Emerging market IPOs

Posted in Finance Articles, Total Reads: 3149 , Published on September 30, 2013

The growth of a company depend the most on its ability to draw funds. Funds are required for different purposes like expansion, research, payment of existing debt or progress of new projects in the pipeline. The company can raise funds through primary markets by public issues, rights issue or preferential issues. Out of the three, public issues have become a common source of funds.

Public issues include the Initial Public Offerings (IPO’s) and the Further Public Offerings (FPO’s).  When a private companies offers its shares for the first time to the general public on a securities exchange then it is called as Initial Public Offerings. A private company transforms into a public company through this act and is said to be going public. The Further Public Offerings, on the other hand refers to the further issue of shares to the public.

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IPO have many pros and cons associated with them. IPO’s are considered as costly and very time consuming process which affects the shareholders base of the company. It dilutes the shareholders base and could also be seen as an exit strategy for the original stake owners. The compulsory disclosures to be made to the investors by the issuing company and the norms to be followed by the company, laid by the government of the country after the IPO, are the major drawbacks that are considered by most of the company and play an important role in the company’s decision to go for IPO.

In spite of the above, IPO’s are considered as a cheap source of raising funds. This is so because unlike debts, the issuing company has nothing to pay back. After the IPO, the shares and money rotate among the people. The decision of issuing dividends to the shareholders lies solely in the hands of the issuing company. Listing on the stock exchange also makes the company more publicly known.

The shares are issued either at face value or premium. The prices are decided by fixed price method or book building method. In the fixed price method, the issuer company and merchant bankers decide the price keeping in mind the demand for the IPO in the public. In book building method, the price is discovered through bidding and by book building of the received bids. A price band is decided by the issuer company and the merchant bankers and the bidders are allowed to bid in a specified bidding session in the decided price band. A book is maintained of the received bids and then the price is determined based on the bids received.

Once the company decides to go for an IPO, it has to appoint various intermediaries for the smooth functioning of the IPO plans. The various intermediaries involved are

  • Book Running Lead Manager (BRLM) or Merchant Banker
  • Bankers to the Issue or Escrow Bankers
  • Underwriters
  • IPO Grading Agency
  • Registrars
  • Auditors
  • Legal Counsels
  • Syndicate Banks
  • Printers and Advertising Agency

The merchant bankers are the bankers that look after the complete process of the IPO and are specialized in this task. They are the first ones’ to be appointed by the issuing company and they in turn appoint the rest of the intermediaries on behalf of the issuing company. Their main purpose is to make the IPO process as smooth as possible. They are advised by the legal counsel from time to time and are in direct contact with the syndicate banks which facilitate the IPO process online by proper techniques of fund transfer from the buyer’s to the seller’s account.

The escrow bankers are the banks that are authorized to receive payments from the buyers of the shares. Underwriters are the companies that agree to purchase the shares of the issuing companies if the issuing company is not able to sell of its issues to the public. The underwriters offer this guarantee on some premium. IPO grading agencies are the independent agencies that grade the fundamental practices of the company like financial practices, current projects, associated risk etc. The grades from 1 to 5 are awarded representing poor fundamentals and strong fundamentals respectively. Registrars register or issue the shares on the name of individuals. Auditors help the company to prepare the financial statements according to the governmental norms which are required by both, the exchanges and government. All these intermediaries play a very important role in the IPO process.

The IPO issuing timeline varies from country to country. In India, a company can go public in around six months. The IPO issuing process generally consists of the following steps:

  • Preparation and Approvals
  • Marketing
  • Launch and Completion

The preparation and approval process consists of the appointment of the merchant bankers and other intermediaries, due diligence and the drafting of the red herring prospectus and filing with the securities commission for the country (SEBI in case of India) and exchange.

The red herring prospectus is a document filed by the issuer company with designated authority of the country (SEBI in India) through the merchant banker. It is given by the issuer company to its potential investors in order to make them aware about the IPO procedure and the company.

The marketing stage includes the pre marketing process which sending of red herring prospectus to the potential investors and promotion of the issues by the merchant banker, filing with the Registrar of Companies (ROC) where the company is registered and the roadshows. Roadshows are the formal presentations, discussions that are held by the management of the company offering securities or IPO, all over the country to promote the securities and IPO and to generate interest among the potential investors, analysts, general public about the securities and IPO.

The Launch and Completion process includes the pricing decision and the listing process. The prices of the shares could be allocated either by fixed price method or by book building method. The listing process includes ROC filing of final prospectus, listing and funds transfer.

Along with the selection of good merchant bankers and other intermediaries and following the correct process for the IPO, pricing also plays an important role in the success of the IPO. Overpricing may lead to loss for the shareholders along with decreasing value of the share price. The perfect example for this case is the IPO of Facebook whose share prices fell below the IPO offer price causing losses to the shareholders. In the same way, underpricing of the IPO may lead to losses to the company because the company could have raised more capital from the issue.

Thus, IPOs are very effective and magnificent way to raise funds especially when the company has nothing to pay back as in case of debts. However, the IPOs should be properly handled by the issuer companies and the merchant bankers otherwise it may lead to heavy losses, both to the company and to the shareholders.

The article has been authored by Amber Vasudeo and Rhythm Minhas, University of Petroleum and Energy Studies.

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