Public Offer of Securities

What this chapter covers

Chapter 7 carries 5 marks out of 100 — 5% of the paper.

Learning Objectives: After studying this chapter, you should know about the different ways of raising capital from the market: Issuing Equity Capital · Public offer of shares · Reservations · Initial Public Offer · Eligibility for public issue of shares · Further public offer · Buyback of Securities

How capital builds up

The capital structure of a company is primarily made up of equity contributed by its shareholders. The first contribution to the equity capital happens from the promoters at the time the company is formed. Subsequently, the share capital increases every time the promoters and others bring in additional capital.

The first sample question tests that first sentence — the first contribution comes from the promoters.

Apart from the promoters, the capital of a company may be contributed by institutional investors such as financial institutions and venture capitalists, large investor groups and retail investors. The capital structure of the company may be modified by actions such as raising fresh capital, offer for sale, rights and bonus issues, buy back and tender offers, splits and consolidation.

And the rules change with the situation: the regulations that govern each type of action and group of investors will differ as well as the role of the constituents involved in it.

7.1 Three ways of categorising an issue

Based on when equity capital is raised:

Initial public offer · Further public offer

Based on the category of investors:

Private placement of shares · Preferential allotment of shares · Qualified institutions placement · Rights issue of shares

Based on the method of issue:

Fixed Price offer · Book-building offer

Two by when, four by whom, two by how.

The issue of capital by a company is governed by the regulations of SEBI and the Companies Act. The extent of regulatory compliances to be followed will depend upon the type of issue and the type of investors from whom capital is being raised.

The second sample question asks whose regulations govern the issue of capital — SEBI.

And the principle behind the graduation: if capital is being raised from large institutions that have the capacity to evaluate the issue or from promoters or existing investors who already have all relevant information about the company, the procedures and regulatory requirements are simpler, as compared to the company raising issue from the public.

The less sophisticated the investor, the heavier the compliance.

7.2 Public offer of shares

In a public offer of shares, a company issues shares to a large number of new investors, who are members of the public. When these investors become shareholders of the company, none of them, in themselves, hold a large enough portion of the equity capital of a company to participate in the management of the company.

Therefore, a public issue refers to a distribution, rather than concentration of ownership in a company.

Distribution, not concentration — the defining idea of a public offer.

This market for the first time offer of shares is called the primary market offer. It is an opportunity given by the promoters of the company for the retail investors to participate in the ownership of the company. This also means that the proportional holding of promoters and large investors in the company, will reduce after the public issue.

The regulatory package: the regulations of SEBI and the Companies Act aim at protecting the interest of the retail investors by prescribing:

Disclosure of relevant information both at the time of the issue and periodically thereafter so that investors can evaluate the viability of their investments.

Arrangement for the allotment of shares in dematerialised form.

Listing the shares on a stock exchange so that investors have liquidity.

The continued participation of the promoters in the business through a lock-in of the promoters' holdings.

Four protections — disclosure, demat allotment, listing, and promoter lock-in.

The price at which the shares are issued to the public is decided by the company in consultation with the lead manager to the issue. A public offer of shares results in a change in the shareholding pattern of the company.

7.3 Reservations and promoter contribution

A public issue of shares made through the book building process could be combined with a reservation of shares to certain categories of investors such as the employees, specified shareholders or retail individual investors for specified categories of issue.

Differential pricing: the issuing company can have differential pricing for the retail investors, which can be at a discount not exceeding 10 percent of the price at which shares are allotted to other categories of investors.

A retail discount of up to 10 per cent.

Minimum promoter contribution

The promoters of a company making a public issue of shares are required to continue to hold at least 20 percent of the post-issue paid up capital of the company.

And if they fall short: in case the post issue shareholding of the promoters is less than 20 percent, alternative investment funds or foreign venture capital investors or scheduled commercial banks or public financial institutions or insurance companies registered under IRDAI may contribute for the purpose of meeting the shortfall in minimum contribution as specified for promoters, subject to a maximum of 10 percent of the post issue capital.

Five categories may fill the gap, up to 10 per cent of post-issue capital.

An exemption for seasoned listed companies. In a further public offer this is not required for a listed company whose equity shares are frequently traded on a stock exchange for a period of at least 3 years immediately preceding the reference date and (a) the issuer has redressed at least 95 percent of the complaints received from the investors till the end of the quarter immediately preceding the month of the reference date, and (b) the issuer has been in compliance with the SEBI (LODR) Regulations, 2015 for a minimum period of 3 years immediately preceding the reference date.

Three years of frequent trading, 95 per cent of complaints redressed, and three years of LODR compliance.

Lock-in

The minimum contribution made by the promoters including contribution made by alternative investment funds or foreign venture capital investors or scheduled commercial banks or public financial institutions or insurance companies registered under IRDAI will be locked-in for a period of 18 months from the date of allotment in the initial public offer. In case the majority of the issue proceeds (excluding portion of offer for sale) is proposed to be utilised for capital expenditure, the lock-in period shall be 3 years from the IPO allotment date.

Any holding of the promoter in excess of the minimum prescribed holdings will be locked-in for a period of 6 months from the date of allotment in the initial public offer. In case the majority of the issue proceeds (excluding portion of offer for sale) is proposed to be utilised for capital expenditure, the lock-in period shall be 1 year from the IPO allotment date.

Capital expenditure doubles the exposure — because money sunk into civil work, miscellaneous fixed assets, purchase of land, building and plant and machinery takes longer to bear fruit, so the promoter must stay longer.

7.4 Initial Public Offer

The first public offer of shares made by a company is called an Initial Public Offer (IPO). An IPO is made by a company whose shares are not listed on a stock exchange. Once the IPO is made, the shares have to be compulsorily listed and the shares become available for trading on the stock exchange.

An IPO can either be a fresh issue of shares or it can be an offer for sale of existing shares by any of the existing share holder.

Fresh issue against offer for sale

A fresh issue of shares results in an increase in the share capital of the company. New shares are allotted to the investors. A fresh issue does not change the holding of shares of the investors prior to the issue in terms of the number of shares held. The percentage holding of the investors in the share capital of the company may however change.

Number unchanged, percentage reduced — for existing holders.

In an offer for sale, existing promoters/or any other existing share holder (venture fund or private equity) off-load a portion of their holdings to the public. This will not increase the share capital of the company. The proceeds of the public offer go to the persons off-loading the shares and not to the company.

In a public offer, the money invested by the new shareholders, goes to the company, and its share capital increases.

So the money goes to different places. In an offer for sale the promoters' holding or the existing shareholder who has sold his shares in the company comes down and new shareholders get added to the list of shareholders. There is a change in the list of shareholders, but not in the amount of share capital.

A real example: the Government had made offer for sale of its holding in several public sector companies/banks to the public, through the divestment route. The shares of the company get listed on the stock market after the offer for sale is over.

Pricing — fixed price or book building

Currently, the companies are free to price the issue. In today's scenario, there are two ways of pricing viz. fixed price or book built.

In fixed price issue, the issuer fixes the price of the securities right at the beginning of the issue and the demand for the issue is known only at the end of the issue.

In the book built method, the process aids price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process.

Fixed price: price first, demand later. Book building: demand first, price later.

A note on QIPs: the listed issuer can make a Qualified Institutions Placement (QIP) only if they fulfil certain conditions. The Compliance Officer is required to check whether the issuer is eligible to make a QIP and whether the conditions specified are fulfilled. A QIP is an issue of eligible securities by a listed issuer to qualified institutional buyers on a private placement and includes an offer for sale of specified securities by the promoters/ and promoter group on a private placement basis.

7.5 Eligibility for an IPO

SEBI's regulations prescribe certain eligibility requirements for a company planning a public issue.

1. The issuer company should have net tangible assets of at least Rs. 3 crores in each of the preceding 3 full years (of 12 months each) of which not more than 50 percent are held in monetary assets. The limit of 50 percent on monetary assets is not applicable in case the IPO is made entirely through an offer for sale.

2. It has an average operating profit of at least Rs.15 crores, calculated on a restated and consolidated basis, during the preceding 3 years, with operating profit in each of these preceding 3 years.

3. It has a net worth of at least Rs. 1 crore in each of the preceding 3 full years, calculated on a restated and consolidated basis.

4. If the issuer company has changed its name within the last one year, at least 50 percent of the revenue, calculated on restated and consolidated basis, for the preceding 1 full year has been earned by it from the activity indicated by its new name.

Rs. 3 crore of net tangible assets, Rs. 15 crore average operating profit, Rs. 1 crore net worth — each tested over three years.

Note the second test carefully. It requires an average operating profit of at least Rs.15 crores over three years with operating profit in each of these preceding 3 years — so no loss-making year is permitted, and the average must still reach Rs. 15 crore.

The fifth sample question asks whether SEBI ignores financial performance in setting eligibility norms — plainly it does not, so the answer is false.

The alternative route

An issuer not satisfying the conditions stipulated above may make an initial public offer only if the issue is made through the book-building process and the issuer undertakes to allot, at least 75 percent of the net offer to qualified institutional buyers and to refund the full subscription money if it fails to make the said minimum allotment to qualified institutional buyers.

Three conditions together — book building, 75 per cent to QIBs, and full refund on failure.

The logic is the one stated earlier: where the buyers are institutions that have the capacity to evaluate the issue, the financial track record matters less.

7.6 Further Public Offer

A further public offer is made by a listed company. This means, a company that has already made an IPO in the past and the shares have been listed now makes a further issue of shares to the public. A further public offer may be through an issue of additional shares or through an offer for sale.

The fourth sample question asks which issue only a listed company can make — the Further Public Offer.

Why a company makes one: when a company wants additional capital for growth or to redo its capital structure by retiring debt, it raises equity capital through a further public offer.

And why it may take the offer for sale route: this usually happens when it is necessary to increase the public shareholding to meet the requirements laid down by the listing agreement between the company and the stock exchange. Or promoters may look to dilute their holdings in the company after the lock-in imposed at the time of the IPO is over.

A public offer, whether an IPO or a further public offer has to meet the regulatory requirements laid down by SEBI and the Companies Act. A listed company can also make a further issue of shares if it complies with the regulatory requirements laid down for IPOs.

The listing timeline: the securities after the closure of public issue, i.e. both IPO and FPO, are to be listed within 3 working days (i.e. T+3 days, where T is issue closing date).

And for debt: SEBI has also proposed reduction in the timeline for listing of debt securities and Non-Convertible Redeemable Preference Shares to T+3 working days from existing T + 6 working days — optional from November 01, 2024 and permanent from November 01, 2025.

Application through UPI

All individual investors applying in public issues of such securities through intermediaries (viz. syndicate members, registered stock brokers, registrar to an issue and transfer agent and depository participants), where the application amount is upto Rs. 5 Lakh, shall only use UPI for the purpose of blocking of funds and provide his/ her bank account linked UPI ID in the bid-cum-application form submitted with intermediaries.

Up to Rs. 5 lakh through an intermediary — UPI only.

Further, individual investors shall continue to have the choice of availing other modes (viz. through SCSBs, Stock Exchange Platform and 3-in-1 account) for making an application in the public issue.

Note that the R&T agent is one of the listed intermediaries.

7.7 Buy-back of securities

The SEBI (Buy-back of Securities) Regulations, 2018 apply to listed companies and the rules issued by the Ministry of Company Affairs apply to unlisted companies.

Why a company buys back: to increase the promoters holding, increase the earnings per share of the company, to stave off or prevent a take-over bid or to use the cash surplus available with the company.

Four reasons.

The permitted sources: a company can use the free reserves available, amounts available in the share premium account or from the proceeds of securities issued for buying back its securities. However, a company cannot use the proceeds from an earlier issue of the same class of securities that are being bought back.

Authorisation and limits

The buy-back needs to be authorised by company's article; Special Board resolution is required to be passed in all cases of buy-back; and prior consent of the lenders is required in case of a breach of any covenant with such lenders.

If the buy-back is within 10 percent of the aggregate of the paid-up equity capital and free reserves of the company, the regulations require only a board resolution to be passed and certain other conditions to be fulfilled. A special resolution has to be passed at the general meeting allowing the buy-back of securities if the proposed buy back is in excess of 10 percent of the aggregate of the paid-up equity capital and free reserves.

Ten per cent is the dividing line between a board resolution and a special resolution.

And the ceiling: buy-back cannot however exceed 25 percent of the total of the paid-up capital and free reserves of the company, based on standalone or consolidated financial statements of the company, whichever sets out a lower amount.

Twenty-five per cent, on whichever basis gives the lower figure.

Completion: every buy-backs are to be completed within 1 year from the date of passing of the special resolution at general meeting or the resolution passed by the board of directors of the company, as the case may be.

And: all shares or other specified securities for buy-back must be fully paid-up.

Public notice and escrow

The company must give a public notice of the buy-back in nationwide newspapers (1 English, 1 Hindi and 1 regional language newspaper where the company is registered) within 2 working days from the day of passing the resolution.

What it must state: the details of the proposed buy-back; the reasons for the buy-back; the total number and percentage of the shares and the price at which they are being bought back; the process and funding of the buy-back; the specified date and the timetable of the buy-back.

The copy of this public announcement shall also be submitted in electronic mode to SEBI and the stock exchanges on which its shares are listed.

The escrow: a company shall open an escrow account within 2 working days of the public announcement by way of security.

What may be deposited: cash including bank deposits with any scheduled commercial banks, bank guarantees issued in favour of merchant bankers by any scheduled commercial banks or government securities or units of mutual funds invested in gilt funds and overnight schemes or combination of all.

And afterwards: any amount remaining in the account after payment of consideration to all security holders will be released to the company.

The permitted routes

A company can buy back its securities in any one of the following ways:

Through a tender offer to existing shareholders to buy back the shares on a proportionate basis; or

From the open market either through a book building process or through the stock exchange

But one route is closing: buy-back from open market through stock exchanges shall be phased-out gradually. Such open market buy-backs through stock exchanges shall not be allowed effective from April 1, 2025.

And one is forbidden outright: a company, however, cannot buy back its shares through a private negotiated deal.

A protection for tendering shareholders: lien should be marked against the shares of the shareholders participating in the tender offer for buy back. Upon finalization of the entitlement, only accepted quantity of shares are to be debited from the demat account of the shareholders, and the lien marked against unaccepted shares are to be released.

Buy-back through a tender

A company may buy-back its shares or other specified securities from its existing security-holders on a proportionate basis.

The small shareholder reservation: 15 percent of the number of securities which the company proposes to buy back or number of securities entitled as per their shareholding, whichever is higher, shall be reserved for small shareholders.

And the definition: 'Small shareholder' means a shareholder of a company, who holds shares or other specified securities whose market value, on the basis of closing price of shares or other specified securities, on the recognised stock exchange in which highest trading volume in respect of such securities, as on record date, is not more than Rs. 2 lakh.

Rs. 2 lakh of market value, measured on the record date.

Pricing and promoter disclosure: if the buy back is through a tender offer, the maximum price at which the buyback of shares will be made should be disclosed.

If the promoters are tendering the shares, then the proposal seeking the approval of the shareholders should include information on the quantum of shares to be tendered and the details of the transactions and holdings of the promoters in the securities in the last 6 months prior to the special resolution authorizing the buyback of shares, including information of the number of shares acquired, price and the date of acquisition.

The timetable:

In case of buy-back through tender offer, no draft letter of offer is required to be filed with SEBI.

The dispatch of the letter of offer, shall be through electronic mode... within 2 working days from the record date, with a physical copy on request.

The date of the opening of the offer shall be not later than 4 working days from the record date.

The offer for buy-back shall remain open for a period of 5 working days.

Within 5 working days from the closure of the buy-back offer, the payment has to be made to the shareholders or share certificates returned if the offer is rejected.

Two working days to dispatch, four to open, five open, five to pay.

Acceptance is by entitlement: the company shall accept shares or other specified securities from the security holders on the basis of their entitlement as on record date. The shares proposed to be bought back shall be divided into two categories; (a) reserved category for small shareholders and (b) the general category for other shareholders.

And the spillover rule: after accepting the shares or other specified securities tendered on the basis of entitlement, shares or other specified securities left to be bought back, if any in one category, shall first be accepted, in proportion to the shares or other specified securities tendered over and above their entitlement in the offer by security holders in that category and thereafter from security holders who have tendered over and above their entitlement in other category.

Own category first, then the other.

Finally: the share certificates representing the shares that have been bought back will be destroyed and a certificate to that effect signed by the Registrar of the issue, the secretarial auditor and directors of the company will be submitted to SEBI.

Note that the Registrar signs that certificate — a direct R&T agent responsibility.

Buy-back through the stock exchange

If the buy back is made through a stock exchange, the company has to appoint a merchant banker to manage the buy back. The public notice shall give details of the brokers and stock exchanges through which the buyback will be conducted. The company can only use a stock exchange with nation-wide trading terminals. The buy-back through stock exchanges is undertaken only in respect of frequently traded shares. The buy-back offer on stock exchange shall open not later than 4 working days from the record date.

Reporting is daily: information about the shares bought-back shall be given to the stock exchange on a daily basis and also the company shall upload the information of securities bought back on its website on a daily basis. The shares bought back will be extinguished and a certificate to that effect be given to SEBI and the stock exchange.

Subject always to the sunset: buy-back from the open market through the stock exchange shall not be allowed with effect from April 1, 2025.

Buy-back through book building

If the buy-back is through a book building process then the company has to appoint a merchant banker to manage the issue. Only listed companies are allowed to have a buy back through this process. The public notice should give details of book building process to be followed. The book building will be done through an electronically linked facility.

The offer shall remain open for a minimum of 2 trading days. The certificates pertaining to the accepted bids will be destroyed and the shares tendered in electronic form will be extinguished.

The sample questions confirm that the first contribution of equity capital is made by the promoters; that a company must follow SEBI's regulations for the issue of capital; that it is false that only a listed company can make a public issue; that a Further Public Offer can be made only by a listed company; and that it is false that SEBI ignores financial performance in its eligibility norms.