process of floating of ipo and role of merchant banker
Financing New Ventures And Businesses
process of floating of ipo and role of
• What is the process when a company goes for
raising of funds through an ipo and what
steps are to be taken by the merchant bankers
so that funds are raised?
What is IPO?
• Initial public offering (IPO), also referred to simply as a
"public offering" or "flotation", is when a company
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 may obtain the assistance of an
underwriting firm, which helps it determine what type
of security to issue (common or preferred), best
offering price and time to bring it to market.
• An IPO can be a risky investment. For the
individual investor, it is tough to predict what the
stock or shares will do on its initial day of trading
and in the near future since there is often little
historical data with which to analyze the
• Also, most IPOs are of companies going through a
transitory growth period, and they are therefore
subject to additional uncertainty regarding their
future value. However, in order to make money,
calculated risks need to be taken.
• The Initial Public Offering (IPO) for a new
public company is the first opportunity for the
investing public to be able to purchase shares
in the company.
• An IPO is a very exciting time for the company,
and IPOs are often eagerly anticipated by the
investing public as well.
Reasons for company going in IPO
There are several reasons for which a private company may
wish to become a public company.
1. raise capital
2. to allow the original investors or entrepreneurs who
started the company to realize profits on their
investment and time.
• Undertaking an IPO is a large and exciting event for a new
• A well received IPO means that the company will have cash
to further its development and growth.
• It also usually means that the people who started the
company realize some significant profits for their efforts.
Risk associated with IPO
• The investing public is usually excited about an
IPO. It is hard to understand why, since most
stocks that are sold during an IPO tend to
perform badly at first.
• Some companies also do not survive, so investing
in an IPO is more risky and usually less rewarding
then investing in more established stocks.
• Perhaps investors believe the sales hype that
usually accompanies an IPO.
• Perhaps they are excited about being among the
first to own the next potential IBM or Microsoft.
Preparations to be done before issue of IPO
• An IPO requires a great deal of work, from filing the
necessary paperwork with the regulatory bodies and
writing a prospectus for potential investors to devising
and implementing a sales campaign for the sale of the
• Since the company also needs to continue to function
and complete its normal activities, a financial firm is
usually hired to do this work. This firm is referred to as
the underwriting firm for the IPO.
• For a really large IPO, the work may even be split
between several underwriting firms.
• IPOs generally involve one or more investment banks 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 (that is, the allocation and pricing) of shares in an IPO may
take several forms. Common methods include:
Best efforts contract
Firm commitment contract
Self distribution of stock
Pricing of IPO
• A company that is planning an IPO appoints
lead managers to help it decide on an
appropriate price at which the shares should
be issued. There are two ways in which the
price of an IPO can be determined:
the company with the help of its lead
managers fixes a price.
the price is arrived at through the process of
Principal steps in floating a public issue
• Pre-issue task
1. Drafting and finalization of the prospectus
2. Selecting the intermediaries and entering into
agreements with them
3. Attending to other formalities-printing of
prospectus and application forms, dispatching to
intermediaries, filing of initial listing application
with stock exchange
• Opening and closing of the issue
• Post-issue task1. Scrutiny, processing and tabulation of
2. Determination of liabilities of underwriters
3. In case of over subscription, basis of allotment
to be decided in consultation with stock
4. Allotment letters and share certificates to be
dispatched to the allottees. Refund orders to be
dispatched to the applicants whose applications
What is Merchant Bank?
• A Merchant Bank deals with the commercial
banking needs of international finance, long term
company loans, and stock underwriting.
• A merchant bank does not have retail offices
where one can go and open a savings or checking
• A merchant bank is sometimes said to be a
wholesale bank, or in the business of wholesale
banking. This is because merchant banks tend to
deal primarily with other merchant banks and
other large financial institutions.
Role of merchant banker
• The most familiar role of the merchant bank is stock underwriting.
• A large company that wishes to raise money from investors through
the stock market can hire a merchant bank to implement and
underwrite the process.
• The merchant bank determines the number of stocks to be issued,
the price at which the stock will be issued, and the timing of the
release of this new stock.
• The merchant bank files all the paperwork required with the various
market authorities, and is also frequently responsible for marketing
the new stock, though this may be a joint effort with the company
and managed by the merchant bank.
• For really large stock offerings, several merchant banks may work
together, with one being the lead underwriter.
Role of Merchant Bank in IPO
• When a company wants to raise funds through initial public offering (IPO)
it appoints an merchant bank for underwriting the issue. Since in an IPO a
company participates for the first time, it doesn’t have complete
understanding of the rules and documentation, required to be
submitted, to get a clearance from the regulator.
• Famous merchant bankers world over are Goldman Sachs, Credit Suisse
and Morgan Stanley. Banks like Deutsche, Citi, UBS etc. have investment
banking wings. Underwriters assess and analyse firm’s current
performance, firm’s future earnings potential, industry
scenario, competition in the same sector, current local and global market
situations etc. to decide the issue price/price band. They also work on the
activities like completion of the mandatory documentation as required by
the regulatory body. Underwriters charge a fee for this activity, which is
generally a percentage of the issue size.
• If the issue size is very large a syndicate of merchant banks takes up the
task of underwriting the issue. However one merchant bank leads the
Functions of a Merchant Banker:
1) Management of debt and equity offerings- This forms
the main function of the merchant banker. He assists the
companies in raising funds from the market. The main
areas of work in this regard include:
• instrument designing
• pricing the issue
• registration of the offer document
• underwriting support
• marketing of the issue
• allotment and refund
• listing on stock exchanges.
2) Placement and distribution- The merchant banker helps in
distributing various securities like
• equity shares
• debt instruments
• mutual fund products
• fixed deposits
• insurance products
• commercial paper to name a few.
The distribution network of the merchant banker can be classified as
institutional and retail in nature. The institutional network consists of
mutual funds, foreign institutional investors, private equity
funds, pension funds, financial institutions etc. The size of such a
network represents the wholesale reach of the merchant banker. The
retail network depends on networking with investors.
3) Corporate advisory services- Merchant bankers offer customised solutions to their
clients financial problems. The following are the main areas in which their advice is
• Financial structuring includes determining the right debt-equity ratio and gearing
ratio for the client, the appropriate capital structure theory is also framed.
• Merchant bankers also explore the refinancing alternatives of the client, and
evaluate cheaper sources of funds.
• Another area of advice is rehabilitation and turn around management.
• In case of sick units, merchant bankers may design a revival package in
coordination with banks and financial institutions.
• Risk management is another area where advice from a merchant banker is sought.
He advises the client on different hedging strategies and suggests the appropriate
4) Project advisory services- Merchant bankers help their clients in various stages of
the project undertaken by the clients. They assist them in conceptualising the project
idea in the initial stage. Once the idea is formed, they conduct feasibility studies to
examine the viability of the proposed project. They also assist the client in preparing
different documents like the detailed project report.
5) Loan syndication- Merchant bankers arrange to tie up loans
for their clients. This takes place in a series of steps. Firstly
they analyse the pattern of the client’s cash flows, based on
which the terms of borrowings can be defined. Then the
merchant banker prepares a detailed loan memorandum,
which is circulated to various banks and financial institutions
and they are invited to participate in the syndicate.
The banks then negotiate the terms of lending on the basis of
which the final allocation is done.
6) Providing venture capital and mezzanine financingMerchant bankers help companies in obtaining venture capital
financing for financing their new and innovative strategies.