Initial Public Offerings

When a private company first sells shares to the public, this process is called an initial public offering (IPO). IPO means that the ownership of the company is transitioning from private ownership to public ownership. That is the reason, the IPO process is popularly referred to as "Going Public."

Start-up companies or even companies that have been in business for decades can decide to go public through an IPO. For instance, TCS was established in 1968 but went public only after 36 years in 2004. IPO proceeds are normally used to pay off debts, fund growth, fund mergers and acquisitions, raise public profile, offer exit to early investors etc.

The first step for any IPO is to select the Book Running Lead Manager (BRLM), which acts as the lead manager for the entire issue process till it is actually listed.

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The working of the IPO entails 5 important steps as under.

Here are the five primary steps in the IPO process and what investors can look for along the way:

• The first step is to hire an investment bank to lead manage the issue. At this stage, the company issuing the IPO and the investment bankers discuss the future plans of the company, the quantum of funds required and an indicative issue size and pricing.
• The second stage is the due diligence and filing. The DRHP or draft red herring prospectus is filed with SEBI and the normal time frame for approval and SEBI observations is 2-3 months. IPO process only starts after that.
• Once the SEBI approves the DRHP the next big challenge is the marketing. Normally, marketing of the issue is done through road show for institutional investors and via broker meets for retail and HNI investors. The idea is to create interest in investors and to gauge likely price for the issue.
• The next step is pricing of the IPO and here the price band is determined by the issuer and the investment banker based on the feedback received from the road shows. The pricing has to also be justified based on valuation parameters. Companies try to slightly under-price the issue to leave returns on the table for investors.
• The last step is the actual public issue, ensuring subscriptions, coordinating with the exchanges for the finalization of the basis of allotment, allotment and demat credits and finally the listing. Most IPOs are tracked for a few months post the IPO also.

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Here are some of the pre-requisites for a person to be eligible to apply for the IPO.

• The IPO application must be an adult i.e. above 18 years of age as on the date of the IPO and hence eligible to enter into a contract.
• The applicant must be eligible to enter into a contract under Indian Contracts Act and must not have been barred from entering into contracts due to reasons like being of unsound mind, insolvency or for any other reason.
• To be eligible to apply for an IPO, the person must have a valid Demat account. While a trading account is not mandatory for applying in the IPO, it is always advisable to have a trading account as the IPO shares cannot be sold on listing without a trading account.
• Any investor interested in buying IPO shares must be mandatorily holding a valid PAN card issued by the Income Tax Department (ITD). An investor is not eligible to apply for the IPO unless he/she has a valid PAN card and it is mapped to demat account.

There are several reasons for a company to launch an IPO.

• The first reason is to raise capital for the business. All businesses need capital to grow and expand and one of the best ways is to raise through risk equity. Equity funds can also be used for reducing debt and occasionally for working capital needs too.
• Many companies, especially in the digital space, get a lot of private equity investors and venture capitalists investing in these companies when they are still private. The IPO can be used as a route to give them an exit from the company.
• Indian companies are offering employee stock option plans (ESOPs) to senior employees and getting the company listed can give a valuation benchmark for the employees and also an eventual exit route for them.
• In some sectors, it is much easier to go through the inorganic mergers and acquisitions route. IPOs can be used to fund these M&A deals so as to accelerate the growth of the company, rather than recreating the wheel all over again.
• In many cases, the IPO is purely meant to increase the visibility and the image of the company and give the company a solid brand image in the market.

Once you have submitted the bids and the IPO is closed, do you know what exactly happens after that?

• The first thing after the IPO closes is the finalization of allotment, which is normally done by the third working day. This is the basis of allotment date. The day after that, the refunds are initiated for unallotted shares and the next day, shares are allotted and credited to the demat account. You are ready for the listing.
• Are all IPO applications accepted? The first step is to distil the valid bids. Any bid form that is incomplete or incorrect is rejected. Then the subscription level over the issue size is determined. If the issue is oversubscribed in the retail portion, the first attempt will be to see that all valid applicants at least get minimum number of shares. Then allotment is done proportionately.
• Since applications are via ASBA, no amount is debited but only funds are blocked in the bank accounts. The day after the basis of allotment, refunds are initiated by unblocking such excess ASBA mandates. After that the allotment and demat credit is done.

While the stock lists only about 6 working days after the closure of the IPO, the informal Grey market starts trading much earlier. Once the stock is listed, it can be sold by most investors, unless there is lock in, as in the case of insiders and anchors in the IPO.