The IPO Process: How a company goes public
Companies, usually when they are incorporated, they are incorporated as private companies as entrepreneurs are not that financially and economically sound so as to form a public company at the stage of the conception of their idea. They have to start small as not a lot of investors and banks will be willing to raise capital for the birth of a risky idea. There is also the complication of following the regulations and obligations stipulated by the Securities Exchange Board of India. So, private companies at the stage of their incorporation are usually funded by family members and friends of the founders. That is, people who understand the idea behind the business and know that there might be a good chance to prosper and yield great returns. Once a company is ready to comply with the provisions of SEBI and are stable enough in earning profits while having a surety to be able to give the benefits and responsibilities so required by the public investors, then the company can raise their interest of going public. This is when a company gets listed on the different stock exchanges for the public investors to invest in and reap benefits from the company’s success in conducting their business efficiently. This process is done by conducting the process of an Initial Public Offering (IPO).
Why the need to go public?
A company while doing sound business as a private company might want to expand its business and raise its capital by a substantial amount in order to venture into newer areas of business and introduce newer and more advanced products into their business. In short, going public is an essential step for a company to grow beyond its limited scope. This process also helps in providing an exit for the existing shareholders as they can cash in on their profits when the existing shares along with newly created shares are publicly traded for the first time in the stock markets. Going public also helps the companies to increase the value of their shares due to the fact that the shares can be easily transacted upon in an open market. The companies can also use these publicly traded shares as a form of security towards banks when they give out a loan to the company.
The IPO Process
The Initial Public Offering (IPO) is a long-drawn process that involves a multitude of sub-processes and following legal obligations and disclosures laid down by SEBI’s guidelines and regulations.
- The IPO process is initiated by a proposal by the management of a company to the board of directors. The management has to pitch to the board why an IPO should be opted for providing detailed descriptions involving the company’s past performance, objectives, business plans and financial projections. The board then makes a decision regarding whether or not to go forward with the IPO process.
- Once the board approves of the IPO, underwriters or investment bankers are hired to assist the company in listing its shares, existing and new, to the public. This is done via an underwriter’s agreement which is regulated by the SEBI (Underwriters) Regulations, 1993. The Underwriter’s agreement usually contains details such as the amount to be raised and the securities to be issued.
- The next step is to prepare the Registration Statement along with the Red Herring Prospectus which is prepared by the underwriters or the investment banks and as per Section 32 of the Companies Act, 2013, registered with the Registrar of Companies at least 3 days before the offer is made to the public and with the Securities and Exchange Board of India. A red herring prospectus is an initial prospectus that does not contain the complete particulars of the price of the securities involved.
- After the registration, SEBI reviews and analyzes all the details so disclosed by the company. SEBI checks whether the company’s disclosed information meets the eligibility requirements as per Chapter II, Part I of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, specifically regulation 6 of the same. Once SEBI has completed the scrutinization process, the company gets the green signal to move ahead with the IPO process.
- The company after approval by SEBI decides in which stock exchange it wants to list its shares, whether it be the National Stock Exchange or the Bombay Stock Exchange, or both.
- The next phase of the process is the advertisement phase. This is where the executives of the Company travel around showcasing to potential investors why they should fund the company in exchange for equity shares. All this is done before the company has gone public.
- Now, the next phase is setting the price of the IPO, that is, the price of each share is to be fixed at this point of the IPO. This is done by two means, either the fixed cost method or the book building method. The fixed cost method includes the underwriter/investment bank and the company working together to fix a particular price for the shares. Whereas the book-building method includes deciding upon a price range which is again done by the underwriters/investment banks and the company. The investment banks are responsible for the pricing of the shares. They do this by checking the growth potential of the company, the demand of potential buyers, and the company’s financials after which they arrive at a price range for the shares. So, the fixed cost method is fixing a particular price that is known to the investor, and the book-building method is setting a price range that is just indicative of the actual price. The actual price is usually set at the higher end of the range in the case of the book-building method.
- Application forms are made available to the public via designated banks or brokerage firms. These forms are to be filled by the public and submitted with a cheque, or this process can be done via the internet as well. SEBI has fixed the period of availability of the IPO to be 5 working days. Choosing the right time to go public is a question of smart decision-making. Usually, when a big private company goes public, smaller companies avoid doing so to eliminate competition and have a chance to succeed by choosing a time when no bigger private company is opting for an IPO.
- The Company and the underwriters, after pricing the IPO, sit and decide how many shares each investor will receive. These shares are then credited to their Demat accounts once the application forms mentioned above have been filled out along with the payment. Once this stage has been completed, the stock market lists the shares of the company and starts trading them with potential investors.
- Now, after the closure of the IPO bidding process at the lapse of 5 working days, the company then has to submit the final prospectus to both the Registrar of Company and SEBI.
- Finally, the IPO shares are allotted to the bidders within 10 days of the last date of bidding.
Negative impacts of going public
As seen above, a company might go public for a lot of reasons, the main one being raising funds and subsequently, expansion. There are a few drawbacks to the process of going public too. This is a complex, costly and time-consuming process. The entire expenditure to materialize the IPO process goes up substantially including underwriting fees, lawyer fees, and fees to other advisory firms. SEBI’s stringent regulations start to apply which is a cumbersome process and requires constant disclosure of information to the public. This is a benefit to the shareholders as the disclosure of information keeps them updated with the inner workings of the company so that they can make reasonable decisions regarding the retainment of the equity shares held by them. This becomes a detriment to the company as the burdens on the company increase and further resources have to be spent and costs incurred so that the information is correctly disclosed on time as per the SEBI regulations. Directors also have to be more careful and disclose all their duties and actions to the public as they start to fall under SEBI’s listing regulations. Since the share price of the company goes public, the general populace including the private and institutional investors use that share price to gauge the performance of the company which was not disclosed when the company was private. These reasons are some of the detriments of the company going public.
Companies are usually incorporated as private entities as most companies, at the stage of their conception, do not have enough resources and funds to go public and be regulated by SEBI’s listing disclosure requirements and regulations. At this stage, the company’s investors are usually the founders or the friends and families of the founders. When the company has made enough profits and gained a reputation in the market, then as per the ideas and aspirations of the company, it may decide to go public to raise funds for newer ventures and expansion projects. This is where the company decides to opt for an IPO which is the Initial Public Offering. This helps the company reach out to a more diversified range of investors from private investors to big institutional investors. This also provides for an exit strategy to the existing shareholders and also helps the company in increasing its value and reputation in the open market. The process of IPO goes on for a long time and a lot of obligations and requirements stipulated by SEBI and the Companies Act, 2013 has to be followed. A company at its initial stages might not be equipped to handle these rules and regulations till it reaches a stage in its business where they are confident enough with its funds and resources to go for an IPO. To conclude, a company goes public through the process of IPO and gets its shares listed on the stock exchanges to be traded by the public so as to increase its capital and expand into newer ventures.
- Initial Public Offering (IPO): What It Is and How It Works (investopedia.com)
- IPO Process In India: 7 Steps Of IPO – Initial Public Offering – India Infoline
- IPO Process in India: 7 Steps Involved in Initial Public Offering | Angel One
- What is Grey Market Premium (GMP) in IPO? (upstox.com)
- Understanding the IPO Process in India – ABC of Money (adityabirlacapital.com)