Processes related to Public Offering of Shares

What this chapter covers

Chapter 9 carries 8 marks out of 100 — 8% of the paper.

Learning Objectives: After studying this chapter, you should know about the different process involved in public offering of shares: Pre-issue Work · Post Issue Work · Prospectus & Red Herring Prospectus · Underwriting · Green Shoe Option · Methods of making a public issue of share · Small and Medium Enterprise Initial Public Offer (SME IPO)

Getting started

A company making an issue of shares has to go through certain internal and external steps to give effect to the issue. Internally, the company needs to get the approval of the board of directors and the existing shareholders for the issue.

Once this is done, the company has to appoint a merchant banker who will be the lead manager of the issue. The lead manager is responsible for ensuring that the regulatory requirements of the issue are complied with. The lead manager is responsible for all activities till the issue is listed.

Board and shareholders first; then the lead manager, who carries the issue to listing.

9.1 Pre-issue work

The lead manager undertakes the following steps in managing a public offer of shares:

Appoint R&T agents, bankers, syndicate brokers, brokers and underwriters to the issue. In case of a book built issue, the book runners, who are merchant bankers, will be appointed. The merchant banker has to ensure that the constituents are registered with SEBI.

Obtain the in-principle approval of the recognised stock exchanges where the shares are proposed to be listed.

Designated Stock Exchange means the recognised Stock Exchange in which the Basis of Allotment has to be approved and chosen by the issuer as a Designated Stock Exchange for the purposes of the current issue.

Ensure that the mandatory number of bidding centres is covered by the syndicate brokers to the issue.

For an issue by an unlisted company, get the IPO graded by an approved credit rating agency.

Note the limit — grading applies to an issue by an unlisted company, not to every public issue. The third sample question turns on this and the answer is false.

Enter into agreements with depositories for the admission of the securities in both the depositories before filing of Draft Red Herring Prospectus (DRHP) with SEBI.

File DRHP with SEBI.

Make changes, if any, to the DRHP as suggested by SEBI and file the Red Herring Prospectus (RHP) with the Registrar of Companies.

Sign the due diligence that all the regulatory requirements are complied with.

The first sample question asks who signs the due diligence certificate — the lead managers.

Issue advertisements in national papers as required by regulations.

Arrange for the printing and dispatch of prospectus and application forms and other issue material.

Ensure that every application form is accompanied by an abridged prospectus.

9.2 Post-issue work

An issue is required to be kept open for a minimum of 3 working days and a maximum of 10 working days.

The lead manager's post-issue functions:

Once the issue opens, ensure that the Self Certified Syndicate Banks (SCSBs) block the funds as per the amounts mentioned in the application forms and then bid the applications. Effective September 1st, 2022, the ASBA applications in Public Issues shall be processed only after the application monies are blocked in the investor's bank accounts.

Block first, process afterwards.

Ensure the R&T agent collect the bid data from Stock Exchanges and reconcile the data received from the SCSBs and obtain a final collection certificates.

Finalize the basis of allotment in consultation with the designated stock exchange.

Basis of allotment

Basis of allotment is the process of deciding the number of shares that each investor is entitled to be allotted.

A floor on the number of allottees: the issuer shall not make any allotment if the number of prospective allottees is less than 1000.

How it is worked out: once the issue closes, the applications/bids are collated under various categories such as retail investors, Non-Institutional Investors (NIIs), Qualified Institutional Buyers (QIBs) and reservations. The number of shares applied for is compared with the shares reserved for each category and the over-subscription ratio is calculated. This is applied to each application to determine the shares to be allotted.

If the number of shares that have been subscribed for is equal to or less than the number of shares offered by the company, then each investor will get the same number of shares he has applied for. If the issue is over-subscribed, then the number of shares allotted to each investor will be in proportion to the over-subscription within the specified investor categories, except for retail individual investors, non-institutional investors and anchor investors.

Three categories are treated differently — retail, NII and anchor investors.

For retail: in the event the number of retail applicants who have submitted valid bids in the issue is equal to or less than maximum retail allottees, (i) all such retail applicants shall be allotted the minimum bid lot; and (ii) the balance available equity shares, if any, remaining in the retail category shall be allotted on a proportionate basis to the retail applicants, who have received allotment as per (i) for the balance demand of the equity shares bid by them.

Everyone gets one lot first; the surplus is then shared proportionately.

For NIIs: the allotment of specified securities to each Non-Institutional Investor (NII) shall not be less than the minimum application size, subject to availability in the Non-Institutional Portion, and the remainder, if any, shall be allotted on a proportionate basis.

Who signs off: the authorised employees of the designated stock exchange, along with the lead manager(s) and registrars to the issue, shall ensure that the basis of allotment is finalised in a fair and proper manner as prescribed in SEBI (ICDR) Regulations.

Three parties together — the exchange, the lead manager and the registrar.

And then: the basis of allotment has to be approved by the board of directors of the company and published in national newspapers.

The final steps: ensure that the shares are credited to the individual shareholders' depository account and refund/unblocking of application money are done electronically · seek listing of shares on the stock exchanges and commencement of trading.

9.3 Categories of investor

Retail Individual Investors are those who invest not more than Rs. 2 lakh in an issue. In a book building issue this category of investors are alone allowed to bid at cut-off price. They are required to tender the entire subscription amount through ASBA facility at the time of making the application.

Only retail investors may bid at cut-off — a privilege of the category.

Non-Institutional Investors invest Rs. 2 lakh or above in an issue. Within that category:

one-third is reserved for application size of more than Rs 2 lakhs and upto Rs 10 lakhs;

two-thirds is reserved for application size above Rs 10 lakhs.

In addition, the allotment for the NII categories will be done by draw of lots (like retail segment) for allotment of minimum application size of NII / HNI and balance, if available, on proportionate basis.

Qualified Institutional Buyers (QIB) which includes mutual funds, financial institutions, scheduled commercial banks, alternative investment funds etc.

Anchor Investors are Qualified Institutional Buyers who make an application for a value of Rs. 10 crore or more in a public issue on the main board made through the book building process. 50 percent of anchor allotment will have a 30-day lock-in and the balance 50 percent will be locked in for 90 days.

Rs. 10 crore, book-built, main board — and a split lock-in of 30 and 90 days.

Also eligible: shareholders of the promoter group companies · employees; and in case of a new issuer, persons who are in the permanent and full time employment of the promoting companies excluding the promoters and an immediate relative of the promoter · Qualified Foreign Investors.

Minimum public offer

At least 25 percent of each class or kind of equity shares is required to be offered and allotted to public if the post issue capital of the company calculated at offer price is less than or equal to Rs. 1,600 crore.

If the post issue capital of the company calculated at offer price is more than Rs. 4,000 crore, the company is required to offer and allot at least 10 percent of each class or kind of equity shares to the public. However, the company shall increase its public shareholding to at least 25 percent within a period of 3 years from the date of listing.

Twenty-five per cent is the norm; ten per cent for very large companies, rising to twenty-five within three years. The second sample question tests the 25 per cent figure.

The remaining portion of the public issue can be reserved on a competitive basis or allotted on a firm allotment basis or on preferential basis to categories of investors such as employees, mutual funds, FPIs, shareholders of the promoting company, employees of the issuer company and scheduled banks.

The allocation percentages

In case an initial public offer is made through book building process, out of the total issue, not more than 50 percent shall be offered to the QIBs, out of which 5 percent shall be allocated to mutual funds. Not less than 15 percent to non-institutional investors and not less than 35 percent to the retail individual investors of the net offer to be allocated.

Note the direction of each limit — a ceiling for QIBs, floors for the other two.

For fixed price offers, a minimum of 50 percent of the net offer of securities to the public shall be initially made for allotment to retail individual investors and the balance to individual applicants other than retail individual investors and other investors including corporate bodies or institutions.

9.4 and 9.5 Prospectus and Red Herring Prospectus

The prospectus is the document which contains all the information relevant to an investor to make an investment in a public issue of shares made through a fixed price offer. The content and format of the prospectus is prescribed by SEBI in its regulations.

A company making a public issue of shares files a draft prospectus with SEBI through the lead manager of the issue. SEBI may require clarifications or changes to be made to the draft prospectus which have to be complied with before the prospectus is filed with the Registrar of Companies.

The red herring

Draft Red Herring Prospectus (DRHP) is a draft prospectus which is used in book built issues. It contains all disclosures except the price. It is filed with SEBI for their observations/comments, if any. DRHP contains all statutory disclosures.

Red Herring Prospectus (RHP) contains the issue dates. It is filed with the Registrar of Companies (ROC) prior to the bid opening date.

DRHP to SEBI; RHP to the Registrar of Companies.

The upper and lower band of the price and the number of shares may or may not be disclosed or the issue size may or may not be mentioned. This is because the price at which the shares are being issued will be determined based on the bids received in a book building offer which will be known only after the issue closes.

A preliminary red herring prospectus is filed with SEBI before the issue opens and the observations made by SEBI, if any, are incorporated into it. Once the price is discovered, it is included in the offer document along with the number of shares if not already mentioned and the prospectus signed and dated is filed with the Registrar of Companies and SEBI.

A recent addition: salient disclosures made in the DRHP, RHP and price band advertisement for public issues shall also be made available in Audio Visual format (AV) for ease in understanding the features of public issues. Such AV shall be prepared and placed in the public domain for all main board public issues. The same shall initially be in bilingual format i.e. English and Hindi.

9.6 Underwriting

SEBI's Regulations on public issues and the Companies Act require that an issue should receive subscription of a minimum of 90 percent of the net offer to the public, failing which the company has to refund (i.e. unblock) the entire subscription amount received within 4 days from the close of the issue.

Ninety per cent, or everything goes back within four days. The fourth sample question tests the 90 per cent figure.

To protect against this, Companies enter into an underwriting agreement with lead managers or syndicate members or merchant bankers or stock brokers, registered with SEBI, prior to filing of the prospectus/ red herring prospectus, to subscribe to the shares of the company if they remain unsubscribed by the investors. For undertaking this commitment, the underwriters are paid a commission.

Underwriting is mandatory. For an issue that is underwritten, SEBI's minimum subscription requirement will be 90 percent of the net public offer including the subscription by the underwriters.

Including the underwriters' own subscription — which is how the guarantee works.

Hard and soft underwriting

In hard underwriting, the underwriter is expected to subscribe to the extent of commitment if the issue is undersubscribed.

In soft underwriting, the underwriter buys the share at a later stage when the pricing process is complete and if investor's amounts are not blocked due to insufficient funds in their accounts. They usually place these shares with institutional investors.

One exception: the minimum subscription norms of SEBI, and hence the requirement for underwriting, does not apply for a public issue through an offer for sale.

Because in an offer for sale the company raises nothing — the money goes to the selling shareholders.

9.7 The Green Shoe Option

Companies may also go in for a Green Shoe Option (GSO). The objective of this option is to provide stability to the price of the share in the secondary market immediately on listing.

A company, which opts for Green Shoe option shall disclose the same in the offer document. The company can allot additional shares not exceeding 15 percent of the issue size to the general public who have subscribed in the issue.

Fifteen per cent of the issue size, over and above it.

The shares will be allotted in the same ratio in which reservation is being made for the various categories. For this purpose, the required over allotment shares will be lent by the promoter and/or any investor holding more than 5 percent of the total issued capital.

Borrowed shares, not new ones — at least to begin with.

The money realised out of this over-allotment will be kept in a separate bank account to be designated as GSO bank Account. This amount will be used by the Stabilizing Agent (SA), who is usually one of the merchant bankers or lead managers to the issue.

How stabilisation works

The SA will utilize the money for buying shares from the secondary market whenever the market price goes below the issue price. However, he is under no obligation to take any direction from the issuing company or the promoter for his market operations.

Independent of the company — an important safeguard.

The SA can only buy shares and cannot sell any shares. Moreover, he can buy a maximum up to the extent of the over-allotment made. The shares purchased from the secondary market will be kept in a separate demat account designated as GSO demat account.

Buy only, and only up to the over-allotment.

The entire process of stabilization will be available only for a period of 30 days from the date on which the shares are listed and traded. At the end of the 30 day period, the SA will take stock of the shares purchased and these shares will be returned to the lender/promoter.

If the price never fell far enough to buy back everything: in the event of any shortfall in the shares bought in relation to the shares lent, additional allotment will be made by the company against the unutilised funds lying in the GSO Bank Account. This will be at the same price as per the original issue price.

And any surplus does not go to the company: any balance money lying in the GSO bank Account (arising out of difference between the issue and buying price of the SA) will be transferred by the SA to the Investor Protection Fund of the designated stock exchange.

The GSO bank Account and the GSO demat account are closed once the period of stabilization is over.

9.8 Fixed price and book building

There are basically two ways in which a company can raise capital from a public issue of shares. These are Fixed Price Issue and Book Built Issue.

Fixed price

In a fixed price issue of shares to the public, the company in consultation with the lead manager to the issue would decide on the price at which the shares will be issued.

Companies can freely price the issue. The price is justified by the company on the basis of quantitative and qualitative factors. This is clearly laid out in the prospectus for the investors to make an informed investment decision. Investors know the price at which the shares will be allotted to them at the time of making the application.

Freely priced, not by formula — which is what the fifth sample question tests, and the answer is false.

Shares allotted to the investor will depend upon the basis of allotment finalised after the issue closes. If the issue is oversubscribed, the investor will get shares proportionate to the oversubscription in the respective category. The investor is sent a Confirmatory Allotment Note (CAN)/ refund order within the prescribed timelines.

Book building

The objective of a book build process is to identify the price that the market is willing to pay for the shares being issued by the company.

The company and its lead managers will specify either a floor price or a price band within which investors can bid. This information is in the red herring prospectus. When the issue opens, investors will put in bid applications specifying the price and the number of shares bid at that price.

Investors can revise the bids in the period when the issue is open. The issuer, in consultation with the book running lead manager will decide on the cut-off price at which the issue gets subscribed.

All allottees who bid at or above the cut-off price are successful bidders and are eligible for allotment in the respective categories.

The worked example

A company wants to issue 5000 shares through a book built offer within a price band of Rs 120-Rs 144.

The offer is filled up at the cut-off price of Rs 135. All investors who bid at this price and higher are eligible for allotment in their respective categories.

Read the cumulative column from the top price downwards — demand at Rs. 144 and above is 1,000; at Rs. 140 and above, 2,500; at Rs. 135 and above, exactly 5,000, which fills the offer.

The company may decide the cut-off price at a price lower than the price at which the issue is subscribed for the benefit of the investors.

And retail may get a discount: book built issues may also have a clause which allows allotment to retail investors at a price that is at a discount to the cut off price which cannot however exceed 10 percent of the price at which shares are allotted to the other category of investors.

Regulatory requirements in book building

The issue must be compulsorily underwritten to the extent of net offer to the public.

The lead managers have to be appointed as the book runner.

The cap of the price band will not be higher than 20 percent of the floor price.

The price band can be revised during the offer period within the 20 percent band between floor and cap price. The revision will have to be advertised and the issue period extended by 3 days.

In a book built offer, typically not less than 35 percent of the net offer to the public will be reserved for retail individual investors, not less than 15 percent for non-institutional investors and not more than 50% for qualified institutional buyers.

The issue will be open for a minimum of 3 working days and if the price band is revised, then the issue will be open for a maximum of 10 working days.

Where bids may be placed: with the syndicate members who are brokers of the exchange, SCSBs, Non Syndicate Registered Brokers, Collecting Depository Participants and RTAs, who are authorised to collect bids.

Note that RTAs are among the bid collectors.

All bids shall be accepted in the standardised bid forms that will have the details of the investor, the price and the quantity bid for. The bids can be revised during the period that the offer is open.

And afterwards: investors who are entitled to allotment in the issue should be sent intimations after the issue closing. Demat credit of shares or unblocking of funds should be completed within 3 working days of the closure of the issue.

9.9 SME IPOs

SEBI (ICDR) Regulations provide detailed requirements for public issue by small and medium enterprises. SMEs issue capital to public and get listed on SME exchanges.

'SME Exchange' as a trading platform of a recognized stock exchange having nationwide trading terminals permitted by SEBI to list the specified securities... and includes a stock exchange granted recognition for this purpose but does not include the Main Board. Main Board is a recognized stock exchange having nationwide trading terminals, other than SME exchange.

Note the two most examinable rows — allottees (1,000 against 200) and who observes the DRHP (SEBI against the Exchange).

Regulatory requirements for an SME IPO

Incorporation: The Company shall be incorporated under the Companies Act.

Tangible Assets: The net tangible assets should be Rs. 3 crores in last preceding 2 full financial years.

Track Record: either the company or the partnership/proprietorship/LLP Firm or the firm which have been converted into the company should have combined track record of at least 3 years, or, if not, it should have been funded by NABARD or SIDBI or Banks or financial institutions and should have a track record of operations for 1 full financial year and audited financial result for 1 full financial year.

Disclosures: a certificate that "The Company has not been referred to the Board for Industrial and Financial Reconstruction (BIFR)" and that there is no winding up petition against the company, which has been admitted by the court or a liquidator has not been appointed.

Trading lot size: the minimum application and trading lot size shall not be less than Rs. 2,00,000, and the minimum depth shall be Rs 2,00,000 and at any point of time it shall not be less than Rs 2,00,000.

A concession for small holders: the investors holding securities amounting to less than Rs 2,00,000 shall be allowed to offer their holding to the Market Maker in one lot. However in functionality market maker shall not sell in lots less than the minimum contract size allowed for trading on the SME exchange.

Participants: the existing members of the stock exchange shall be eligible to participate in SME Platform.

Other requirements: it is mandatory for a company to have a website · it is mandatory for the company to facilitate trading in demat securities and enter into an agreement with both the depositories · there should not be any change in the promoters of the company in preceding 1 year from date of filing the application.

The sample questions confirm that the due diligence certificate is signed by the lead managers; that the minimum public issue is 25 percent of the post issue capital; that it is false that all public issues require a credit rating; that the refund threshold is 90 percent subscription; and that it is false that a fixed price issue is priced by a SEBI formula.