An IPO is known as "going public," changes a company from being privately owned and controlled to being owned by public stockholders. An initial public offering (IPO) is a very important phase in the development of any company because it gives them access to the public capital market. The IPO increases the reputation and visibility of the issuing company. Thus an Initial Public Offering (IPO) can be defined as-
"The mechanism by which a privately owned company issues shares of its ownership to the public for the first time."
Becoming a public body entails major responsibilities and answerability to the investors, investment governing bodies. It may also lead to changes in a company, including losing management independence and power. In certain cases, an IPO could be the only way to fund rapid expansion and development. Venture capitalists or entrepreneurs who want to profit from their early investment may often influence a company's decision to go public. However, not every company can just issue securities, and there are certain eligibility norms that a company needs to fulfil before it can issue an IPO.
Eligibility Criteria for IPO Application As Mandated By SEBI
- Profit Norms
SEBI has mandated the following criteria based on the company's profitability for any company desirous of issuing an IPO.
- The company should have at least Rs 3 crore in net tangible assets in each of the previous three years. Out of this 3 crore amount, not more than 50% should be cash or cash equivalent like money in an account, cash receivable or investment accounts. However, if the Initial Public Offer is being made through offer through sale, this restriction of 50% on monetary assets is not applicable.
- The company should have a net worth of at least one crore rupees in each of the previous three years.
- The company should have an average operating profit of at least fifteen crore rupees (pre-tax) in each of any three years among the previous 5 years.
- If the company has taken a new name, then 50% of the total revenue earned in the previous one year should have come from the activity performed by the company after assuming the new name.
- The total value of the issue size of the IPO by the company should not be more than 5 times the net worth of the company before the issue of the IPO.
- Non-Profitability routes
SEBI ensures that legitimate companies are not held back due to the stringent profitability norms, thus to provide the necessary flexibility to these companies to access the primary market, SEBI provides the QIB route.
In the QIB route, the IPO must be issued through the book building method and out of the entire offer, a minimum of 75% of the issue size should be allotted to the QIBs (Qualified Institutional Buyers). The company issuing the IPO would be required to refund the entire IPO subscription money if this minimum allotment requirement is not attained.
Prerequisites Mandated by NSE and SEBI for IPO Application Apart from Eligibility Norms
There are certain prerequisites mandated by the NSE and SEBI, which are apart from the eligibility criteria, but these also need to be fulfilled by the company before it can issue the IPO. These include:
- Mandatory Prerequisites by NSE
The NSE requires the annual reports of the previous three financial years from any company which desires to be listed on the stock exchange. The prerequisites include:
- The company should not have been referred to the NCLT (National Company Law Tribunal) or NCLAT (National Company Law Appellate Tribunal).
- The company's net worth should not have been washed out by its losses, resulting in negative net worth.
- The company should have a paid-up equity capital of not less than Rs. 10 crores. The capitalisation on the equity being issues should not be less than Rs 25 crores.
- SEBI's Prerequisites for Directors
Promoters are individuals who have worked in the same line of business for at least three years. They must also own at least 20% of the post-IPO equity share to be considered a promoter. One person or many people can own this 20%.
The founders, directors, and selling shareholders of the company are subject to the next set of criteria
- The SEBI must have taken no disciplinary action against them. The company cannot enter the markets if the directors have been denied entry to the markets. The organisation cannot proceed with the IPO with these individuals as promoters/directors during their debarment time, i.e. if these promoters or director are serving their debarment time mandated by SEBI, the DRHP of the company would not be accepted. This limitation does not apply if the date of debarment has already expired when filing a draft of the IPO with SEBI.
- The DRHP of the IPO will also be rejected if these individuals are promoters/directors of another corporation that has been barred from entering the markets. The company cannot proceed with the IPO with these people as promoters/directors if it wants to issue an IPO. The limitation is valid for the period the other company has been barred from entering the market.
- The company cannot proceed with the IPO if any bank, financial institution, or consortium has listed these individuals as wilful defaulters. A willful defaulter is someone who has failed to repay debts to banks, financial institutions, and other financial institutions. The company can either drop them as directors/promoters or get their debts fulfilled.
- The company's DRHP will be accepted only if none of the promoters/directors has been classified as a fugitive or an offender under the Fugitive Economic Offenders Act 2018.
Grounds of Rejection of DRHP by SEBI
SEBI can reject the Draft Red Herring Prospectus for the IPO if:
- No one knows who the ultimate promoters of the company applying for the IPO are.
- The company is collecting funds for a purpose that is not clear to SEBI or mentioned in DRHP.
- The issuer's business model is exaggerated, complex, or deceptive, and investors cannot determine the risks associated with it, which makes it difficult to predict the risks associated with the company's future.
- There is an unexpected surge in business prior to filing the draft offer paper, and the responses to the clarification requests for this sudden increase in business are inadequate.
- A litigation concerning the company is going on, and the outcome of the litigation will judge the company's future existence.