Initial Public Offering (IPO) in Public Unlisted Companies

I. Introduction

IPO is the acronym for Initial Public Offering. It is the sale of stock by a company to the public. An IPO is primarily referred to as ‘going public’ because until a company’s stock is offered for sale to the public, the latter is not able to invest in it. Section 23 (1) of the Company Act, 2013 deals with a Public offer by both Public and Private Companies.

The primary goal behind issuing stocks is the generation of capital and expanding its business scope. A Private Company may issue securities by way of the private placement as established by the organization itself and they are not publicly traded. For understanding how IPO operates, let’s take a look at the observation and judgment in Sahara India Real Estate Corporation Ltd. v. SEBI [2012] 174 Comp Cas 154 (SC).

Facts of the case

The Supreme Court on 31st August 2012 directed the Sahara Group and its two companies – Sahara India Real Estate Corporation Ltd. and Sahara Housing Investment Corporation Ltd. to refund Rs. 17,400/- crores to their investors within 3 months from the date of the order with an interest of 15%.

Earlier, SIRECL and SHICL floated an issue of OFCDs and started collecting subscriptions from non-investors with effect from 25th April 2008 up to 13th April 2011. During this period, the company had a total collection of the amount of Rs. 17,656/- crores. The amount was collected from about 30 million investors in the guise of a Private Placement, without complying with the requirements applicable to the public offerings of securities.

The Whole Time Member of SEBI while taking cognizance of the matter passed an order dated 23rd June 2011, thereby directing the two companies to refund the money so collected to the investors and also restrained the promoters of the two companies, including Mr. Subrata Roy from accessing the securities market till further orders. Roy then preferred an appeal before SAT against the order of the Whole Time Member and after hearing the SAT confirmed and maintained the order dated 18th October 2011.

Subsequently, Sahara filed an appeal before the Supreme Court. The question with regard to offering by an unlisted company was – whether the issue of the OFCDs to millions of persons who subscribe to an issue is a Private Placement. It ceases to be a Private Placement when the securities are offered to more than 50 people under Section 67(3) of the Companies Act, 1956, which specifically states the requirement for an issue by an unlisted company to be 50 persons to be called a public issue, and SEBI will have the jurisdiction over their matters.

Although Sahara contended that they’re exempted from the said provision since the information memorandum mentioned that OFCDs were issued only to those related to the Sahara Group and there was no public offer, the Supreme Court, however, didn’t find any strength in this argument.

Observations of the Court

The companies elicited public demand for the OFCDs through the issue of an Information Memorandum under Section 60B of the Companies Act, which is only meant for Public Issues. The issue was not meant for persons related or associated with the Sahara Group because in that case an introducer would not be required as such as the person is already associated or related to the Sahara Group.

Thus, the Supreme Court concluded that the actions and intentions on the part of the two companies clearly show that they wanted to issue securities to the public in the garb of a private placement to bypass the various laws and regulations to that effect. The Company failed to register its final prospectus with SEBI and hence, there was a violation of Section 60(B) of the Companies Act, 1956.

The Supreme Court finally decided that irrespective of the nature of the share being offered, in case it’s done so to more than 50 people it shall be construed as a public issue. It was declared that the offer made by an unlisted public company for the subscription of its shares and debentures shall be construed as a public offer if such offer is made to more than 50 people and that SEBI shall have the jurisdiction over the public offer made by the unlisted public company.Section 67 of the Companies Act, 1956 deals with offers made by a company of more than 50 persons and specifically describes it as ‘public offer’.

Another case in which the judgment given was parallel with that of the former was Kunamkulam Paper Mills Ltd. and Ors v. SEBI [2012] 174 Comp. Cas. 149 (Kar)

An unlisted company made a rights issue in which it allotted shares to 163 persons, which included persons who were not existing shareholders of the company. The existing shareholders had the right to renounce their shares in favour of persons who were not shareholders. Issue: The question was whether the offer to subscribe to the rights issue of the company wherein shares were also subscribed by persons other than the existing shareholders who renounced their right. It was held as a public offer under section 67(3) of the Companies Act, 1956.

II. Procedure for IPO

The first step towards IPO is the filing of offer documents with the concerned authority, i.e., SEBI which have been briefly discussed below-

• Draft offer document: This is filed with the SEBI for specifying changes if any before it is filed with the Registrar of Companies. The draft offer document is nevertheless made public by posting it up on the company’s website, or the SEBI’s website, or the concerned Merchant banker, thus enabling the public to put forward their comments which are altogether taken into consideration.
• Red herring prospectus: This is filed in case of book-built public issue. It contains all the necessary particulars except the number or the price of the shares being offered for subscription. It is filed with the ROC.
• Prospectus: This is mandatory in public offering containing all the relevant information of the shares being offered for subscription, thus enabling the public to make an informed decision on investment. It is filed with the ROC.
• Abridged prospectus: It discloses the salient features of the offering and is filed along with the application form.
• Shelf prospectus: This enables the issuer to make a series of offers as and when calls for, dispensing with the need to file a fresh prospectus every time. It bears the validity for 1 year.

III. Requirements for making an IPO

Entry Norm 1

The company must have net tangible assets of Rs. 3 crores in each of the preceding three years of which not more than 50% are held in monetary assets. Minimum of Rs. 15 crores as average pre-tax operating profit in at least three of the immediately preceding 5 years.

The net worth of at least Rs. 1 crore in each of the preceding three full years.

If the company has changed its name within the last 12 months, at least 50% of revenue for the preceding 1 year should be from the activity suggested by the new name (as per the Companies Act, 2013).

The aggregate of the proposed issue and all the previous issues made in the same financial year in terms of issue size doesn’t exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year.

Entry norm II-Issue shall be through the book-building route, with at least 75% of the net offer to the public to be mandatorily allotted to the Qualified Institutional Buyers.

Promoters’ Contribution

If the company is an unlisted issuer, then the promoters shall contribute not less than 20% of the post-capital issue which should be locked in for a period of 3 years. The remaining ‘pre-issue’ capital of the promoters should also be locked in for a period of 1 year from the date of the listing.

Lock-in requirements in brief

The eligible promoters’ contribution is locked in for three years. The entire ‘pre-issue’ share capital, other than the one locked in as promoters’ contribution shall be locked in for a period of one year. All the securities issued on a firm allotment basis shall be locked in for a period of one year. The date of the lock-in shall be reckoned from the date of commencement of commercial production or the date of allotment in the public issue, whichever is later. The shares held by promoters are locked in and maybe pledged with banks or financial institutions for loans, provided the pledge of shares is one of the terms of the sanction of the loan.

The Intermediaries involved in an issue

Intermediaries which are registered with SEBI are Merchant Bankers. Merchant Bankers do the due diligence to prepare the offer document which contains all the details about the company. They’re also responsible for ensuring compliance with the legal formalities in the entire process and for marketing of the issue. Registrars to the Issue are involved in finalizing the basis of allotment in an issue and for sending refunds, allotment details, etc.

Bankers to the Issue enables the movement of funds in the issue process and the registrars to finalize the basis of allotment by making clear funds status available to the Registrars. Underwriters undertake to subscribe to the securities offered by the company, in case these are not fully subscribed by the public (for an underwritten issue).

Rule 6 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 states the guidelines for filing the draft documents with the Board and the final documents with the ROC. For unlisted companies, the filing of the draft documents is done through the Merchant Banker, at least 30 days prior to registering the prospectus of whichever nature with the board.

IV. Registration

For registration under Section 389 of the Companies Act, 2013, 10 copies of the draft prospectus should be filed with SEBI. The draft prospectus filed is treated as public document. Any amendment to be made in the prospectus should be done within 21 days of the filing of the offer documents as suggested by the board after due scrutiny.

Thereafter, the offer documents are deemed to have been cleared by SEBI. SEBI updates the processing status of offer documents on its website every week under the section ‘Offer/documents’ section on the website. If SEBI suggests any changes or observations, the Company and its merchant banker shall be obliged to carry out the changes before registering the prospectus with the ROC or the board.

Apart from the draft documents, the Merchant banker is to submit to the Board a few other documents as well. Since the offer documents are public documents, Rule 9 requires they are subject to public comments for a period of 20 days from the date of such filing.

Later, after the duration of 20 days expires, the same comments put forward by the public are taken into consideration while preparing the final documents along with the consequential changes thus made. For enabling the public for a reasoned and informed decision on the investment, the company shall either on the same day or on the next day of filing the draft documents shall make a public announcement in one English national newspaper, one Hindi national daily and in one regional daily in circulation in the local area, inviting views and comments from the potential public. They are as mentioned herein below:

1. A certificate confirming the agreement between the company and the Merchant banker in accordance with the format specified in Schedule 2 of this regulation.
   
2. A certificate of ‘Due Diligence’.
   
3. That the observations made and the suggested changes have been incorporated into the final offer documents.
   
4. A copy of a resolution passed by the Board of Directors of the Company (issuer) on the allotment of specific securities to promoters towards the amount received by them for their contribution.
   
5. Chartered Accountant certifying the contribution of the promoters and in this case, it’s mandatorily 20% or more.

Pricing of an Issue

India has a policy of free pricing. SEBI doesn’t play a role in the price fixation of shares. It’s the issuer who decides the price in consultation with the merchant banker upon the market price prevailing at the moment. The offer document contains all the information relating to the parameter used for deciding the price of the issues. These parameters can be EPS, PE multiple, return on net worth and comparison with peer group companies. The company shall deposit, before the opening of the subscription list, with SEBI an amount calculated at the rate of 1% of the total amount of securities offered for subscription to the public, which is refundable by the board.

The issue could be made through:

Fixed Price Issue or Book built Issue

1. Fixed Price Issue: The issuer decides the price of the issue at the outset and mentions it in the offer document.
2. Book Built Issue: When the price of an issue is discovered on the basis of demand received from the prospective investors at various price levels, and then it’s called Book Built Issue. The issuer discloses a price band or floor price 5 days before the opening of the issue of the securities offered. On the basis of the demands received at the various price levels within the price band specified by the issuer, Book Running Lead Manager, in close consultation with the issuer arrives at a price at which the security offered by the issuer, can be issued.

The applicants bid for the shares quoting the price and the quantity they’d like to bid at. After the bidding process is complete, the ‘cut-off’ price is arrived at on the demand of securities. The basis of allotment is then finalized and allotment/refund is undertaken. The final prospectus with all the relevant details including the final issue price and the issue size is filed with the ROC, thus completing the issue process. Only the retail investors have the option of bidding at the ‘cut-off’.

IPO Grading

The grade obtained from the Credit Rating Agency registered with SEBI, to the Initial Public Offering of Equity shares or other convertible securities. The grade represents a relative assessment of the fundamentals of the IPO in relation to the other listed equity securities. Disclosing the IPO grading so obtained is compulsory.

The opening of Issue: Rule 11

• In strict compliance with the Companies Act, 2013, the public issue is opened within a period of one year from the date of the issue of observations and the suggested changes by the board, or,
• Within 3 months of expiry of the period if such observations or suggestions have not been made.
• In the case of the Shelf prospectus, the first issue may be opened within three months from the issuance of the observations by the board. An alternative available to the company is Underwriting for raising capital by the investment bankers on behalf of corporations and governments that are issuing (equity securities) by specifying the responsibility it accepts for the risk of selling its allotment. It is insurance against adverse situations that may crop up at the time of public issue, which may be usually for bearing the risk of not being able to sell a security at a specified price. The underwriters give a guarantee for the subscription and in turn, they receive a commission. The name of the Underwriters and their obligations must be disclosed in the prospectus.
• The stock exchange regulations clearly specify that no stockbroker is allowed to underwrite more than 5% of the public issue. Underwriters facilitate the provision of money during a financial crisis. If the issue is underwritten and the company doesn’t receive 90% of the issued amount from public subscription within 60 days of the opening of issues, the Company should refund the amount of subscription.

Minimum Subscription as per Rule 14 of ICDR

Presently, every company needs to raise 90% of the issued amount failing which the company shall refund the whole amount received. If the minimum subscription is not met in case of a non-underwritten issue, then reimbursement of the said money shall be done within 15 days from the date of closure of the issue. If the minimum subscription and the development obligations are not received within 60 days from the day of closure of issues (underwritten issue), such refunding is to be made within 70 days.

In general, Companies are required to refund the money within 15 days from the closure of the issue. If a delay occurs without reasonable grounds of excuse, 15% interest is to be paid by the issuer. If the minimum subscription is opted to be received in calls, then the company must ensure such receipt within 12 months.

Listing of Shares should be done within 12 days from the closure of issues. On the occasion of Over-subscription of issues, an allotment of not more than 10% of the net offers to the public may be made for the purpose of making allotments in minimum lots.

Duration of Issue

The period for an issue is to be kept open:

1. Fixed price issue – 3-10 working days.
   
2. Book Built issue – 3-7 working days, extendable in case of revision in the price band.
3. Rights issue – 15-30 working days.

Post-Issue obligations of the company

1. Separate accounts are to be opened for the applications received from the public.
2. The basis of allotment in consultation with the Regional Stock Exchange
3. Post issue advertisement
4. Dispatch of refund orders
5. Filing of form for returning of allotment with ROC.
6. Redressal of investors’ grievances
7. Application for refunding security deposit calculated at 1% of the total securities.

Basis of Allotment

After the closure of the issue, the bids received are aggregated under different categories, i.e., firm allotment, Qualified Institutional Buyers, Non-Institutional Investors, Retail Individual Investors, etc. Allotment to QIBs and NIIs is done on a proportionate basis. However, the allotment to each retail individual investor shall not be less than the minimum bid, subject to the availability of shares in the retail individual investor category, and the remaining available shares, if any, shall be allotted on a proportionate basis.

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