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What is IPO (Initial Public Offering) Process and Eligibility Criteria?

Posted in Finance Articles, Total Reads: 2502 , Published on January 28, 2016

This article covers about IPO or Initial Public Offering, and explains all the various steps taken in creating an IPO, when a company decides to go public. It talks about the IPO eligibility criteria, the IPO process, and why companies choose this option of initial public offering.

What is Initial Public Offering (IPO):

It is where the privately held companies can sell its shares to the General Public for the first time. Usually, the company issues only 20-30% of its shares, but it may vary from industry to industry and company to company. Generally, investors find the company riskier if it makes less number of shares available to them.

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Why companies want to go Public:

• Companies want to raise capital from the market to either pursue their expansion plans or to pay off their debts.

• If the company wishes to be acquired, then they go public and get acquired by investors or other companies using stock. IPO gives the companies a very easy exit, if they want to.

• IPO may be used to market the company as it is a great way to increase its prestige and thereby attract new investors.

Who decides the company should go for an IPO?

In most cases, the board members or the major shareholders decide whether to go public or not.

Eligibility criteria for the company to go for IPO

• Company must have Net Tangible Assets of Rs.3 Crore in each of the 3 preceding years.

• It should have a track record of distributable profits in at least 3 out of 5 preceding years.

• It should also have a Net worth of Rs.1 Crore in preceding 3 years.

IPO Process:

Step 1 – The Pitch

Bankers from many firms stay in touch with the company and develop relationships with it, so they know well in advance about the company’s intentions. Or the company would itself reach out to the bankers and invite them to pitch for the business. After the bankers have prepared their pitch book, the company would select a bank as a book runner and other banks as their co-managers based on the relationship the company has with the bank or the bank’s IPO track record, reputation etc.

E.g.: Facebook’s first preference for the Book runner role was going to be given to Goldman Sachs as it helped them to arrange $1.5 Billion for financing back in 2011, but due to some issues with SEC (Securities and Exchange Commission) the bid went to the Morgan Stanley.

Step 2 – The Kick-off Meeting

The people involved in the whole IPO process would be the Company’s Management, auditors, accountants, the banks and the lawyers. In the kick-off meeting, all these people would be present and discuss about the offering, the registration formalities, who is doing what tasks and most importantly deciding the timing for the filling.

After the meeting, common tasks that need to be taken care of are as follows:

• Customer Calls: It is the job of the bankers, as they feel that sometimes they hear something from customers that they would have never heard from the company. It helps them to understand the company’s brand image in the market and what sentiments the customers have for the company.

• Industry/Market Due Diligence: It is the job of the business analysts. They would research the market, discuss with the experts to figure out what would be the future for the industry.

• Legal and IP Due Diligence: Lawyers handle most of these tasks starting from reviewing contracts to taking care of the registration process.

• Financial and Tax Due Diligence: Accountants handle most of these tasks starting from studying historical financial statements to tax returns and find for any irregularities.

Step 3 – The S-1 Filling

Form S-1 is an SEC filling used by companies to register their securities. The S-1 contains basic business and financial information apart from the securities offering of the company. Here all the information comes out about the company like who is selling the shares, how many shares are they selling, overview of the company etc.

Step 4 – Pre-selling the offering

After form S-1 is filled with the SEC, now the company holds a pre-IPO analyst meeting wherein the company would educate the bankers about the company and also teach them how to sell it to investors. Bankers then draft a “Red Herring” (Preliminary Prospectus), which would be used by the company to pitch to the investors. The prospectus would not contain the offering’s price, the discounts/commissions to the dealers; it would just have the company’s story in it.

The company has a period of 2 weeks for the pre-marketing to happen. In this, research analysts meet with the investors and tell them about the company. Also they would take the investor’s feedback about what they think about the company, what price are they willing to pay. All this is done, just to set a price range for the offering on the basis of the market feedback.

Now after the price range is fixed, the company brings amendment in the S-1 form with the revised price range.

Step 5 – The Road show

Now this is the exhaustive task, where the management, the banks travel all over to meet the investors and make a deal with them. This process is very important as the orders are taken from investors and how many shares and how much are they willing is to pay is ascertained.

During this time, management and bankers keep track of the orders that are coming and the feedback they are receiving from the investors, which would help them further revise their price range.

E.g. Facebook changed its price range from $28 - $34 to $34 - $38 after getting tremendous response from the market.

Step 6 – The Pricing Meeting 

This is the most important process, on the basis of the orders received; the management team will decide the final price of the deal.

If the deal is over-subscribed, the company will price itself at the higher range and will do the opposite for under-subscriptions.

Sometimes, the company will deliberately price themselves at lower range, so that the stock could trade up on the 1st Day of trading – a positive indicator for the company.

Step 7 – Allocation and Trading 

Once the deal is priced, the banks would allocate shares to the investors. After allocation is done to the investors, the stock starts trading on the exchanges and the shares would be open to the general public for buying and selling.

This article has been authored by Kshitij Jain from SIBM Pune

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