Sangeeta Lakhi | Sulakshna Sinha
The success of an initial public offering (IPO) is not an overnight affair.
A company's dream to go public does not just involve groundwork but also skill and experience of the advisors to the public issue. The merchant banker or lead manager is entrusted with the task of managing an IPO and their rights, obligations and responsibilities are more or less included in the regulations that govern public issues -- the SEBI ICDR Regulations, arrangement with the company, due diligence certificate, pricing of the issue, advertising the issue, underwriting services etc., to name a few.
In fact, the role of the merchant banker continues until completion of the issue and till the company obtains the listing and trading permission. The merchant bankers must also look into the post-issue activities such as dispatch of refund orders, allotment letters, share certificates, coordination with the intermediaries and other activities relating to the investors and regularly monitor redressal of investor grievances arising therefrom.
However, the role of a merchant banker goes beyond the mere wordings of the regulations. No doubt an issuer company offers a myriad of representations to the merchant bankers about the company, the fate of the IPO depends on how the issue is positioned in terms of size, timing, valuation and marketing of the issue.
Having said that, choosing the right merchant banker is critical to the success of the IPO. This is typically done through the 'pitch meetings. Other factors relevant to the selection of the merchant banker is the bank's track record, reputation and most importantly the relationship with institutional investors. This helps in an easier mobilisation of funds and success of the IPO.
Benefits of effective transaction structuring
The key ingredients to an effective IPO transaction structuring include, deployment of right resources, understanding and preparing a business and financial model, due diligence exercise, agreed on timelines, investor relations and marketing strategy, amongst others.
In an IPO, both the merchant banker and legal advisors conduct diligence on the affairs of the company, which involves reviewing of contracts, licenses and approvals and other material documents. Once the diligence is done, the material is formatted into chapters and then added to the offer document.
At their end, merchant bankers conduct a market and industry diligence to obtain a fair sense of what may be in store for the company in the future. The merchant banker also conducts a tax and financial diligence on the company to identify any irregularities. Providing solutions to eradicate any non-compliances or irregularity becomes an integral part of the diligence exercise. All these actions are supplemented by the guidance that is offered by the merchant bankers and legal advisors in relation to the IPO process.
SEBI co-ordination for disclosure and timelines
The next step is filing the offer document by the company with the help of the merchant banker. The merchant banker then co-ordinates with SEBI at different levels, more particularly if the regulator calls for any clarifications or any additional information or documents.
The merchant banker is responsible to ensure that all SEBI observations on the draft offer document have been carried out by the company before its registration with the registrar of companies. Before the opening of the issue, the merchant bankers submit various documents such as the diligence and other certificates as required by the SEBI ICDR Regulations.
The role timing and sizing plays in the success of an IPO
The timing of the IPO plays a very important role in its success. Weak market conditions and poor timing of the IPO can jeopardise the issue completely.
Recently, we have witnessed undersubscribed IPOs and withdrawal of issues, all of which may be attributed to unfavourable market conditions. The merchant banker can always keep a track of the factors that adversely affect the market conditions particularly the events that directly affect the receptiveness and decision of the investors.
Preparing early for an IPO can help mitigate such risks during which time the company and the merchant bankers can analyse the market conditions, preparedness and performance of the company so that they could be ready with an alternative plan of fundraising in case the IPO is not feasible in the near future.
These alternative plans include a third party sale, private equity investment, private placement or even a joint venture or a strategic alliance. It always helps to have a plan B. Also, if an IPO is timed appropriately, it is possible to price the IPO at a higher price of the range.
Key factors influencing positive valuations for the IPO
The price of the shares in the IPO is determined by the company in consultation with the merchant banker, usually on the basis of demand from investors.
The price is generally arrived at through a book building process in case the valuation of shares arrived at by the company and merchant bankers do not represent the true market value of shares. The valuation is arrived at on the basis of certain qualitative and quantitative factors that include earning per share, price earnings ratio, return on net worth, net asset value, comparison of accounting ratios with listed industry peers, etc.
In case of fixed price issue, the company itself fixes the price of the shares in consultation with the merchant banker. This method also deploys the same qualitative and quantitative factors to arrive at the price but is devoid of any investor demand. Pricing shares of an IPO is generally risky business as it lacks a historical performance history.
Guidelines for marketing the IPO
The publicity and marketing of the IPO is another important service provided by the merchant banker through various investor meets once the offer document is filed with the regulator. Here too, there is a selection criteria such as brokerage commissions, interest and track record of the investors.
The response received from the investors plays a vital role in the pricing of the issue. The merchant banker organises road shows during which the management of the company travels to different parts of the world to meet investors. A roadshow provides the company with an opportunity to convince the potential investors to invest in the company.
A basic principle that must be followed while marketing an IPO is how well the company differentiates itself from the competition. To realise this objective, the right marketing strategy is a crucial aspect of an IPO plan. The merchant bankers need to clearly define the target audience. They may not be interested in the company's business model alone but on how they can actually make money by investing in the company. A well demonstrated and realistic forecast of the company's growth potential is a must for the IPO success.
(Sangeeta Lakhi is Senior Partner, Rajani Associates; and Sulakshna Sinha is Head of Department – Domestic Capital Market, Rajani Associates)