Capital Markets – Chap-4 IPO Process

Lack of other financing choices 1. Increases transparency of firm actions Employee compensation 1. Diversification / Risk sharing 4. Firm is valued by the market. shares sold get market price Future source of capital 1. . 3. want to sell stake in firm 2. Issue seasoned equity – “secondary share offering” 3. Firm can offer incentive contracts – stock options 2. Founders demand liquidity. Establish the firm in public capital markets for future capital raising 2. 4. so firm optimizes capital structure Allow current investors to cash out 1. Private financing unavailable 2.Why Need Public Capital 1. Lowers the cost of capital (cost of equity mitigates cost of debt) 3. Too much debt.

Founder (entrepreneur) loses control Public monitoring increases 1. Decision making is delegated to an increased number of owners 2. 2.Problems with Public Capital 1. even when they are in need of additional financing Ownership is diluted 1. Regulators have increased authority (legal restrictions to public firms) Direct financial costs 1. Competitors benefit from transparency 3. Going public is costly and may not be appropriate for all firms. Investment banks and new investors charge the firm via large transactions costs 1. Filing costs of prospectus and subsequent federal filings – requires additional staff 2. Underwriters collect fees (7% of gross proceeds) 3. 4. . SEBI filing requirements (Disclosure) 2. Shares are under priced (can be greater than 15%) 2.

) 2. Insurance underwriters create contracts that indemnify (protect against loss) their customers (auto liability. Securities underwriters guarantee the placement of new debt or equity with public financial markets in case of under subscription .Securities Underwriting Underwriting: To assume financial responsibility and guarantee against public issue failure Underwriter – an investment banker/intermediary 1. 2. flood protection etc. life insurance. 1.

Prior relationships between the firm owners (often VC’s) and investment banks 4. Follow-on products like research coverage 3. Distribution channels available to underwriter (institutional clients) 5. The reputation and expertise of the underwriter 2. The investment banks willingness to take on the firm (high reputation underwriters may not risk their reputation on a firm with uncertain prospects . Firm selects an underwriter who also acts as the advisor.The IPO Process 1. based on 1.

but makes a best effort to sell at the agreed price (uninsured) 3. Rights offer can be insured or uninsured .The IPO Process 2. Best effort: underwriter makes no promise about the price. 2. Firm commitment: firm sells the entire issue to the underwriter who then attempts to sell it to the public (insured) – Although the underwriter fully commits to purchasing the issue. the price is not agreed (or committed to) until later in the issuance process. Firm and underwriter agree on the offering method: 1. Rights offering: securities are first offered to existing shareholders 4.

and different financial metrics (PE. Mkt-book.The IPO Process 3.) are used to arrive at value of offer (Price band) . Valuing the offer: Underwriter performs its duediligence and provides a value of the firm – Firm provides all information and books to underwriter – the underwriter is the agent that reduces asymmetric information – Method such as Discounted cash flow method. ROA etc.

“red herring” prospectus covering potential and risks is published The IPO Process . The filing contains that information which forms part of public (prospectus) 5. based on additional filings desired by SEBI 3. SEC spends up to certain period reviewing the filing 2. The exact length of the waiting period can change. SEBI . financials and future plans.4. firm history.filing: The underwriter files a registration statement with the SEBI that gives specific information on the offering. 1. The intended exchange (NSE/BSE) reviews the filing as well 4.

The lead underwriter allocates portions of the offering to syndicate members with the primary purpose of a syndicate to risk share 4. Underwriter may take on a co-manager (co-lead) to help with the underwriting 3. Securities underwriting syndications is similar in nature to loan syndication by banks 6. Road show: Begins a few weeks prior to the IPO to create a market 1. Syndication: The underwriter arranges a syndicate to help with the distribution (ENAM – DLF) 1.The IPO Process 5. The lead underwriter visits large investors (institutional) to solicit interest and build a demand schedule . The primary (original) underwriter is designated the “lead” underwriter 2.

Depending on demand underwriter may have to rationing – proportionate/lottery basis 2.The IPO Process 7. Offer: Underwriter sells the issue and an exchange begins trading the issue in a primary market. New investors who didn’t get an allocation of the primary shares can now buy shares in the open market 5. Usually remains open for 3-5 days 1. After the shares are allocated listed market maker begins trading the shares 4. Shares are sold to investors prior to trading in secondary markets 3. Investors who received an initial allocation of shares can begin selling them to new investors .