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Navigating the Transition: A Comprehensive Guide to the Initial Public Offering (IPO) Process

12 min read

By Tanushree Dubey

Published on: November 22, 2023 at 11:10 IST

The Initial Public Offering (IPO) process is a big step for a company, moving from being private to becoming a publicly traded one. This significant change includes many complicated legal and financial steps. It’s crucial to navigate these carefully to follow the rules and make sure the company’s debut on the public market is successful. In this article, we’ll look at the main parts of IPOs and how corporate finance law helps companies go through this complex process.

When a company that used to be private decides to sell its shares to the public for the first time, it’s called an initial public offering or IPO. This means the company’s ownership is shifting from private to public. this process is also called “going public.”

Whether a company is just starting or has been around for a long time, it can choose to go public through an IPO. Usually, companies do this to get money to pay off debts, support new projects, boost their public image, or let the people inside the company sell some of their shares to the public.

In an IPO, once a company decides to “go public,” it picks a lead underwriter to help with the paperwork and selling the shares to the public. The lead underwriter gets a team together, made up of banks and brokers (called a syndicate), and they’re in charge of selling the IPO shares to big investors and regular people.

The process of conducting an Initial Public Offering (IPO) is a critical and transformative step for companies, carrying significant advantages for both the businesses going public and the investors participating in the offering. Here’s a more detailed exploration of the compelling reasons behind the necessity of the IPO process:

  • Raising Capital:

An Initial Public Offering (IPO) is like a financial milestone for companies. It’s a way for them to open their doors to the public, inviting investors to buy shares in the company. The funds raised through an IPO serve as a financial boost, providing the company with the necessary resources to expand its operations, invest in new projects, or even pay off existing debts. Essentially, it’s a significant injection of capital that can propel a company forward.

  • Boosting Brand Visibility:

Going public is not just about the numbers; it’s also about perception. When a company becomes listed on the stock exchange, it gains a level of credibility and prestige. This enhanced reputation not only attracts more investors but also opens doors for potential partnerships and collaborations. Moreover, the increased visibility in the public market can be a magnet for top-notch talent, as professionals often seek out companies with a strong market presence.

  • Providing Liquidity for Shareholders:

Prior to going public, a company’s shares are often not easily tradable. The IPO changes this by creating a market for the company’s stock. This newfound liquidity benefits existing shareholders, such as founders, early investors, and employees, allowing them to sell their shares more easily. It’s like turning an investment into cash, providing a way for these stakeholders to realize the value of their contributions to the company.

  • Determining Market Value:

The IPO process is a meticulous exercise in valuation. The company needs to evaluate its worth in the eyes of the market. This involves setting the right price for its shares, a price that reflects not only the company’s current standing but also its potential for future growth. The market demand and investor appetite play a crucial role in determining this value, making the IPO a dynamic and strategic financial maneuver.

  • Accessing the Capital Market:

Going public opens the doors to a broader capital market. This means that, beyond the initial offering of shares, the company gains ongoing access to various financial instruments. It can issue more shares, explore bond offerings, or leverage other forms of capital. This flexibility is vital for sustaining and fueling the company’s growth initiatives over the long term.

It’s worth noting that the entire process is not a free-for-all. Regulatory bodies, such as the Securities and Exchange Board of India (SEBI), are actively involved to ensure that the IPO process is transparent, fair, and secure for investors. Successfully navigating this transition from a private to a public company requires a collaborative effort involving external experts, including auditors, lawyers, underwriters, and accountants. Their expertise is crucial in addressing the unique challenges that arise in this complex financial undertaking.

In India, the primary regulatory body overseeing securities and capital markets is the Securities and Exchange Board of India (SEBI). SEBI has laid down comprehensive regulations and guidelines to govern the conduct of IPOs. The key legal provisions and regulatory requirements related to IPOs in India include:

  1. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018: These regulations prescribe the disclosure requirements, procedural aspects, and conditions that companies must comply with when making an IPO. It covers aspects such as filing the draft offer document, pricing of the issue, minimum promoter contribution, and other matters related to the issuance of securities to the public.
  2. Companies Act, 2013: The Companies Act provides the legal framework for the incorporation, regulation, and dissolution of companies in India. It contains provisions related to the issuance of securities, including shares, and the process for converting a private company into a public company.
  3. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015: These regulations specify the continuous disclosure and compliance requirements for companies listed on stock exchanges. It includes provisions related to corporate governance, periodic financial reporting, and disclosures to be made by listed companies.
  4. SEBI (Underwriters) Regulations, 1993: These regulations govern the role and responsibilities of underwriters in the IPO process. Underwriters are financial intermediaries that play a crucial role in ensuring the success of the public offering.
  5. SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993: These regulations pertain to the appointment and obligations of registrars and share transfer agents involved in the IPO process.
  6. SEBI (Prohibition of Insider Trading) Regulations, 2015: Insider trading regulations are crucial in the context of IPOs to prevent individuals with access to non-public information from trading securities for personal gain.
  7. Other Applicable Laws: Apart from SEBI regulations, various other laws may come into play depending on the nature of the business and the securities being offered. These may include tax laws, competition laws, and sector-specific regulations.

Companies planning an IPO must comply with these legal provisions and seek approvals from regulatory authorities, including SEBI. The process involves filing a draft red herring prospectus (DRHP) with SEBI, which is scrutinized for compliance with regulatory requirements before the company can proceed with the IPO.

The process of an Initial Public Offering (IPO) involves several key steps. Here’s an overview of the IPO process:

  • Step 1: Engage an Investment Bank

Embarking on the IPO journey begins with enlisting the expertise of investment banks. Often, a team of underwriters or multiple banks is involved. Their role is to delve into the company’s financial landscape, scrutinize assets and liabilities, and strategize to meet the financial requirements. An underwriting agreement is crafted, outlining the deal specifics, the targeted fund amount, and the securities to be issued. It’s noteworthy that, while underwriters ensure capital generation, they do not bear all the risks associated with the financial transactions.

  • Step 2: Draft RHP and Register with the SEBI

Collaboratively, the company and underwriters compile a registration statement and Draft Red Herring Prospectus (RHP). This comprehensive document includes financial data, business details, management information, potential share prices, risk assessments, and disclosure requirements under the SEBI Act and Companies Act. The submission is made to the Registrar of Companies (ROC) at least three days before the IPO opens for public bidding. Subsequently, the company applies to the Securities and Exchange Board of India (SEBI). If the application aligns with SEBI’s stringent guidelines, signalling thorough disclosure, it receives approval. If not, the company addresses SEBI’s comments and resubmits. The IPO can only proceed once SEBI approves the application.

  • Step 3: Apply to the Chosen Stock Exchange

A crucial decision for the company is selecting the stock exchange where it intends to list its shares. The formal application process is initiated at this stage.

  • Step 4: Conduct a Roadshow

Prior to the public launch of the IPO, a dynamic two-week phase unfolds where company executives embark on a roadshow. This involves traversing the country to market the impending IPO to potential investors, particularly Qualified Institutional Buyers (QIBs) in key financial hubs. The roadshow agenda includes presentations of pertinent facts and figures designed to generate positive interest. Larger organizations may be given an opportunity to acquire company stocks before the public offering.

  • Step 5: Price the IPO

The IPO pricing mechanism hinges on whether the company opts for a Fixed Price IPO or a Book Building Issue. In the Fixed Price method, the company and underwriters collaborate to set a fixed price for shares based on comprehensive considerations. Conversely, the Book Building method involves fixing a price band within which investors can bid. The final price is determined by factors such as demand, bids received, and the targeted capital. The company also makes a decision on the stock exchange where it will list its shares.

  • Step 6: Make the IPO Accessible to the Public

On a predetermined date, application forms for the IPO become available to the public. Interested individuals can obtain these forms from designated banks or broker firms. Submission can be done with a cheque or online. The IPO is open to the public for a specified period, typically five working days, in adherence to SEBI guidelines. Deciding the opportune time for the IPO release is critical, considering potential competition from other major companies entering the market.

  • Step 7: Execute the IPO

After finalizing the IPO price, stakeholders collaborate to determine the allotment of shares to each investor. In most cases, investors receive the full number of securities unless oversubscribed. The credited shares are then placed in their demat account, with refunds issued if oversubscribed. Once allotted, the IPO shares are ready for trading on the stock market. Internal investors must refrain from trading to prevent manipulation of stock prices.

In instances of oversubscription, shares are allotted proportionately to applicants. For example, if oversubscribed five times, an application for 10 lakh shares will receive an allotment of only 2 lakh shares. The entire IPO process is meticulously designed to uphold transparency and fairness, ensuring a seamless transition for a company into the realm of public offerings.

Going public through an Initial Public Offering (IPO) has many advantages for a company. It affects how well the company is doing financially, how much people know about it, and how easily shareholders can turn their investments into cash. Let’s look at the important benefits that make the IPO process a good choice for companies thinking about becoming public.

  • Access to More Money:

When a company goes public, it can raise a significant amount of money, often more than it could get through other means. This influx of funds can have a big impact on the company’s growth plans. It allows them to do things like research and development, hiring new employees, building facilities, paying off debts, investing in technology, and more.

2. Increased Recognition:

Going public brings a lot of attention to a company. It makes the company more known and credible. Publicly traded companies are often more recognized than private ones. The process of going public also attracts attention from the media, especially in the financial sector.

  • More Financial Flexibility:

Before going public, companies might struggle to get funds. They may have to take loans with high-interest rates or give up some ownership to get investors. Going public makes it easier to get new financing, lowering the barriers to obtaining funds. With more money on hand, companies can invest in things like acquiring assets and hiring top professionals.

  • Trading Shares in the Future:

Once a company is public, it can use its publicly traded stock as a form of payment. While private companies can also use their stock for this, the value of private stock is only realized when there’s a good opportunity to sell it. Public stock, however, is like cash that can be bought and sold at any time at a market price. This flexibility makes it useful for paying employees and acquiring other companies.

When a company decides to go public through an Initial Public Offering (IPO), it gains several advantages. However, this move also brings challenges and drawbacks that need careful consideration. It’s crucial for businesses thinking about the shift from private to public ownership to understand these potential downsides. Let’s take a closer look at the challenges that come with the opportunities of the IPO process.

  • Higher Initial Costs:

Going public can be very costly. Apart from the ongoing expenses related to complying with regulations for public companies, the process of an IPO itself requires investing money in an underwriter, an investment bank, and an advertiser to manage everything smoothly.

  • Pressure to Perform:

Once a company is listed on the stock market, there’s intense pressure to keep the stock value high, especially during market ups and downs. Executives may feel compelled to avoid risky decisions that could negatively impact stock prices. This sometimes leads to prioritizing short-term gains over long-term strategies.

  • Increased Administrative Burden:

Public companies are obligated to submit their financial accounts annually to regulatory bodies like the Securities and Exchange Board of India (SEBI). This requirement, not applicable to private companies, adds administrative work and costs. Preparing and auditing these financial statements as part of the disclosure process involves additional expenses.

  • Reduced Control:

Publicly traded companies are managed by a board of directors, accountable to shareholders rather than just the CEO or president. While the board may grant the management team authority for day-to-day operations, the final decision-making power lies with them. They have the right to replace CEOs, including company founders. Some companies try to address this by going public in a way that allows their founder to retain veto authority.

If you’re thinking about investing, consider getting in on an Initial Public Offering (IPO) sooner rather than later. The potential payoff comes if the company grows significantly over time, allowing you to build wealth in the long run as the company expands.

Investing in an Initial Public Offering (IPO) is like being there from the very beginning of a company’s stock journey. It’s a special opportunity to join early and potentially gain as the company grows. Here are some key reasons to consider investing in IPOs.

Investing in an Initial Public Offering (IPO) is like being there from the very beginning of a company’s stock journey. It’s a special opportunity to join early and potentially gain as the company grows. Investing in an Initial Public Offering (IPO) is like being there from the very beginning of a company’s stock journey. It’s a special opportunity to join early and potentially gain as the company grows. Bottom of Form

  • Transparency:

Investing in an IPO provides you with transparency in pricing, similar to major investors. The IPO order reveals the price of the securities, making the entire process transparent. However, keep in mind that share prices after the company goes public can be influenced by unpredictable market conditions.

  • Long-Term Goals:

IPO investment aligns with long-term equity investment strategies. Over time, successful investments in IPOs can potentially help you achieve your long-term financial goals, such as buying a home.

  • Affordable Entry, Potential Gains:

Companies planning to go public often offer shares at a discounted price initially. This means you can get in on the ground floor when the company first goes public, potentially leading to significant gains as the company performs well in the stock market.

Before diving into IPO investments, it’s crucial to be aware of both the positives and negatives. Like any investment, IPOs have their advantages and drawbacks. Let’s take a look at the downsides. One significant disadvantage is that there’s no guarantee you’ll be able to secure shares, as obtaining them during an IPO is not guaranteed.

Investing in Initial Public Offerings (IPOs) can be exciting, but it’s essential to know that there are challenges involved. Recognizing these challenges helps investors make smart decisions. Now, let’s look at the potential drawbacks that come with investing in IPOs.

  • Privacy Concerns:

When you apply for an IPO, you’re required to provide detailed investor information in the documentation and application. This may include personal details you’d rather keep private, but sharing this information is mandatory.

  • Time Investment:

Investing in an IPO demands time and effort. Thoroughly researching the company and understanding its past performance is crucial before making any investment decisions. While the information is available in the company’s prospectus, grasping it requires dedicated time and attention.

  • External Influences:

The pricing of IPOs can be significantly impacted by external factors, especially when companies operate within government regulations that may change based on the current political climate. These external influences can introduce uncertainties into the investment landscape.

The IPO process is a critical yet intricate step for companies transitioning from private to public. The benefits, including capital infusion and increased visibility, come with challenges like higher costs and loss of control. Key steps involve engaging an investment bank, drafting a prospectus, pricing the offering, and making shares accessible. For investors, IPOs offer transparent pricing and potential gains but pose risks like privacy concerns. Success in going public requires strategic evaluation and a nuanced understanding of legal, financial, and market dynamics.

Edited By: Bharti Verma, Associate Editor at law insider