What is IPO?
IPO stands for Initial Public Offering. As the name suggests it’s the process wherein a company goes to public for the first time for raising money by offering ownership in the company. In this process a private limited company becomes Public Limited Company.
The main aim of coming to IPO is to raise funds for expanding the business. The structure of a public limited company is different from that of a privately held company. Once it becomes public it must disclose its financial reports on a regular basis (In most cases, Quarterly) to public. It has to appoint share holders elected directors who take key decisions of business. But if the promoter holds major percentage he still can influence the decisions. Read more
IPO β Methods of Pricing
Once the registration gets approved by the regulator and the completion of meetings with potential investors the company and investment bank together decide on issue date, issue price and the minimum lot quantity that an investor should subscribe to. The maximum quantity (amount) that an investor can subscribe to depends on the category (eg; retail investor, Mutual Fund etc) that the investor falls into. This limit and categorization are provided by the regulator. However the exact price is decided by one of the following methods.
Fixed Price Method
Book Building method
Fixed Price Method: In this method of pricing the investment bank in consultation with the firm fixes the price at which an investor can subscribe to. This price could be at par value or at a premium above the par value. Read more
IPO β Filing Documents and Red Herring Prospectus
The investment bank prepares a registration statement to be filed with the regulator (SEC in US and SEBI in India). This registration document contains the management related information, the current promoters’ holdings structure, financial statements of the firm, legal issues related information, if any and the purpose of IPO.
This document must be signed off for further proceedings. The regulator takes some time, which is called as ‘cooling off period’, to verify accuracy of the information provided in the registration document. Since the company will become public limited (from privately held) and the regulator has to look after the interests of investors, there are strict rules in place to get the required approval. Read more
IPO β Agreement with Investment bank
A company first informs the underwriter how much capital it wants to raise through IPO. Then the merchant bank analyzes the market conditions and the goodwill the company has in the market and lets the firm know if they can raise that much amount. Once the capital to be raised is frozen fee structure to be paid to the investment bank (merchant bank) is finalized.
There are two types of structures as far as the underwriting is concerned.
Firm Commitment basis
Best efforts basis
Firm Commitment basis: In this type of agreement the investment bank agrees to underwrite the issue i.e. it buys the shares from the firm and sells them in IPO. If some part of the issue is not subscribed then it will have to take the responsibility and hold the shares. However it can sell them off in secondary market in favorable conditions, if they want. In this process, the merchant banker acts as a dealer and the spread (difference between the price it offers to public and the price at which it buys from the firm) is the profit. Read more
IPO β Role of Underwriter
When a company wants to raise funds through initial public offering (IPO) it appoints an investment bank for underwriting the issue. An Investment bank is also called as merchant bank. There is no regulatory restriction to use the services of a merchant bank for IPO. Since in an IPO a company participates for the first time, it doesn’t have complete understanding of the rules and documentation, required to be submitted, to get a clearance from the regulator. Read more
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