procedure for ipo & book building

8/3/2019 Procedure for IPO & Book Building

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Procedure for IPO & Book Building

Introduction

To keep pace with the globalization and liberalization process,the government of India was very keen to bring the capital

market in line with international practices through gradual

deregulation of the economy. It led to liberalisation of capital

market in the country with more expectations from primary

market to meet the growing needs for funds for investment in

trade and industry. Therefore, there was a vital need to

strengthen the capital market which, it felt, could only beachieved through structural modifications, introducing new

mechanism and instruments, and by taking steps for

safeguarding the interest of the investors through more

disclosures and transparency. As such, an important mechanism

named as Book building in the system of initial public offerings

(IPOs) was recognised by SEBI in India after having the

recommendations of the committee under the chairmanship of

Y. H. Malegam in October, 1995. SEBI guidelines recognizedbook building as an alternative mechanism of pricing. Under

this approach, a portion of the issue is reserved for institutional

and corporate investors.

SEBI guidelines, 1995 defines book building as a process

undertaken by which a demand for the securities proposed to be

issued by a body corporate is elicited and built up and the pricefor such securities is assessed for the determination of the

quantum of such securities to be issued by means of a notice,

circular, advertisement, document or information memoranda or

offer document. Book building process is a common practice


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used in most developed countries for marketing a public offer of

equity shares of a company. However, book building is a

transparent and flexible price discovery method of initial public

offerings (IPOs) in which price of securities is fixed by theissuer company along with the Book Running Lead Manager

(BRLM) on the basis of feedback received from investors as

well as market intermediaries during a certain period.

Initial purchase offer (IPO)

An initial public offering or initial purchase offer (IPO),

referred to simply as an "offering" or "flotation", and is when acompany (called the issuer) issues common stock or shares to

the public for the first time. They are often issued by smaller,

younger companies seeking capital to expand, but can also be

done by large privately owned companies looking to become

publicly traded. In an IPO the issuer obtains the assistance of an

underwriting firm, which helps determine what type ofsecurity

to issue (common orpreferred), best offering price and time tobring it to market.

Procedure

IPOs generally involve one or more investment banks known as

"underwriters". The company offering its shares, called the

"issuer", enters a contract with a lead underwriter to sell its

shares to the public. The underwriter then approaches investors

with offers to sell these shares.

The sale (allocation and pricing) of shares in an IPO may take

several forms. Common methods include:

Best efforts contract

Firm commitment contract
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All-or-none contract

Bought deal

Dutch auction

A large IPO is usually underwritten by a "syndicate" ofinvestment banks led by one or more major investment banks

(lead underwriter). Upon selling the shares, the underwriters

keep a commission based on a percentage of the value of the

shares sold (called the gross spread). Usually, the lead

underwriters, i.e. the underwriters selling the largest proportions

of the IPO, take the highest commissionsup to 8% in some

cases.

Multinational IPOs may have many syndicates to deal with

differing legal requirements in both the issuer's domestic market

and other regions. For example, an issuer based in the E.U. may

be represented by the main selling syndicate in its domestic

market, Europe, in addition to separate syndicates or selling

groups for US/Canada and for Asia. Usually, the lead

underwriter in the main selling group is also the lead bank in theother selling groups.

Because of the wide array of legal requirements and because it

is an expensive process, IPOs typically involve one or more law

firms with major practices in securities law, such as the Magic

Circle firms of London and the white shoe firms of New York

City. Public offerings are sold to both institutional investors and

retail clients of underwriters. A licensed securities salesperson (

Registered Representative in the USA and Canada ) selling

shares of a public offering to his clients is paid a commission

from their dealer rather than their client. In cases where the
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salesperson is the client's advisor it is notable that the financial

incentives of the advisor and client are not aligned.

In the US sales can only be made through a final prospectus

cleared by the Securities and Exchange Commission. Investmentdealers will often initiate research coverage on companies so

their Corporate Finance departments and retail divisions can

attract and market new issues.

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

Why Book Building?

The abolition of the Capital Issue Control Act, 1947 has brought

a new era in the primary capital markets in India. Controls over

the pricing of the issues, designing and tenure of the capital

issues were abolished. The issuers, at present, are free to make

the price of the issues. Before establishment of SEBI in 1992,the quality of disclosures in the offer documents was very poor.

SEBI has also formulated and prescribed stringent disclosure

norms in conformity to global standards.

Book building acts as scientific method through which a

consensus price of IPOs may be determined on the basis of

feedback received from most informed investors who are

institutional and corporate investors like, UTI, LICI, GICI,

FIIs, SFCI etc. The method helps to make a correct

evaluation of a companys potential and the price of its

shares.
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The main drawback of free pricing was the process of pricing of

issues. The issue price was determined around 60-70 days

before the opening of the issue and the issuer had no clear idea

about the market perception of the price determined. Thetraditional fixed price method of tapping individual investors

suffered from two defects: (a) delays in the IPO process and (b)

under-pricing of issue. In fixed price method, public offers do

not have any flexibility in terms of price as well as number of

issues. From experience it can be stated that a majority of the

public issues coming through the fixed price method are either

under-priced or over-priced. Individual investors (i.e. retail

investors), as such, are unable to distinguish good issues frombad one. This is because the issuer Company and the merchant

banker as lead manager do not have the exact idea on the fixed

pricing of public issues. Thus it is required to find out a new

mechanism for fair price discovery and to help the least

informed investors. Thats why, Book Building mechanism, a

new process of price discovery, has been introduced to

overcome this limitation and determine issue price effectively.

Public offers in fixed price method involve a pre issue cost of 2-

3% and carry the risk of failure if it does not receive 90% of the

total subscription. In Book Building such cost and risks can be

avoided because the issuer company can withdraw from the

market if demand for the security does not exist.

Book Building and Fixed Price Option in the IPOs

A company may raise capital in the primary capital market

through initial public offers (IPOs), rights issues and private

placement. IPOs, the largest sources of funds in the primary


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capital market, to the company are basically an invitation by a

company to the public to subscribe to its securities offered

through prospectus. In fixed price process in IPOs, allotments of

shares to all investors are made on proportionate basis.

Institutional investors normally are not interested to participate

in fixed price public issues due to uncertainty of allotment and

lack of opportunity cost. On the other, they like to participate

largely in book built transactions as in this process the costs of

public issue and the time taken for the completion of the entire

process are much lesser than the fixed price issues. In Book

Building the price is determined on the basis of demandreceived or at price above or equal to the floor price whereas in

fixed price option the price of issues is fixed first and then the

securities are offered to the investors. In case of Book Building

process book is built by Book Runner Lead Manager (BRLM)

to know the everyday demand whereas in case of fixed price of

public issues, the demand is known at the close of the issue.

Steps Involved in Book Building Process:


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Regulatory Framework:

The Book Building guidelines were first introduced by SEBI in1995 (clarification XIII, dated 12.10.95) for optimum price

discovery of corporate securities. The SEBI, from time to time

modifies the guidelines in order to upgrading the existing

mechanism. The SEBI in its press release dated 7th September,

1998 prescribed the fresh guidelines for book building

mechanism after thorough modification and it was again

modified in 2001(dated 6.12.2001) and 2003(dated 14.08.2003).

According to the SEBI, a public issue through Book Buildingroute should consist of two portions:

(a) The Book Building portion and

(b) The fixed price portion.

The fixed price portion is conducted like normal public issues

(conventionally followed earlier) after the book built portion

during which the issue price is fixed after the bid closing date.Basically, an issuer company proposing to issue capital through

book building shall comply with the guidelines prescribed by

SEBI. However, the main theme of SEBI guidelines regarding

book building can be presented at a glance in the following

manner:

Offer to public through Book building process

The process specifies that an issuer company may make an issue

of securities to the public through prospectus in the following

manner:


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100% of the net offer to the public through book building

process, or

75% of the net offer to the public through book building

process and 25% of the net offer to the public at the pricedetermined through book building process.

100% of the net offer to the public through100% Book

Building process

The net offer to the public, under this process shall be fully

underwritten by the syndicate members/book running lead

managers. The syndicate members are to enter into an

underwritten agreement with the BRLMs indicating the number

of securities which they would like to subscribe at the pre-

determined price and BRLMs shall in turn enter into an

underwritten agreement with the issuer company. If thesyndicate members are not able to fulfill their underwritten

obligations, the BRLMs shall be responsible for bringing in the

amount involved. The bid remains open for at least five days.

The date of opening as well as closing of the bidding, the names


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and addresses of BRLMs, syndicate members, bidding terminals

for accepting the bids must be mentioned in the advertisement.

SEBI is regulator to control Indian capital market. Since its

establishment in 1992, it is doing hard work for protecting the interests

of Indian investors. SEBI gets education from past cheating with naive

investors of India. Now, SEBI is more strict with those who commit

frauds in capital market.

The role of security exchange board of India (SEBI) in regulating Indian

capital market is very important because government of India can only

open or take decision to open new stock exchange in India after getting

advice from SEBI.

If SEBI thinks that it will be against its rules and regulations, SEBI can

ban on any stock exchange to trade in shares and stocks.

Now, we explain role of SEBI in regulating Indian Capital Market more

deeply with following points:

1. Power to make rules for controlling stock exchange :

SEBI has power to make new rules for controlling stock exchange in

India. For example, SEBI fixed the time of trading 9 AM and 5 PM in

stock market.

2. To provide license to dealers and brokers :

SEBI has power to provide license to dealers and brokers of capital

market. If SEBI sees that any financial product is of capital nature, then

SEBI can also control to that product and its dealers. One of main

example is ULIPs case. SEBI said, " It is just like mutual funds and all

banks and financial and insurance companies who want to issue it, must

take permission from SEBI."
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3. To Stop fraud in Capital Market :

SEBI has many powers for stopping fraud in capital market.

It can ban on the trading of those brokers who are involved in fraudulentand unfair trade practices relating to stock market.

It can impose the penalties on capital market intermediaries if they

involve in insider trading.

4. To Control the Merge, Acquisition and Takeover the companies :

Many big companies in India want to create monopoly in capital market.So, these companies buy all other companies or deal ofmerging. SEBI

sees whether this merge or acquisition is for development of business or

to harm capital market.

5. To audit the performance of stock market :

SEBI uses his powers to audit the performance of different Indian stock

exchange for bringing transparency in the working of stock exchanges.

6. To make new rules on carry - forward transactions :

Share trading transactions carry forward can not exceed 25% of broker's

total transactions.

90 day limit for carry forward.

7. To create relationship with ICAI :

ICAI is the authority for making new auditors of companies. SEBI

creates good relationship with ICAI for bringing more transparency in
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the auditing work of company accounts because audited financial

statements are mirror to see the real face of company and after this

investors can decide to invest or not to invest. Moreover, investors of

India can easily trust on audited financial reports. After Satyam Scam,SEBI is investigating with ICAI, whether CAs are doing their duty by

ethical way or not.

8. Introduction of derivative contracts on Volatility Index :

For reducing the risk of investors, SEBI has now been decided to permit

Stock Exchanges to introduce derivative contracts on Volatility Index,

9. To Require report of Portfolio Management Activities :

SEBI has also power to require report of portfolio management to check

the capital market performance. Recently, SEBI sent the letter to

all Registered Portfolio Managers of India for demanding report.

10. To educate the investors :

Time to time, SEBI arranges scheduled workshops to educate theinvestors

Functions of Investment Banking:

Investment banks carry out multilateral functions. Some of the most

important functions of investment banking are as follows:

Investment banking helps public and private corporations in

issuance of securities in the primary market. They also act as

intermediaries in trading for clients.

Investment banking provides financial advice to investors and

helps them by assisting in purchasing and trading securities as well

as managing financial assets
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Investment banking differs from commercial banking as

investment banks don't accept deposits neither do they grant retail

loans.

Small firms which provide services of investment banking are

called boutiques. They mainly specialize in bond trading,providing technical analysis or program trading as well as advising

for mergers and acquisitions

Core activities of Investment Banking

Investment banking: is the traditional aspect of investment banks

that involves helping customers raise funds in the capital markets

and advise them on mergers and acquisitions. Investment banking

can also involve subscribing investors to a security issuance,

negotiating with a merger target and coordinating with bidders.

Sales and trading: Depending on the needs of the bank and its

clients, the main function of a large investment bank is buying and

selling products. In market making, the traders will buy and sell

securities or financial products with the goal of earning an

incremental amount of money on every trade. Sales is the term that

is used for the sales force, whose primary job is to call on

institutional and high-net-worth investors to suggest trading ideasand take orders

Research: is the division of investment banks which reviews

companies and makes reports about their prospects, often with

"buy" or "sell" ratings. Although the research division generates no

revenue, its resources can be used to assist traders in trading, can

be used by the sales force in suggesting ideas to the customers, and

by the investment bankers for covering their clients.

procedure for ipo & book building

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