ability to meet principal and interest payment on their debts.
• A unique letter based scores (AAA, +AAA) are used to indicate if debt is low or high.

Registrar to the Issue

Registrar to the issue deletes the invalid application and ensures that the refund is dispatched. He finalizes the list of eligible allottees’. Overall, the flow of applications from collecting, processing, basis of allotments and dispatch of security certificates. It should have connectivity with all depositories.

Syndicate Members

• The broking houses are responsible for the distribution and gathering of the applications and updating the data on the stock exchange on a regular basis in a book built issue.
• Syndicate members have to procure ASABA forms and submit them to Self Certified Syndicate Banks.

ASBA (Application Supported by the Block Amount)

• SEBI has enabled the investors to make payments through ASBA route. Under this option, the bank holds a lien on investor deposits. The amount remains in the saving account and the applicant receives interest on the blocked amount.
• The issuer has to provide  ASBA facility if the applicant is holding shares in dematerialized form.
• In ASABA facility one can give five IPO application through a single saving account.

Documents      

Draft Offer Document

• An offer document provides detailed information about operational and financials of the company. The document contains disclosures which enable applicants to take an apposite investment decision.

Red Herring Prospectus

• A Red Herring Prospectus is an offer document used for book built issue. As already discussed, the bookbuild issue does not offer a fixed price but merely price band, the RHP contains the price band.

Prospectus    

• An offer document circulated during the fixed price issue is known as a prospectus.

Listing Agreement

• A listing Agreement is entered between an issuer and stock exchanges where the shares of the company would trade pursuant to an IPO.
• It contains an exhaustive list of compliances and conditions that have to be complied and followed by the issuer.

Agreement with depository

The issuer has to enter into an agreement with the depositories as the investors can receive their securities in dematerialized form through any of the depositories.

Abridged Prospectus

• Abridged Prospectus contains disclosures that are specified in Schedule VI Part E.
• Applications distributed to people have to be accompanied by an abridged prospectus.

Allocation of the shares

• Rule 19 of Securities Contracts (Regulations) Rules, 1957 states that the minimum public shareholding in a listed company should be at least 25%.

Retail Investors                           not less than 35%

Qualified Investors                            not less than 15%

Non-Institutional Investors                not more than 50%

The issuer may make reservations on a competitive basis out of the issue size excluding promoters’ contribution in favor of the following categories of persons: a) employees;  b) shareholders (other than promoters and promoter group) of listed subsidiaries or listed promoter companies.

 Retail Institutional Investors (RII)

Retail Investors includes the public and the maximum amount of investment for them is 2 lakh rupees.

Qualified Institutional Buyer (QIB)

Qualified Institutional Buyers are defined in clause 2.2.2B (v) of the DIP Guidelines. Foreign Venture Capital Investors, Mutual Funds, Venture Capital Investors etc are few of the QIB.

Non-Institutional Investors (NII)

Resident Indian Individuals, HUF’s, companies, corporate bodies, societies and trusts investing more than  2 lakh fall under the category of Non-Institutional Investors.

Anchor Investors

• Regulation 2(c) defines Anchor investors as the qualified institutional buyer who makes an application of at least ten crore rupees in the book building process.
• InterGlobe Aviation had raised Rs. 832 crore from 43 anchor investors ahead of its IPO.
• Anchor allotment happens a day prior to the IPO. Roping in anchor investors gives comfort to the banker and security to other investors as a large number of the IPO gets covered before the opening day. Anchor Investors not only pool in good investments but are efficacious for subscriptions.

Procedure

Filing of Offer Document

• The issuer has to choose one of the stock exchanges to seek in principle approval for listing which has the power to grant or reject the approval.
• The issuer has to file three copies of the draft offer letter with SEBI along with the fees through the lead managers.
• Along with the offer documents the lead manager has to submit a certificate confirming agreement between him and the issuer and a due-diligence certificate.
• The draft offer document has to be filed with stock exchanges.
• SEBI may specify changes or issue observations on the documents. If certain changes are suggested by the Board then the same has to be incorporated.
• The document is then registered with the Registrar of Companies. Copies of the document are again sent to the stock exchanges and Board pursuant to the filing.

Pre-issue Advertisement

• The issuer has to make a public announcement in English, Hindi and Regional Language within two days from filing the draft letter of offer.
• The issuer has to disclose the floor price/price band two working days prior to the two working days in a book built issue if the same is not disclosed in the red herring prospectus.
• The draft letter of offer and the letter of offer is to be hosted on the website of the stock exchanges where the securities are proposed to get listed so that it is available for the public to comment.
• The lead manager has to file the comments by the public and the changes that the company incorporated.
• The stock exchanges and the lead managers have to provide copies of the draft to the public if requested by them.
• During the period the issue is open for subscription, no advertisement shall be released giving an impression that the issue has been fully subscribed or oversubscribed or indicating investors’ response to the issue.

Issue Marketing

• In order to market the issue, roadshows are conducted and pre-issue meets are arranged with media men and investor associations.
• A roadshow is a series of meetings and presentation that is given to potential buyers about the issue.

Security Deposit

• The issuer has to pay an amount which is equal to 1% of the issue size before opening the subscription list.
• The amount deposited is refunded to the issuer on the total completion of the issue or is forfeited in the case of default or non-compliance.

Bidding in case of Book Building Procedure

• Book building procedure is a price discovery mechanism. The investors have to bid in order to buy shares at price pursuant to the announcement of the price band through the Red Herring Prospectus.
• The applications of money and bids have to be submitted to the investment banker.
• The final price is determined by the weighted average of all the received bids. The applications of the bidders with bids lower than the cut-off price are rejected.
• The price difference of the application and cut-off price are refunded to the investors.

Issue

• The issue should open within a year from the date of issuance of the observations by SEBI.
• The issue is opened after at least three working days pursuant to registering offer document with RoC
• A public issue is kept open for three days; however, in case there is a revision in the price brand an additional three days is given. The total extensions cannot be for more than ten working days.
• The minimum application size is one lakh rupees per application.   
• The invites for the applications have to be in multiples of the minimum application size.

Allotment of the shares

Undersubscribed

• An IPO has to be subscribed at least 90% of the issue, the underwriters buy the securities that are needed to complete the threshold in case the total subscription does not reach the threshold.
• Despite underwriters coming into play, the subscription is not able to reach 90% then the issuer has to refund all the monies within fifteen days from the date of closure.

Oversubscribed

• In the event of oversubscription of the IPO, not everyone is successful in getting the allotment. The allotments happen on the pre-defined rules by SEBI.
• The IPO of Avenue Supermarket, the parent of DMART was oversubscribed for a whopping 104.48 times.
• PNB Housing Finance’s ₹3,000 crore offer in October last year received bids for 463.61 crore shares against the total issue size of 4.43 crore shares. Advanced Enzyme was oversubscribed 116 times      

Post Issue Advertisements

• Pursuant to the issue an advertisement is to be given with the important details regarding the issue. Regulation 51(1) explicitly states the topics which have to be mentioned. The advertisement has to be released within ten days from the date of completion in English, Hindi and regional language newspapers with wide circulation.
• The details have to be uploaded on the websites of the stock exchanges as well.

Release of the Subscription money

• Copies of listing and trading approvals have to be sent to the banker for them to release the money to the issuer.
• In case the issuer is unable to obtain requisite approvals the subscription money is refunded.

Conclusion

Investing in a listed company is preferred by investor due to easy exit opportunities. Listed companies are under obligation to give timely disclosures and follow all the compliances. This transparency boosts investments as it creates confidence amongst the investors. Further, a company can raise capital pursuant to the IPO through FPO and Private Placements. It can also delist itself from the stock exchanges.

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