When a private company makes its very first sale of stock to the public it is called an Initial Public Offer (IPO). Until an IPO, the stake holders in the company are usually family, friends, venture capitalists, professional investors, banks, etc. Post an IPO, the companies’ offer shares are traded on the stock exchanges.
Companies choose to go public for various reasons like expansion of business, diversification, debt repayment or new product launch. The Securities Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 or the SEBI ICDR has laid down rules for making an initial public offer in India. The Securities Contract (Regulation) Act, 1957, Securities Contract (Regulation) Rules, 1957, Companies Act 2013, also include the rules and legal compliances imperative for filing an IPO.
Eligibility Norms TO File An IPO in India
Companies should fulfill the following norms laid down by SEBI ICDR before attempting any initial public offer:
Entry Norm 1 (Profitability Route)
- Minimum net worth of Rs 1 Crore in each preceding three full years.
- Minimum net tangible assets, of at least Rs 3 Crores each, not more than 50% of which are held in monetary assets, in the preceding three full years.
- Minimum Rs 15 Crores as average operating profit (before tax) in at least three out of five preceding years.
- When a listed company goes for fresh issue of shares (Further Public Offer, FPO), it should ensure that the size of issue should not exceed five times the pre-issue net worth.
- Also, in the case of FPO, if the company changes its name, minimum 50% of the revenue in preceding one year should be from the activity denoted by the new name.
Entry Norm II (QIB Route)
For all those companies who genuinely require a larger capital base, but fail to accomplish any of the rules laid down above, SEBI has introduced an alternative. This route enables the companies to access the public interest through book building process. 75% of this net offer to the public is to be mandatorily allotted to Qualified Institutional Buyers (QIBs). If the minimum subscription of QIB is not achieved, the company shall refund the subscription fee.
ICDR General Regulations:
- The promoters, directors or any other persons in control of the issuing company should not have been debarred from accessing the capital market.
- The peers of the company, like promoters, directors etc should not be playing similar roles in any other companies.
- All partly paid up equity shares should be fully paid up.
- Issuing company has to enter into agreements with a depository for dematerialization of specified securities.
- Issuer has to make application to recognized stock exchanges for listing of the shares.
- Every listed company should maintain a public shareholding of minimum 25% and if it falls below that percent at any time, it shall bring the shareholding up to 25% within one year.
- Excluding the amount put up for the new issue, the company has to make arrangement of finances from verifiable sources for all other financial requirements.
Other Requirements To File An IPO
- The IPO process should start with companies (making public issue of more Rs 50 Lakhs) filing a draft offer document called Draft Red Herring Prospectus to SEBI. Depending on the complexity of the issue, companies can take anywhere between eight weeks to few months for DHRP preparation. This draft is then reviewed, accompanied by issue of final observation letter from SEBI. Reviews include a thorough scrutiny ensuring proper communication of public offer related information to the investors and stock exchanges. The final offer document or the red herring prospectus is then filed with the Registrar of Companies (ROC). Offer document is a powerful marketing tool for the issuer company to gain investors’ confidence.
- Companies can alternatively choose book building process, i.e., a regulated bidding from shareholders with a specific price band to determine the share value. In such case the process should be completed within one year from the SEBI issuing the final observation letter. In other words the validity period for the SEBI Final Observation Letter is 12 months.
- Should fulfill all requirements necessary to be a listed company.
- Half the members of Board of Directors of the company should be independent investors with no obligation to the promoters or the company itself. SEBI has laid down this stipulation to protect the interest of minority shareholders.
- None of the directors or promoters of the company should be an economic offender. A person who is declared an economic offender by a special court and who has fled the country to avoid the criminal prosecution and refuses to return to India, and against whom an arrest warrant is issued for committing any of the economic offences stated in schedule of Fugitive Economic Offenders Bill, 2018, is called a fugitive economic offender.
- ICDR 2018 has specified rules for selling shareholders and brought them under the eligibility criteria for issuing a public offer. They are the existing investors of the company who offer specified securities for sale in the IPO. As per SEBI ICDR guidelines selling shareholders should specify:
- On the front page of offer document, a statement of their responsibility to the extent of shares offered by them in IPO
- Their aggregate pre-issue shareholding as a percent of total paid up capital of the company
- Weighted average price at which the securities were acquired in the last one year
- Average cost of acquisition of shares
- Confirmation about not being debarred by SEBI or under any jurisdiction from accessing the capital markets
- Confirmation of compliance with Companies Rules, 2018
- For further capital issuances, the issuing company should disclose to SEBI either the number of shares or the amount of shares, if not both, between the date of filing DRHP and issuance of specified securities.
- Companies which go for issue up to the size of Rs 100 Crores should file the draft offer document in the regional offices of SEBI under whose jurisdiction the issuing company falls.
Compliance of all these regulations acts towards protecting the shareholders’ interest. Companies at times get desperate to infuse additional capital and the funds may be completely pocketed by the promoters or for clearing debt, which may not be in the best interest of the shareholder. While SEBI ensures that the market is inviting a healthy player to the game, the investor must conduct his/her due diligence before investing.