What Is The IPO Process

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  • 01 Dec 2023
What is the process of investing in an IPO?

For a business that has decided to go public, the road to launching an IPO is a long and lonely one. Typically, an IPO process takes six to nine months. The following outline should give you an idea of all the steps involved:

The IPO Process

Step1: Appointment of investment bankers/underwriters

These financial experts carry out the IPO process on behalf of the company. They act as intermediaries between the company and the investors.

Step 2: Registration for IPO

The investment bank and the company prepare a registration statement and a draft prospectus. Known as the red herring prospectus (RHP), it is the most important document that a retail investor has access to and can use to evaluate the offer. The document details all the information about the business, with the exception of price or quantum of shares being offered. All businesses have to submit the red herring prospectus. According to Section 32 of the Companies Act:

  • The company offering an IPO needs to submit the Red Herring Prospectus with the Registrar of Companies at least 3 days before the offer is opened to the public for bidding.
  • All the obligations that the company’s prospectus will have, should also be contained in the RHP. Any variations between the two will have to be highlighted and be duly approved by SEBI and ROC.
  • Once the IPO bidding is closed, the company has to submit the final prospectus to both ROC and SEBI. This should contain both the quantum of shares being allotted and the final issue price on which the sale is closed.

The RHP is the document that the issuer and the underwriters use to market the IPO with. It is the most important tool that a retail investor has access to and can use to evaluate the offer. The document contains all the financial and other information about the company. All the mandatory disclosures that SEBI and the Companies Act are collated in this document as well. The sections include:

  • Definitions: All the important issues and industry specific keywords are defined in this section. If you are analyzing an offer from an industry you are already familiar with, this section may not warrant a close reading.
  • Risk Factors: Every business faces risks and uncertainties.This section is meant to disclose every possibility that could have a material impact on company’s performance post listing, and the share price.
  • Use of Proceeds: This is probably the most important section of the prospectus. This gives the investors information about where the money raised through the IPO will be used. This is a good indicator of the direction the business will develop in, and proxy for how well the finances are being handled by the company.
  • Industry Description: This section provides forecasts and predictions about the larger industry the company operates in.
  • Business Description: This section talks about the core activities that the company carries out. It describes how the company generates profits. Investors pay close attention to this, as it describes what they will end up owning, if they get the shares of the company.
  • Management: Details about the promoters, directors and key management personnel is provided in this section. Investment in a new company is largely an investment in the management team’s competency. Therefore, investors read this section with interest and gather whatever information they can about the people behind the company.
  • Financial Information: This section contains auditor’s reports and the financial statements of the company for the previous 5 years.
  • Legal and Other Information: All litigations filed against the company or a promoter or a director which are not yet settled are listed in this section.

Step 3: Cooling-off period

This is the time when SEBI verifies the facts disclosed by the company. It looks for errors, omissions, and discrepancies. Only after SEBI approves the application can the company set a date for the IPO.

Step 4: Application to stock exchange

The company files an application with the stock exchange where it plans to float the initial issue.

Step 5: Creating a buzz

Companies need to ensure that the IPO is a big-ticket event, much like how summer Hollywood blockbusters or the Khan tentpole movies are. One way to spread the excitement in the investor circles is through the IPO road show. Upon getting approval for an IPO, the investment bankers and underwriters hired by the business get into action. They travel to important finance destinations around the world to showcase the IPO offer. Since they literally ‘take to the road’, the name ‘road show’ has stuck.

The Timing

Road shows are organised much before the IPO date. This gives investors time to decide how much to invest. Typically, the timeline is like this:

  • When a company decides to go public, it employs one or more teams of investment bankers or underwriters. These teams help the company to carry out the IPO process.
  • Upon getting approval from the market regulator, the date for floating the IPO is set.
  • Following this, a financial prospectus is released.
  • Soon after, the investment bankers, underwriters, and company management set out on the road shows.

The Process

Road shows are used to convince investors about the potential of the company. They highlight the future growth trajectory of the business as well as the expected market share. The teams responsible for the road shows also meet with business analysts and fund managers. Such professionals may offer insights that enhance the company’s IPO process. Company executives provide every detail about the IPO through multimedia presentations, Q&A sessions, and other user-friendly means. Increasingly, companies are posting online versions of road shows which any individual can access. To help out investors, companies may also arrange small group meetings a few days or weeks before floating the IPO.

Step 6

There are two types of IPO processes. They are:

  • Fixed price issue
  • Book building issue

In a fixed price issue, the price at which shares will be sold and allotted is made known to the investors in advance. Whereas, in a book building issue, the issuer offers a 20% range within which investors can bid for the shares. The final price is decided only after the bidding is closed. This 20% range is called an IPO price band. Both retail and institutional buyers are called to submit their bids within this price range. The book, that is the collection of bids that have come in for the IPO, is open to all investors. In other words, the demand for the shares offered at various prices is available for all current and potential investors. No bid price can be less than the IPO floor price, which is the lower bound of the band. Neither can it be higher than the IPO cap price, the upper bound of the band. The book is normally open for 3 days, and the bidders can revise their bids as long as the book is open. Issuers prefer book building issues over fixed price issues as the process gives them the opportunity to discover the price and demand. This way, the issuer is able to ensure that the issue generates as much value as the market is willing to provide. The price at which the issue is finally sold is called the cut-off price. This is the highest price at which all the shares offered can be sold.

Step 7

This is the last step before an IPO is launched.. Businesses also ensure that company insiders (internal investors) don’t trade in the IPO. That’s because:

  • It helps stabilise the market without additional selling pressure from insiders. It prevents corrupt executives from pawning off overpriced shares at the expense of general buyers. It protects retail investors from a manipulated offer price of the shares. It stops the market from being flooded with too many shares that might disturb the natural demand–supply balance.

Step 8

Finally, the issues are sold on the primary market and the money is collected from the investors. The bidding period is usually about five working days.

Step 9

The IPO shares are allotted to bidders within 10 days of the last date of bidding. In case the IPO is oversubscribed, the shares are allotted proportionately to the applicants. For example, suppose the oversubscription is four times the allotted number of shares. Then an application for 10 lakh shares will be allotted only 2.5 lakh shares.

A Quick Recap

The IPO jamboree is a months-long process. It requires the company to put on a charm offensive, launch ad blitzes, do exhaustive paperwork, solve insurmountable problems, ceaseless number-crunching and endless legwork.

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