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5.1 Brief description

In the previous chapter, we saw how a company gradually grows from the idea stage to IPO. Through a story, we saw the journey of the company’s development. How does the company need money at different levels and what are the ways it can raise money? What are the conditions the company has to deal with before bringing the IPO? 

It is important to know and understand all this because many times such companies also come in the IPO market or primary market, which have never raised money from anywhere before. Before the IPO, more information is available about the promoter and business of companies that have raised money from good VC, PE funds, or some other big investors, so they can be trusted a bit more. 

5.2 Why do companies raise money from the public? (Why do companies go public?)

In the last chapter, we raised some important questions. One of them was why companies go public to raise money, and why choose the IPO route.

Whenever a company decides to bring an IPO, it usually wants to raise CAPEX to grow the business. In this way the company has three advantages: 

1. The company gets money for CAPEX.
2. The company is saved from taking loans, and saving interest on the loan saves the company more money in the form of profits. 
3. When you buy shares of a company, you share in the risk just like the promoter of the company. However, the risk depends on the number of shares you hold. But the promoter definitely succeeds in distributing his risk among many people. 

 Apart from this, there are some other advantages of raising capital through IPO: 

1. Early investors of the company get a chance to withdraw their investment:  When the company is listed after the IPO, its shares can be bought and sold by anyone. Due to this, many people like the promoter of the company, angel investors, venture capitalists, and PE funds, get a way to sell their shares. In this way, they are able to withdraw their initial investment.
2. Award to the employees of the company: Some shares can be allotted to the employees already working in the company. In this way, when the company gives shares to its employees, then this agreement is called Employee Stock Option. These shares are given to the employees at a discount. When the company’s shares are listed after the IPO, the employees benefit from the increase in the share price. Employees of companies such as Google, Infosys, Twitter, and Facebook have benefited from such stock options. 
3. The name of the company grows:   After the public listing, the name of the company becomes big because its shares are held by the public, and people can buy and sell them, and people start knowing more about that company.  

So now let’s go back to the story of the previous chapter and take it forward. You may recall that the company needed Rs 200 crore for CAPEX and the management decided to raise this amount through its own resources and through an IPO.

Remember that the company still has 16% of the authorized capital i.e. 800,000 shares which have not been allotted to anyone. These shares were valued at around 64 crores when the PE firm made the investment. The business of the company has been very good since the PE firm’s investment and it can be expected that the price of these shares would have increased further. Let us assume that the value of these 16% shares is now somewhere between 125 to 150 crores. This means the price of each share is between 1562 to 1875 ( 125 crores / 8 lakhs)

So now if the company sells these 16% i.e. 8 lakh shares to the public, then it will get an amount of around 125 to 150 crores. He will have to raise the rest of the amount from his own sources. It is obvious that the company would like to get maximum money by selling shares.

5.3 Merchant Banker: 

After deciding to bring an IPO, the company has to do many things so that it can get maximum money. The first and most important of these is the appointment of a merchant banker. Merchant banker is also called Book Running Lead Manager or just Lead Manager. Their job is to help the company in its IPO. As:

• Conducting due diligence of the company and providing a due diligence certificate. They also have to see that the company has followed every rule of the law.
• Preparation of all listing documents including Draft Red Herring Prospectus (DRHP) in conjunction with the Company. We will discuss this in detail later. 
• Underwriting shares. This means that the merchant banker has entered into an agreement to buy all or some of the IPO shares from the company and later sell them to the public.
• Helping the company in deciding the price band of the shares in the IPO. Price band means the limit of the lower and upper price of the share in between which the shares will be sold at any price. In the example of our story the price, of the band is 1562/- to 1875/-.
• Helping the company in its road shows. The roadshow is called the promotion and marketing of the IPO of the company. The entire responsibility of marketing is of the lead manager.
• Appointing other intermediaries like registrar, banker, advertising agency, etc. for IPO. 

After coming along with the merchant banker, the company starts the IPO work. 

5.4 IPO sequence of events: 

Every step in IPO has to be taken according to the rules of SEBI. And these steps are taken in this order: 

1. Appointment of a merchant banker. There can be more than one merchant banker in a large public issue.
2. Submission of application to SEBI along with a registration statement. In the registration statement, it is told what the company does, why it needs to bring an IPO, and what is the financial condition of the company. 
3. Getting approval for IPO from SEBI. After receiving the registration statement, SEBI decides whether to grant approval or not.
4. DRHP- After getting the initial approval for the issue, the company has to prepare its DRHP i.e. Draft Red Herring Prospectus. It is also shared with the public. The information required to be included in the DRHP is: 
5. The size of the IPO means how big the IPO will be
6. Total number of shares being issued
7. Why is the company bringing the issue and what will be the use of the money raised from it? 
8. Full details of the company’s business, business model, expenses, etc.
9. all financial documents
10. Management’s view of how the company’s business is going to be in the coming years. 
11. All business-related risks
12. Complete information on the people associated with the management.

• Marketing of IPO (Market the IPO) – Issuance of advertisements related to the IPO of the company so that people can know about the IPO. This work is also called a road show. 
• Setting a price band – The company cannot set a price band that is too different from what the market is expecting, otherwise, people will not subscribe to it.
• Book Building – After the roadshow is over and the price band is decided, the company officially opens the subscription of shares for a few days so that people can invest in the issue. Suppose the price band is 100 to 120, then book building will tell at what price people are investing and what price they think is right. Accumulating all this information is called book building. This gives an idea of ​​the true value.
• Closure – After the book building is completed, the listing price of the share is decided. This price is usually the price at which the maximum number of applications have come. 
• Listing Day – On this day the shares of the company are listed on the exchange. The listing price is decided on the basis of the demand and supply of the share on that day. The stock is then listed at a premium, par, or discount to its cut-off price. 

5.5 What happens after the IPO? (What happens after the IPO?)

As long as the IPO or issue is open, investors can bid or bid for shares at the price of their choice within the price band of the IPO, till then it is called the primary market. But as soon as the share is listed on the exchange, anyone can buy and sell that share, it is called the secondary market. After this, buying and selling of shares start happening daily.

Why do people buy or sell shares? Why do share prices go up and down? We will try to answer each such question in the coming chapter. 

5.6 Few key IPO Jargon

Under Subscription: Suppose a company wants to sell 100,000 shares to the public, but during book building it is found that bids have been received for only 90,000 shares, the issue is said to be undersubscribed. This is not considered a good situation for the company as it would be assumed that the public did not like the issue.

Over Subscription: If an issue of 100,000 shares receives 200,000 bids, the issue is said to be oversubscribed two times.

Green Shoe Option: Under the underwriting agreement, the issuer has the right to allot additional shares (usually 15%) in the event of oversubscription. It is also called the overallotment option.

Fixed Price IPO: Many times companies bring IPO by fixing the price of the share instead of the price band. This is called Fixed Price IPO. 

Price Band & Cut-off Price: The price band is the range within which the shares are issued. Suppose the price band is 100 to 130 and the closing price of the share is fixed at Rs 125, then Rs 125 is called the cut-off price.

5.7 Recent IPOs in India: 

Everything you have learned so far will help you understand this table.

Important points of this chapter:

1. Companies bring public issues to raise money, give early investors a way to withdraw money, reward employees and increase the company’s reputation.
2. Merchant banker is the most important partner of any company for IPO.
3. The IPO market is completely under SEBI and it is SEBI that decides whether a company should be allowed to bring an IPO or not.
4. Before investing money in an IPO, every investor must read DRHP so that they can get complete information about the company.
5. More and more IPOs in India take the route of book building.