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It is that market in which shares, debentures and other securities are sold for the first time
for collecting long-term capital.
This market is concerned with new issues. Therefore, the primary market is also called
New issue market.
In this market, the flow of funds is from savers to borrowers (industries), hence, it helps
directly in the capital formation of the country.
The money collected from this market is generally used by the companies to modernize
the plant, machinery and buildings, for extending business, and for setting up new
business unit.
Promoter's Credibility _
Promoter's past performance with reference to the companies promoted by them earlier.
The integrity of the promoters should be found out with enquiries and from financial
magazines and newspapers.
Their knowledge and experience in the related field.
Note: A promoter conceives an idea for setting-up a particular business at a given place and
performs various formalities required for starting a company. A promoter may be a individual,
firm, association of persons or a company.
Project Details
The credibility of the appraising institution or agency.
The stake of the appraising agency in the forthcoming issue.
Product
Reliability of the demand and supply projections of the product.
Competition faced in the market and the marketing strategy.
If the product is export oriented, the tie-up with the foreign collaborator or agency for the
purchase of products.
Financial Data
Accounting policy.
Revaluation of the assets, if any.
Analysis of the data related to capital, reserves, turnover, profit, dividend record and
profitability ratio.
Litigation
Pending litigations and their effect on the profitability of the company. Default in the
payment of dues to the banks and financial institutions.
Risk Factors
A careful study of the general and specific risk factors should be carried out.
Auditor's Report
A through reading of the auditor's report is needed especially with reference to significant
notes to accounts, qualifying remarks and changes in the accounting policy. In the case of
letter of offer the investors have to look for the recently audited working result at the end
of letter of offer.
Statutory Clearance
Investor should find out whether all the required statutory clearance has been obtained, if
not, what is the current status. The clearances used to have a bearing on the completion of
the project.
Investor Service
Promptness in replying to the enquiries of allocation of shares, refund of money, annual
reports, dividends and share transfer should be assessed with the help
of past record.
To ensure healthy growth of primary market, the investing public should be protected. The term
investor's protection has a wider meaning in the primary market. The principal ingredients of
investor protection are:
_ Provision of all the relevant information,
_ Provision of accurate information and
_ Transparent allotment procedures without any bias.
To provide the above-mentioned factors several steps have been taken. They are project
appraisal, under writing, clearance of the issue document by the stock exchange and SEBI's
scrutiny of the issue document.
1. Project Appraisal
This is the first step in the entire process of the project. Technical and economic feasibility of the
project is evaluated. If the project itself is not technically feasible and economically viable,
whatever may be the other steps taken to protect the investors are defeated. Appraisal shows
whether the project is meaningful and can be financed. The investors' protection starts right from
the protection of the principal amount of investment. Based on the appraisal, the project cost is
finalized. The cost should be neither understated nor overstated. The profitability of the project
should be estimated and given. To ensure fair project appraisal, SEBI has made it mandatory for
the project appraisal body to participate a certain amount in the forthcoming issue.
2. Underwriting
Once the issue is finalized the under writing procedure starts. Reputed institutions and agencies,
providing credibility to the issue normally underwrite the issue. If the lead managers participate
more than 5 percent of the minimum stipulated amount offered to the public, it would increase
the confidence of the public regarding the pricing and sale ability of the issue.
6. SEBI's Role
(a) SEBI scrutinizes the various offer documents from the viewpoint of investors' protection
and full disclosure. It has the power to delete the unsubstantiated claims and ask for
additional information wherever needed. This makes the lead manager to prepare the
offer document with due care and diligence;
(b) When the disclosure of the information is complete, wide publicity has to be given in the
newspapers;
(c) In the allotment procedure to make sure of transparency, SEBI's nominee is appointed
apart from the stock exchange nominee in the allotment committee. Inclusion of valid
applications and rejection of invalid applications are checked. The representative of the
SEBI see to it that un-due preference is not given to certain group of investors.
(i) Lead managers are independent financial institution appointed by the company going
public. Companies appoint more than one lead manager to manage big IPO's. They are
known as Book Running Lead Manager and Co Book Running Lead Managers.
Their main responsibilities are to initiate the IPO processing, help company in road
shows, creating draft offer document and get it approve by SEBI and stock exchanges
and helping company to list shares at stock market.
(ii) Merchant Banker: The merchant banker are those financial intermediary involved
with the activity of transferring capital funds to those borrowers who are interested in
borrowing. Merchant banker does the due diligence to prepare the offer document which
contains all the details about the company. They are also responsible for ensuring
compliance with the legal formalities in the entire issue process and for marketing of the
issue.
The activities of the merchant banking in India are very vast in nature of which includes
the following:
a) The management of the customers securities
b) The management of the portfolio,
c) The management of projects and counseling as well as appraisal
d) The management of underwriting of shares and debentures
e) The avoidance of the syndication of loans
f) Management of the interest and dividend etc
(ii) Registrars to the Issue: Registrar of a public issue is a prime body in processing
IPO's. They are independent financial institution registered with SEBI and stock
exchanges. They are appointed by the company going public.
Responsibility of a registrar for an IPO is mainly involves processing of IPO applications,
allocate shares to applicants based on SEBI guidelines, process refunds through ECS or
cheque, transfer allocated shares to investors Demat accounts and dispatch of refund
orders to those applicable are sent.
(iii) Bankers to the Issue: “Banker to an issue” means a scheduled bank carrying on all
or any of the following activities, namely acceptance of application and application
monies, acceptance of allotment or call monies, refund of application monies and
payment of dividend or interest warrants. The Bankers to the Issue enable the movement
of funds in the issue process and therefore enable the registrars to finalize the basis of
allotment by making clear funds status available to the Registrars.
(v) Syndicate members are the broking houses responsible for distributing IPO
applications, receiving filled applications from investors and timely update the data on
the stock exchange IPO shares bidding platform (NSE / BSE).
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PROCESS OF IPO
The process of initial public offering consists of several steps. Those are discussed
below:
The investment bank and the company will first initiate the process of deal negotiation.
The main discussing issues are the money amount that the company is going to raise,
security type to be issued and all the other details involved with the underwriting
agreement.
Once the deal gets finalized, the investment bank sets a registration statement which will
be submitted to the Securities and Exchange Commission. That registration statement
consists of information regarding the offering and also other company informations like,
background of the management, financial statements, legal issues etc.
Then the Securities and Exchange Commission (SEC) needs a cooling off period during
which it will examine all the submitted documents and make sure that all information
regarding the deal have been given to them. After getting the SEC's approval, a date is
going to be fixed on which the company will offer the stock to the public.
During the above mentioned cooling off period the underwriter publishes an initial
prospectus that contains all the necessary information regarding the company. The
effective date of issuing the stock as well as the price have not been mentioned in the
prospectus, for these are not known at this time.
Then the company and the underwriter meets to decide the price of the stock. This
decision depends highly on the current market condition.
Lastly, the stocks are sold in the market and money is raised from the investors.
Below is the detail process flow of a 100% Book Building Initial Public Offer IPO. This
process flow is just for easy understanding for retail IPO investors. The steps provided
below are most general steps involve in the life cycle of an IPO. Real processing steps are
more complicated and may be different. Please visit SEBI website, stock exchange
website or consult an expert for most current information about IPO life cycle in Indian
Stock market.
Draft offer document: It is an offer document filed with SEBI for specifying changes, if
any, in it, before it is filed with the Registrar of companies (ROCs). Draft offer document
is made available in public domain including SEBI website, for enabling public to give
comments, if any, on the draft offer document.
Red herring prospectus: It is an offer document used in case of a book built public
issue. It contains all the relevant details except that of price or number of shares being
offered. It is filed with Registrar of Companies before the issue opens.
Prospectus: It is an offer document in case of a public issue, which has all relevant
details including price and number of shares being offered. This document is registered
with Registrar of Companies before the issue opens in case of a fixed price issue and after
the closure of the issue in case of a book built issue.
Letter of offer: It is an offer document in case of a Rights issue and is filed with Stock
exchanges before the issue opens.
(b) Risk Factors: Under this head the management of the issuer company gives its view
on the internal and external risks envisaged by the company and the proposals, if any, to
address such risks. The company also makes a note on the forward looking statements.
This information is disclosed in the initial pages of the document and also in the abridged
prospectus. It is generally advised that the investors should go through all the risk factors
of the company before making an investment decision.
(c) Introduction: Under this head a summary of the industry in which the issuer
company operates, the business of the Issuer Company, offering details in brief, summary
of consolidated financial statements and other data relating to general information about
the company, the merchant bankers and their responsibilities, the details of
brokers/syndicate members to the Issue, credit rating (in case of debt issue), debenture
trustees (in case of debt issue), monitoring agency, book building process in brief, IPO
grading in case of First Issue of Equity capital and details of underwriting Agreements
are given. Important details of capital structure, objects of the offering, funds
requirement, funding plan, schedule of implementation, funds deployed, sources of
financing of funds already deployed, sources of financing for the balance fund
requirement, interim use of funds, basic terms of issue, basis for issue price, tax benefits
are also covered.
(d) About us: Under this head a review of the details of business of the company,
business strategy, competitive strengths, insurance, industry-regulation (if applicable),
history and corporate structure, main objects, subsidiary details, management and board
of directors, compensation, corporate governance**, related party transactions, exchange
rates, currency of presentation and dividend policy are given.
** Corporate governance is the system of rules, practices and processes by which a
company is directed and controlled. Corporate governance essentially involves balancing
the interests of a company's many stakeholders, such as shareholders, management,
customers, suppliers, financiers, government and the community. Since corporate
governance also provides the framework for attaining a company's objectives, it
encompasses practically every sphere of management, from action plans and internal
controls to performance measurement and corporate disclosure.
(e) Financial Statements: Under this head financial statement and restatement as per the
requirement of the guidelines and differences between any other accounting policies and
the Indian Accounting Policies (if the Company has presented its Financial Statements
also as per either US GAAP/IFRS) are presented.
(f) Legal and other information: Under this head outstanding litigations and material
developments, litigations involving the company, the promoters of the company, its
subsidiaries, and group companies are disclosed. Also material developments since the
last balance sheet date, government approvals/licensing arrangements, investment
approvals (FIPB/RBI etc.), technical approvals, and indebtedness, etc. are disclosed.
(g) Other regulatory and statutory disclosures: Under this head, authority for the
Issue, prohibition by SEBI, eligibility of the company to enter the capital market,
disclaimer statement by the issuer and the lead manager, disclaimer in respect of
jurisdiction, distribution of information to investors, disclaimer clause of the stock
exchanges, listing, impersonation, minimum subscription, letters of allotment or refund
orders, consents, expert opinion, changes in the auditors in the last three years, expenses
of the issue, fees payable to the intermediaries involved in the issue process, details of all
the previous issues, all outstanding instruments, commission and brokerage on, previous
issues, capitalization of reserves or profits, option to subscribe in the issue, purchase of
property, revaluation of assets, classes of shares, stock market data for equity shares of
the company, promise vis-à-vis performance in the past issues and mechanism for
redressal of investor grievances is disclosed.
(h) Offering information: Under this head Terms of the Issue, ranking of equity shares,
mode of payment of dividend, face value and issue price, rights of the equity shareholder,
market lot, nomination facility to investor, issue procedure, book building procedure in
details along with the process of making an application, signing of underwriting
agreement and filing of prospectus with SEBI/ROC, announcement of statutory
advertisement, issuance of confirmation of allocation note("can") and allotment in the
issue, designated date, general instructions, instructions for completing the bid form,
payment instructions, submission of bid form, other instructions, disposal of application
and application moneys, interest on refund of excess bid amount, basis of allotment or
allocation, method of proportionate allotment, dispatch of refund orders,
communications, undertaking by the company, utilization of issue proceeds, restrictions
on foreign ownership of Indian securities are disclosed.
(i) Other Information: This covers description of equity shares and terms of the
Articles of Association, material contracts and documents for inspection, declaration,
definitions and abbreviations, etc.
Issue Requirements
SEBI has laid down entry norms for entities making a public issue/ offer. The same are
detailed below:
Entry Norms: Entry norms are different routes available to an issuer for accessing the
capital market.
(i) An unlisted issuer making a public issue i.e. (making an IPO) is required to
satisfy the following provisions:
Entry Norm I (Profitability Route): The Issuer Company shall meet the following
requirements:
(a) Net Tangible Assets of at least ` three crores in each of the preceding three full years.
(b) Distributable profits in atleast three of the immediately preceding five years.
(c) Net worth of at least ` one crore in each of the preceding three full years.
(d) If the company has changed its name within the last one year, at least fifty percent
revenue for the preceding one year should be from the activity suggested by the new
name.
(e) The issue size does not exceed five times the pre- issue net worth as per the audited
balance sheet of the last financial year
To provide sufficient flexibility and also to ensure that genuine companies do not suffer
on account of rigidity of the parameters, SEBI has provided two other alternative routes
to the companies not satisfying any of the above conditions, for accessing the primary
market, as under:
Note: A "market maker" is a broker-dealer firm that stands ready to buy and sell a
particular stock on a regular and continuous basis at a publicly quoted price. Market-
making is aimed at infusing liquidity in securities that are not frequently traded on stock
exchanges. A market-maker is responsible for enhancing the demand-supply situation in
stocks
(ii) A listed issuer making a public issue (FPO) is required to satisfy the following
requirements:
If the company has changed its name within the last one year, atleast 50 percent revenue
for the preceding one year should be from the activity suggested by the new name.
The issue size does not exceed five times the pre- issue net worth as per the audited
balance sheet of the last financial year. Any listed company not fulfilling these conditions
shall be eligible to make a public issue by complying with QIB Route or Appraisal Route
as specified for IPOs.
(iii) Certain category of entities which are exempted from the aforesaid entry
norms, are as under:
(a) Private Sector Banks
(b) Public sector banks
(c) An infrastructure company whose project has been appraised by a Public Financial
Institution or IDFC or IL&FS (Infrastructure leasing and financial services ltd) or a bank
which was earlier a PFI (Private Finance Initiative) and not less than five percent of the
project cost is financed by any of these institutions.
There is no entry norm for a listed company making a rights issue.
Note: The private finance initiative (PFI) is a procurement method which uses private
sector investment in order to deliver public sector infrastructure and/or services according
to a specification defined by the public sector
Minimum Promoter’s contribution and lock in: In a public issue by an unlisted issuer,
the promoters shall contribute not less than 20 percent of the post issue capital which
should be locked in for a period of three years. “Lock-in” indicates a freeze on the shares.
The remaining pre issue capital should also be locked in for a period of one year from the
date of listing. In case of public issue by a listed issuer [i.e. FPO], the promoters shall
contribute not less than 20 percent of the post issue capital or 20 percent of the issue size.
This provision ensures that promoters of the company have some minimum stake in the
company for a minimum period after the issue or after the project for which funds have
been raised from the public is commenced.
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. 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. The company desirous of making the IPO is required to bear the expenses
incurred for grading such IPO. 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. 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. 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.
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.
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 and capitalise on the opportunities
available, as well as the company’s financial position.
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 grade
1. Business Prospects and Competitive Position
i. Industry Prospects
ii. Company Prospects
2. Financial Position
3. Management Quality
4. Corporate Governance Practices
5. Compliance and Litigation History
6. 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.
IPO grading does not consider the price at which the shares are offered in the issue.
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.
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.
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.
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.
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. 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.
New Provisions in Initial Public Offerings (IPO)
Green shoe Option: Green Shoe Option is a price stabilizing mechanism in which shares
are issued in excess of the issue size, by a maximum of 15 percent. From an investor’s
perspective, an issue with green shoe option provides more probability of getting shares
and also that post listing price may show relatively more stability as compared to market
volatility.
Safety Net: In a safety net scheme or a buy back arrangement the issuer company in
consultation with the lead merchant banker discloses in the RHP that if the price of the
shares of the company post listing goes below a certain level the issuer will purchase
back a limited number of shares at a pre specified price from each allottee.
Open book/closed book: In an open book building system the merchant banker along
with the issuer ensures that the demand for the securities is displayed online on the
website of the Stock Exchanges. Here, the investor can be guided by the movements of
the bids during the period in which the bid is kept open. Indian Book building process
provides for an open book system. In the closed book building system, the book is not
made public and the bidders will have to take a call on the price at which they intend to
make a bid without having any information on the bids submitted by other bidders.
Soft underwriting: Soft underwriting is when an underwriter agrees to buy the shares at
stage after the issue the issue is closed. The risk faced by the underwriter as such is
reduced to a small window of time.
Differential pricing: When one category of investors is offered shares at a price different
from the other category it is called differential pricing. An issuer company can allot the
shares to retail individual investors at a discount of maximum 10 percent to the price at
which the shares are offered to other categories of public.
(ii) Further public offer (FPO) or Follow on offer: When an already listed company makes
either a fresh issue of securities to the public or an offer for sale to the public, it is called a
FPO.
(b) Rights issue (RI): When an issue of securities is made by an issuer to its shareholders
existing as on a particular date fixed by the issuer (i.e. record date), it is called an rights issue.
The rights are offered in a particular ratio to the number of securities held as on the record date.
According to Sec 81 of the Companies Act 1956, if a public company wants to increase its
subscribed capital by allotment of further shares after two years from the date of its formation or
one year from the date of its first allotment, which ever is earlier should offer share at first to the
existing share holders in proportion to the shares held by them at the time of offer. The
shareholders have no legal binding to accept the offer and they have the right to renounce the
offer in favor of any person. Shares of this type are called right shares. Generally right shares are
offered at an advantageous rate compared with the market rate.
(2) Letter of Offer. Draft a Letter of Offer. As per section 81(1)(b), a 'notice' should make the
offer of rights shares. This notice is called 'Letter of Offer'. (give atleast 15 days time to
shareholders for exercising their option) It is a document sent to the shareholders of a company
offering them shares in a rights issue. No form has been prescribed of the Letter of Offer. It
should contain the following information:
(a) Brief history of the company;
(b) Nature of business carried on by the company;
(c) Highlights of the financial performance for 3 to 5 years;
(d) Management perception about the future prospects of the company;
(e) Particulars of directors, including managing and whole-time directors;
(f) Details of the proposed rights issue;
(g) The number of shares held by a shareholder and the number of rights shares;
(h) Terms and conditions of the present issue and mode of payment.
(3) Board's Approval. Arrange a Board meeting and pass the following resolutions:
(a) To approve the proposal of issuing new shares on rights basis and decide the price, total
number of shares to be offered, proportion in which the rights shares will be offered, etc;
(b) To approve a draft Letter of Offer;
(c) To fix a date as a record date (or dates of closure of the Register of Members) for
drawing up a list of members eligible to receive the offer;
(d) To approve a draft application form (for subscribing to the rights shares, additional
shares, splitting the rights denial);
(e) To authorize Company Secretary or other officer to send the Letter of Offer to the
members and to do such acts, deeds and things as may be necessary to give effect to the
Board's decision;
(f) To convene a general meeting for passing necessary resolutions, if any; to fix date, time
and place of the general meeting and to authorize the Company Secretary or other officer
to issue notice of the meeting.
(4) General meeting. A general meeting will be convened to pass necessary ordinary/special
resolution, if the articles require a resolution. Ensure that the explanatory statement annexed to
the notice of the meeting fully explains the objects and reasons for the rights issue and
justification therefore.
(5) Filing of resolution. The special resolution passed at the general meeting will be filed with
the Registrar of Companies. If a resolution for increasing the authorized share capital has been
passed, requisite registration fee will be paid at the Registrar's office.
(6) Record Date/Book Closure. Announce a record date/book closure as decided by the Board
of directors well in advance allowing at least 2 to 3 weeks for lodgement of share transfer forms
so as to exercise the right to take the rights shares. The closure of the Register of Members
should be in accordance with the provisions of section 154 of the Companies Act.
(7) Drawing up list of members. After the record date/book closure is over, draw up a list of
members to ascertain members eligible to subscribe to the rights shares.
(8) Dispatching Letter of Offer. Dispatch the Letter of Offer to the members eligible to
subscribe to the rights issue as per the list of members drawn up. The Letter of Offer should be
accompanied by application form for subscription, splitting, renunciation, etc. The Letter of
Offer should be sent to the shareholders in such a manner that they get at least 15 days time to
apply.
(9) Collection and scrutiny of application forms. Within a week after the last date for making
the application, collect the application forms received and scrutinize them in all respects. Sort the
valid applications and defective applications. Prepare a statement of allottees with all relevant
particulars.
(10) Allotment. Convene a meeting of the Board/Allotment Committee and pass a resolution for
allotment and file Return of Allotment with the Registrar of Companies.
(11) Allotment Letter/Share Certificates. Prepare and dispatch Letters of Allotment.
Alternatively, prepare and dispatch Share Certificates to the allottees. In any case, Share
Certificates should be dispatched within 3 months from the date of allotment.
(12) Regret Letters/Refund Orders. Simultaneously, prepare and dispatch regret letters and
refund orders to the applicants to whom no shares have been allotted.
(13) Entry in the Register of Members. Immediately after the allotment, enter the particulars of
the allottees in the Register of Members.
The bonus issue is not made unless the partly-paid shares, if any, are made fully paid-up.
The company has not defaulted in payment of interest or principal in respect of term loan
and debentures.
The company has not defaulted in respect of payment of statutory dues of the employees
such as contribution to provident fund, gratuity, bonus etc.
(d)Private placement:
In this method the issue is placed with a small number of financial institutions, corporate bodies
and high net worth individuals. The financial intermediaries purchase the shares and sell them to
investors at a later date at a suitable price. The stock is placed with issue house client with the
medium of placing letter and other documents which taken together contribute a prospectus,
giving the information regarding the issue. The special feature of the private placement is that the
issues are negotiated between the issuing company and the purchasing intermediaries. Listed
public limited company as well as closely held private limited company can access the public
through the private placement method. Mostly in the private placement securities are sold to
financial institutions like Unit Trust of India, mutual funds, insurance companies, and merchant
banking subsidiaries of commercial banks and so on.
Through private placement equity shares, preference shares, cumulative convertible preference
shares, debentures and bonds are sold. In India private placement market is witnessing the
introduction of several innovative debt market instruments such as step-down/step-up
debentures, liquid debentures, bonds etc. Private placement has several inherent advantages:
_ Cost Effective: Private placement is a cost-effective method of raising funds. In a public issue
underwriting, brokerage, printing, mailing and promotion account for 8 to 10 percent of the issue
cost. In the case of the private placement several statutory and non-statutory expenses are
avoided.
_ Time Effective: In the public issue the time required for completing the legal formalities and
other formalities takes usually six months or more. But in the private placement the requirements
to be fulfilled are less and hence, the time required to place the issue is less, mostly 2 to 3
months.
_ Structure Effectiveness: It can be structured to meet the needs of the entrepreneurs. It is
flexible to suit the entrepreneurs and the financial intermediaries. To make the issue more
attractive the corporate can provide discounts to the intermediaries who are buying it. This is not
possible with the public issue with stringent rules and regulations. In the case of debentures the
interest ceiling cannot be breached in a public issue. Here the terms of the issue can be
negotiated with purchasing institutions easily since they are few in number.
_ Access Effective: Through private placement a public limited company listed or unlisted can
mobilize capital. Like-wise issue of all size can be accommodated through the private placement
either small or big where as in the public issue market, the size of the issue cannot fall below a
certain minimum size.
Disadvantages of Private placement
Private placement securities suffer from the following weaknesses.
1. Securities are concentrated in a few hands
2. Artificial scarcity is created for securities
3. Common investors are deprived of their opportunities in subscribe to the issue.
In Short:
When an issuer makes an issue of securities to a select group of persons not exceeding 49, and
which is neither a rights issue nor a public issue, it is called a private placement. Private
placement of shares or convertible securities by listed issuer can be of two types:
Preferential allotment: When a listed issuer issues shares or convertible securities, to a
select group of persons in terms of provisions of Chapter XIII of SEBI (DIP) guidelines,
it is called a preferential allotment. The issuer is required to comply with various
provisions which inter‐alia include pricing, disclosures in the notice, lock‐in etc, in
addition to the requirements specified in the Companies Act.
Qualified institutions placement (QIP):
When a listed issuer issues equity shares or securities convertible in to equity shares to
Qualified Institutions Buyers only in terms of provisions of Chapter XIIIA of SEBI
(DIP) guidelines, it is called a QIP.
The major disadvantage of the bought out deals is that the sponsors are able to create a positive
image about the shares and sell them at a hefty premium. Single investment banker gives scope
for manipulation of the results. Insider trading and price rigging could be carried out, which can
be neither detected nor penalized.
Bought-out deals pose the following difficulties for the promoters, sponsors and investors:
1. Loss of control: The apprehensions in the minds of promoters, particularly of the private
or the closely held companies that the sponsors may control the company as they own large
chunk of the shares of the company.
2. Loss of sales: Bought-out deals pose considerable difficulties in off-loading the shares
in times of unfavorable market conditions. This results in locking up of investments and entailing
losses to sponsors.
3. Wrong appraisal: Bought-out deals cause loss to sponsors on account of wrong appraisal
of the project and overestimation of the potential price of the share.
4. Manipulation: Bought-out deals give great scope for manipulation at the hands of the
sponsor through insider trading and rigging.
5. No accountability: Bought-out deals pose difficulty of penalizing the sponsor as there are
no SEBI guidelines to regulate offerings by sponsors.
6. Loss to investors: Where the shares taken up by issue brokers and a group of select clients
are being bought back by the promoters at a pre-fixed higher price after allotment causing loss to
investors of the company.
Pricing of public issues is the most contentious issue in the management of public issues. In case
of follow-on public offerings, the pricing of securities is known to some extent from the prices
quoted on the floor of the stock exchange. However, in case of Initial Public Offerings (IPOs),
the determination of offer price is more complicated. The disclosures made in the offer
documents are new to the investors and the performance of the company is yet to be tested in the
secondary market. The role of the lead merchant banker acting as issue managers, thus, becomes
more important with respect to pricing of IPOs. Lead merchant bankers play a decisive role in
the determination of issue price for public issues. Issue price of securities is determined by the
issuing companies in consultation with the merchant bankers, called issue managers. It is
determined in the light of legal and regulatory framework of a country.
Till mid 1992, Indian capital market was under the direct control of Central Govt. through CCI.
The new companies were allowed to issue shares at the face value only and the existing
companies with sound financial structure could issue shares at premium. There were strict norms
for the issue of rights shares and bonus shares. For the pricing of equity issues by unlisted and
listed companies, CCI provided a formula for the ‘fair value’ of equity shares. This formula was
based on the:
(i) Net Asset value ( NAV),
(ii) Profit Earning Capacity Value ( PECV), and
(iii) Market Value (MV), in case of listed companies.
The NAV, as at the latest audited balance sheet date was calculated on the basis of the total
assets of the company and deducting there from all debts, dues, borrowings and liabilities
including current and likely contingent liabilities and preference capital, if any. This NAV
calculated from the assets side of the balance sheet in the above manner was cross checked with
equity capital plus free reserves & surpluses, less the likely contingent liabilities.
The Price Earning Capacity Value (PECV) was calculated by capitalizing the average of the after
tax profits at the following rates:
(i) 15% in the case of manufacturing companies.
(ii) 20% in the case of trading companies, and
(iii) 17.5 % in the case of ‘Intermediate companies’, that is to say, companies whose turnover
from trading activities was more than 40% but less than 60% of their total turnover.
In case of listed companies, the market price of equity shares will be the guiding force for
determining the issue price of equity shares to be issued. In such cases, the market price was
taken cognizance of in the following manner:
(i) The average market price was determined taking into account the stock market quotations in
the preceding three years( after making appropriate adjustments for bonus issues and dividend
payments as under:
(a) The high and low of the preceding two years: and
(b) The high and low of each month in the preceding 12 months.
The conservative CCI formula, which used to calculate the ‘fair value’ on the basis of accounting
information, was critised on a number of counts. This often resulted in extreme under pricing and
heavy over subscription. The heavy under pricing deterred the companies from going to public.
Consequently, very few issuers took initiative to issue equity shares to the public. Debt played a
major role in financing the projects and the primary equity market could not develop
significantly.
The Capital Issues (Control) Act, 1947 and CCI was repealed in May 1992. With this,
Government’s control over issue of capital, pricing of the issues, fixing the premium and rates of
interest on debentures etc. ceased and the market was allowed to allocate resources on
competitive basis.
Pricing Methods of Public Issues during Post Reforms Period
In 1991, Government of India ushered in reforms in the area of industrial and trade policy.
Liberalisation and privatization of economy required large funds to be channelized from savings
into investment. In 1992, Government of India decided to have a separate statutory authority to
regulate the Indian capital market. So, Securities and Exchange Board of India (SEBI) Act was
passed in Parliament and SEBI was made a statutory authority.
After repeal of CCI, corporates were given freedom in terms of price, size and timing of their
public issues. SEBI guidelines have provided that the issuer company in consultation with lead
merchant banker shall decide the price. There is no price formula stipulated by SEBI and it does
not play any role in price fixation. However, price of public issue of equity is to be determined
on the basis of following points.
a. EPS, pre-issue, for the last three years (as adjusted for changers in capital).
b. P/E pre-issue.
c. Average return on net-worth in the last three years.
d. Net Asset Value per share based on last balance sheet.
e. Comparison of all accounting ratios of the issuer company as mentioned above with the
industry average and with the accounting ratios of the peer group.
f. The accounting ratios disclosed in the offer document shall be calculated after giving effect to
the consequent increase of capital on account of compulsory conventions outstanding as well as
on the assumption that the option outstanding , if any, to subscribe for additional capital shall be
exercised.
The Process:
The Issuer who is planning an offer nominates lead merchant banker(s) as 'book runners'.
The Issuer specifies the number of securities to be issued and the price band for the bids.
The Issuer also appoints syndicate members with whom orders are to be placed by the
investors.
The syndicate members input the orders into an 'electronic book'. This process is called
'bidding' and is similar to open auction.
The book normally remains open for a period of 5 days.
Bids have to be entered within the specified price band.
Bids can be revised by the bidders before the book closes.
On the close of the book building period, the book runners evaluate the bids on the basis
of the demand at various price levels.
The book runners and the Issuer decide the final price at which the securities shall be
issued.
Generally, the number of shares are fixed, the issue size gets frozen based on the final
price per share.
Allocation of securities is made to the successful bidders. The rest get refund orders.
The crux of book building is that through people’s bids – the issuers find out the highest price at
which they can sell their IPO.
Let me take an example. Suppose you own a company that sells Walkmans and want to do an
IPO for your company. You decide to offer 3,000 shares at a price band of Rs. 20 – 24. you
receive bids from 5 bidders in the following manner:
You obviously want to sell at the highest price of Rs. 24, but at that price you will be able to sell
only 500 shares. So, you come down a rupee, but see that there are only a 1,000 bids at Rs. 23, so
you will be able to sell 1,500 shares at that price only.
So, you come down a rupee again, and see that there are 1,500 bids at Rs. 22, which means that
you’ve received 3,000 bids from people interested in buying your IPO stock at Rs. 22 or higher.
Rs. 22 then becomes your cut – off price, and all bids above this price level are considered legal
bids. You will price your IPO at 22 or lower, but not at a higher price since you didn’t receive
enough bids to be able to get your offering fully subscribed. This is known as the price discovery
mechanism of the book building process, and the way most IPOs are priced these days.
Types of Book Building Process: Three types of options have been provided by SEBI to the
issuer companies under book building. These options are as follows:
(a) 75% Book Building, 25% Fixed Price Offer: In this type of offer, 75% of the issue is
offered to institutional investors who participated in the bidding process. Balance 25% is
offered to the public through prospectus and shall be reserved for allocation to individual
investors who had not participated in the bidding process. The price for 25% offer is the
price as determined through book building. First, the book building portion remains open
for 3 to 7 days and on discovery of issue price after the completion of book building
process, the fixed price portion opens for subscription.
(b) 90% Book Building, 10% Fixed Price Offer: Here issuer company offers 90% of the
issue through book building and the balance 10% through fixed price offer at a price
discovered through book building. This option was available to the issuers during 1999-
2000 and 2000-01 and later on discontinued by SEBI.
(c) 100% Book Building Offer: In this type of offer, the whole issue is offered through
book building route. Issue opens and closes on the same dates for all categories of
investors. Different categories of bidders bid at the point of time. This type of issue takes
minimum number of days for the completion of the process of issue and allotment of
shares. Generally, the issue is listed on a Recognised Stock Exchange after 3 weeks from
the closure of the issue (2 weeks for completion of allotment +1 week for completion of
listing formalities).
In case of fixed price issue the proportionate allotment of securities to the different
investor categories in a fixed price issue is as described below:
1. A minimum 50 percent of the net offer of securities to the public shall initially be made
available for allotment to retail individual investors, as the case may be.
2. The balance net offer of securities to the public shall be made available for allotment
to:
a. Individual applicants other than retail individual investors, and
b. Other investors including corporate bodies/ institutions irrespective of the number of
securities applied for.
SEBI (DIP) guidelines provide that an issuer making an issue to public can allot shares on firm
basis to some categories as specified below:
(i) Indian and Multilateral Development Financial Institutions,
(ii) Indian Mutual Funds,
(iii) Foreign Institutional Investors including Non-Resident Indians and Overseas Corporate
Bodies and
(iv) Permanent/regular employees of the issuer company.
(v) Scheduled Banks
(vi) It may be noted that OCBs are prohibited by RBI to make investment.
Reservation on Competitive Basis is when allotment of shares is made in proportion to the shares
applied for by the concerned reserved categories. Reservation on competitive basis can be made
in a public issue to the following categories:
(i) Employees of the company
(ii) Shareholders of the promoting companies in the case of a new company and
shareholders of group companies in the case of an existing company
(iii)Indian Mutual Funds
(iv) Foreign Institutional Investors (including non resident Indians and overseas corporate
bodies)
(v) Indian and Multilateral development Institutions
(vi)Scheduled Banks
In a public issue by a listed company, the reservation on competitive basis can be made for retail
individual shareholders and in such cases the allotment to such shareholders shall be on
proportionate basis.
There is no discretion while doing the allotment amongst various investor categories as per the
permissible allocations in the allotment process. All allottees are allotted shares on a
proportionate basis within their respective investor categories.
Other Information
The investor get the allotment/ refund of shares within thirty days of the closure of the issue in
case of Fixed price public issues and within fifteen days of the closure of the issue For Book
built public issues.
The status of bidding in a book built issue is available on the website of BSE/NSE on a
consolidated basis. The data regarding bids is also available, investor category wise. After the
price has been determined on the basis of bidding, the public advertisement 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, is issued.
However, in case of a fixed price issue, information is available only after the closure of the
issue through a public advertisement, issued within ten days of dispatch of the certificates of
allotment/ refund orders.
The investor will gets the refund in an issue through various modes viz. registered/ordinary post,
Direct Credit, RTGS (Real Time Gross Settlement), ECS (Electronic Clearing Service) and
NEFT (National Electronic Funds Transfer).
In book built public issue the listing of shares is done within three weeks after the closure of the
issue. In case of fixed price public issue, it is done within thirty seven days after closure of the
issue.
The information about the forthcoming issues may be obtained from the websites of Stock
Exchanges. Further the issuer coming with an issue is required to give issue advertisements in an
English national Daily with wide circulation, one Hindi national newspaper and a regional
language newspaper with wide circulation at the place where the registered office of the issuer is
situated.
IPO 'Market Lot' and 'Minimum Order Quantity' are two important factors investor should know
while bidding for an IPO.
Minimum Order Quantity, as name says, is the minimum number of shares investor can apply
while bidding in an IPO. In the stock market, lot size refers to the number of shares you buy in
one transaction. If investor wants to bid for more shares, they can apply in multiples of IPO
market lot (lot Size or IPO bid lot) of shares.
Example:
IPO: Power Grid Corporation of India Limited IPO
Public Issue Price: Rs. 44/- to Rs. 52/- Per Equity Share
Market Lot: 125 Shares
Minimum Order Quantity:1 lot or 125 Shares
Investor can apply in this IPO as below:
At Rs 44/- * 125 Shares * 1 Lot = Rs 5500/-
At Rs 44/- * 125 Shares * 2 Lot = Rs 11000/-
At Rs 44/- * 125 Shares * 18 Lot = Rs 99000/-
At Rs 52/- * 125 Shares * 2 Lot = Rs 13000/-
At Rs 52/- * 125 Shares * 1 Lot = Rs 6500/-
At Rs 52/- * 125 Shares * 15 Lot = Rs 97500/-
Categories of Investors
Investors are broadly classified into following categories-:
In retail individual investor category, investors can not apply for more than two lakh (`
2,00,000) in an IPO. Retail Individual investors have an allocation of 35% of shares of
the total issue size in Book Build IPO's.
Investors who do not fall within the definition of the above two categories are
categorized as “Non-Institutional Investors”