Initial public offering (IPO) or stock market launch is a type of public offering
in which shares of a company are sold to institutional investors and usually
also retail (individual) investors; an IPO is underwritten by one or more
investment banks, who also arrange for the shares to be listed on one or
more stock exchange. Through this process, colloquially known as floating,
or going public, a privately held company is transformed into a public
company. Initial public offerings can be used: to raise new equity capital for
the company concerned; to monetize the investments of private
shareholders such as company founders or private equity investors; and to
enable easy trading of existing holdings or future capital raising by
becoming publicly traded enterprises.
After the IPO, those shares which trade freely in the open market are
known as the free float. Stock exchanges stipulate a minimum free float
both in absolute terms (the total value as determined by the share price
multiplied by the number of share sold to the public) and as a proportion of
the total share capital (i.e., the number of shares sold to the public divided
by the total shares outstanding). Although IPO offers many benefits, there
are also significant costs involved, chiefly those associated with the process
such as banking and legal fees, and the ongoing requirement to disclose
important and sometimes sensitive information.
History :
The earliest form of a company which issued public shares was the case of
the publicani during the Roman Republic. Like modern joint-stock
companies, the publicani were legal bodies independent of their members
whose ownership was divided into shares, or partes. There is evidence that
these shares were sold to public investors and traded in a type of over-the-
counter market in the Forum, near the Temple of Castor and Pollux. The
shares fluctuated in value, encouraging the activity of speculators, or
quaestors. Mere evidence remains of the prices for which partes were sold,
the nature of initial public offerings, or a description of stock market
behavior. Publicani lost favor with the fall of the Republic and the rise of the
Empire.[13]
In the early modern period, the Dutch were financial innovators who helped
lay the foundations of modern financial system.[14][15] The first modern
IPO occurred in March 1602 when the Dutch East India Company offered
shares of the company to the public in order to raise capital. The Dutch East
India Company (VOC) became the first company in history to issue bonds
and shares of stock to the general public. In other words, the VOC was
officially the first publicly traded company, because it was the first company
to be ever actually listed on an official stock exchange. While the Italian city-
states produced the first transferable government bonds, they did not
develop the other ingredient necessary to produce a fully fledged capital
market: corporate shareholders. As Edward Stringham (2015) notes,
"companies with transferable shares date back to classical Rome, but these
were usually not enduring endeavors and no considerable secondary
market existed (Neal, 1997, p. 61)."[16]
In the United States, the first IPO was the public offering of Bank of North
America around 1783.
Procedure :
Advance planning :
Planning is crucial to a successful IPO. One book[21] suggests the following
7 advance planning steps:
Retention of underwriters
Financial historians Richard Sylla and Robert E. Wright have shown that
before 1860 most early U.S. corporations sold shares in themselves directly
to the public without the aid of intermediaries like investment banks.[23]
The direct public offering or DPO, as they term it,[24] was not done by
auction but rather at a share price set by the issuing corporation. In this
sense, it is the same as the fixed price public offers that were the traditional
IPO method in most non-US countries in the early 1990s. The DPO
eliminated the agency problem associated with offerings intermediated by
investment banks.
The sale (allocation and pricing) of shares in an IPO may take several forms.
Common methods include:
Best efforts contract
All-or-none contract
Bought deal
Public offerings are sold to both institutional investors and retail clients of
the underwriters. A licensed securities salesperson (Registered
Representative in the USA and Canada) selling shares of a public offering to
his clients is paid a portion of the selling concession (the fee paid by the
issuer to the underwriter) rather than by his client. In some situations,
when the IPO is not a "hot" issue (undersubscribed), and where the
salesperson is the client's advisor, it is possible that the financial incentives
of the advisor and client may not be aligned.
The issuer usually allows the underwriters an option to increase the size of
the offering by up to 15% under certain circumstance known as the
greenshoe or overallotment option. This option is always exercised when
the offering is considered a "hot" issue, by virtue of being oversubscribed.
The Final step in preparing and filing the final IPO prospectus is for the
issuer to retain one of the major financial "printers", who print (and today,
also electronically file with the SEC) the registration statement on Form S-1.
Typically, preparation of the final prospectus is actually performed at the
printer, where in one of their multiple conference rooms the issuer, issuer's
counsel (attorneys), underwriter's counsel (attorneys), the lead
underwriter(s), and the issuer's accountants/auditors make final edits and
proofreading, concluding with the filing of the final prospectus by the
financial printer with the Securities and Exchange Commission.[26]
Before legal actions initiated by New York Attorney General Eliot Spitzer,
which later became known as the Global Settlement enforcement
agreement, some large investment firms had initiated favorable research
coverage of companies in an effort to aid corporate finance departments
and retail divisions engaged in the marketing of new issues. The central
issue in that enforcement agreement had been judged in court previously. It
involved the conflict of interest between the investment banking and
analysis departments of ten of the largest investment firms in the United
States. The investment firms involved in the settlement had all engaged in
actions and practices that had allowed the inappropriate influence of their
research analysts by their investment bankers seeking lucrative fees.[27] A
typical violation addressed by the settlement was the case of CSFB and
Salomon Smith Barney, which were alleged to have engaged in
inappropriate spinning of "hot" IPOs and issued fraudulent research reports
in violation of various sections within the Securities Exchange Act of 1934.
Pricing :
Some researchers (Friesen & Swift, 2009) believe that the underpricing of
IPOs is less a deliberate act on the part of issuers and/or underwriters, and
more the result of an over-reaction on the part of investors (Friesen & Swift,
2009). One potential method for determining underpricing is through the
use of IPO underpricing algorithms.
Dutch auction :
A variation of the Dutch Auction has been used to take a number of U.S.
companies public including Morningstar, Interactive Brokers Group,
Overstock.com, Ravenswood Winery, Clean Energy Fuels, and Boston Beer
Company.[31] In 2004, Google used the Dutch Auction system for its Initial
Public Offering.[32] Traditional U.S. investment banks have shown
resistance to the idea of using an auction process to engage in public
securities offerings. The auction method allows for equal access to the
allocation of shares and eliminates the favorable treatment accorded
important clients by the underwriters in conventional IPOs. In the face of
this resistance, the Dutch Auction is still a little used method in U.S. public
offerings, although there have been hundreds of auction IPOs in other
countries.
Quiet period :
Under American securities law, there are two time windows commonly
referred to as "quiet periods" during an IPO's history. The first and the one
linked above is the period of time following the filing of the company's S-1
but before SEC staff declare the registration statement effective. During this
time, issuers, company insiders, analysts, and other parties are legally
restricted in their ability to discuss or promote the upcoming IPO (U.S.
Securities and Exchange Commission, 2005).
Delivery of shares :
Not all IPOs are eligible for delivery settlement through the DTC system,
which would then either require the physical delivery of the stock
certificates to the clearing agent bank's custodian, or a delivery versus
payment (DVP) arrangement with the selling group brokerage firm.
Advantages/significance:
·0 Enlarging and diversifying equity base
Disadvantages
·6 Significant legal, accounting and marketing costs, many of which
are ongoing
How it works ?
Underwriting :
Over‐subscription privilege :
Basic example :
Stock dilution :
Rights offerings offset the dilutive effect of issuing more shares. For
this reason, stock-exchange rules don't require that shareholders
approve rights offerings if the company offers at least 20% of
outstanding shares at a discount.[1]:1 However, some investors see
rights offers as an "unwelcome choice between stumping up more
cash or seeing their existing holding diluted", as a result of which
rumors that a company might undertake an offering can hurt its share
price.[2] Because rights offerings are unpopular, companies typically
choose them as a last resort,[2] perhaps due to insufficient investor
demand.
Given below are few clarifications regarding the role played by SEBI:
(a) Till the early nineties, Controller of Capital Issues used to decide
about entry of company in the market and also about the price at
which securities should be offered to public. However, following the
introduction of disclosure based regime under the aegis of SEBI,
companies can now determine issue price of securities freely without
any regulatory interference, with the flexibility to take advantage of
market forces.
(e) Draft offer document in respect of issues of size upto Rs. 100 crore
shall be filed with the concerned regional office of the Board under
the jurisdiction of which the registered office of the issuer company
falls.
SEBI does not recommend any issue nor does take any responsibility
either for the financial soundness of any scheme or the project for
which the issue is proposed to be made or for the correctness of the
statements made or opinions expressed in the offer document.
Does the SEBI clearance tag make the IPO/FPO safe for the investors?
1. Applicability:
3. Underwriting:
4. Appointment of Registrar:
Appointment of Registrars to Issue shall be compulsory.
Partly paid shares, if any, must either be made fully paid or forfeited.
7. Letter of Offer:
(ii) File with SEBI a copy of the offer document at least 21 days before
filing of the same with the Regional Stock Exchange.
The rights issue must be kept open for a minimum period of 30 days.
It cannot remain open for more than 60 days.
Issue shall be made fully paid-up within 12months except where the
total issue size exceeds Rs. 500 crore.
The draft offer document filed with SEBI shall be made public for a
period of 21 days from the date of filing the offer document with
SEBI.
The Lead Merchant Banker shall:
(a) Simultaneously file copies of the draft offer document with the
stock exchanges where the securities offered through the issue are
proposed to be listed.
After a period of 21 days from the date the draft offer document was
made public, the Lead Merchant Banker shall file a statement with
SEBI:
In the case of rights issues, lead merchant banker shall ensure that
the letters of offer are dispatched to all shareholders at least one
week before the date of opening of the issue.
After the prospectus or letter of offer has been filed with the
Registrar of Companies or stock exchange the printed prospectus or
letter of offer shall be forwarded to SEBI at least 10 days prior to the
issue opening date.
21. Underwriters:
(a) (i) If the issue is proposed to be closed at the earliest closing date,
the Lead Merchant Banker shall satisfy himself that the issue is fully
subscribed before announcing closure of the issue.
(ii) In case, there is no definite information about subscription figures,
the issue shall be kept open for the required number of days to take
care of the underwriters’ interests and to avoid any dispute, at a later
date, by the underwriters in respect of their liability.
The report shall be filed on the 3rd day from the date of closure of
the subscription of the issue.
This report shall be filed on the 50th day from the date of closing of
subscription of the issue.
What is the difference between IPO And Right issue. What are formalities
required to be complied with in both of them. When a listed public
company offers its shares, it has to offer them first to its existing
shareholders, then how IPO is possible ?
All companies in the U.S. start as privately owned entities, which are
generally created by an individual or a group of founders. The owners
typically hold all or most of the stock, which is authorized within the
company's articles of incorporation, a legal instrument created when the
corporation is first established.
To fund operations during the early years, the owners typically put up their
own money (known as self-funding), seek venture capital backing, and/or
obtain loans or other forms of private financing from banks or other
financial entities.
If and when a company decides to sell shares of its stock to the public for
the first time to raise money for operations or other uses, it engages the
services of one or more investment banks to act as the underwriters
responsible for managing the underwriting process of the IPO.
The underwriters help the company organize and file information that is
required by regulators; create a prospectus disclosing all relevant
information about the company (covering investing basics regarding
finances and operations) and making it available to the public; assess the
value of the stock to be issued; and determine the initial price the new
shares sell for to the public. Once the initial shares are purchased in the
IPO, they start to trade among the public in the secondary market.
Conclusion
·13 An initial public offering (IPO) is the first sale of stock issued
by a company to the public.
·16 Going public raises cash and provides many benefits for a
company.
·23 The existing shareholders can also choose to ignore the rights;
however, one may not do so as existing shareholding will be
diluted post issue of additional shares and will result in a loss
(in valuation) for existing shareholder.