ROLE OF UNDERWRITERS IN AN IPO

In the process of a private company going public, IPO is the key step to be undertaken. And one of the prominent stages in the IPO journey is to opt for an investment bank or conglomerate of investment banks who will act as underwriters of the IPO.

Now there are many questions like what is an underwriter? What role do they exactly play and how are they related to the IPOs? In this article, we are going to understand in detail about different aspects of underwriters. Let’s get started.

WHO ARE UNDERWRITERS ?

Underwriters are professionals in the finance field who take on someone else’s risk in exchange for a consideration. They evaluate risk and then determine a cost for financial transactions such as buying insurance or taking out mortgages. In the era of equities, underwriters work for private limited companies to value their operations, connect with investors and issue securities on a public exchange initially.

WHAT IS IPO UNDERWRITING ?

An IPO is the process through which a private entity has its shares sold to the general public on a stock exchange. The company issuing securities works with the underwriters of the IPO throughout the journey to determine how to price the issue and make a hype among the potential investors.

Most entities find their way to the investing public through underwriters who agree to buy the shares and then sell them to investors in general. Nevertheless, only a few dealers belong to this “underwriting syndicate” and few of them sell exclusively to institutional investors.

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WHO IS AN IPO UNDERWRITER ?

An IPO Underwriter is a financial expert and specialist who works closely with the private company to assist them in the issue of securities in the public market. They are almost always IPO specialists who work for an investment bank. They guide and assist the company making sure they satisfy all the requirements whether regulatory or administrative, imposed by the SEBI as well as the rules imposed by the stock exchange such as NSE and BSE.

These underwriters create the market for the securities by contacting a broad range of investors, including mutual funds, pension funds, insurance companies and more. They initially reach out to this network of investors to capture their interest in the stock, and to see what those investors may be willing to pay as a price. These conversations are used to decide the price of the IPO.

On the IPO day, the underwriters are accountable for purchasing any unsold shares at the price it set for the IPO. The way they get paid depends on the deal structure. Usually, they buy the entire issue and then resell the stocks, keping any profits, though in some cases they receive a flat fee for the work done.

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THE IPO UNDERWRITING PROCESS

Underwriting an IPO can take as little as 6 months from start to finish, but it can also take more than a year. While every IPO issue is unique, there are generally 5 steps that are usually common the every issue underwriting journey which are as follows:

Opting for a bank:

The private entity selects an underwriter, usually an investment bank. It may also opt for a conglomerate of investment banks or syndicate of underwriters. In this case, one bank is selected as the book-running or lead underwriter.

One type of agreement between the entity and the underwriters is referred to as the firm commitment which guarantees that the IPO will raise a certain sum of funds. Or they may settle for a best efforts agreement in which the underwriters do not guarantee the amount of funds they will raise. They can also settle for an all or none agreement which says that the underwriter will call off the IPO altogether or sell all of the shares in the IPO.

Conduct due diligence and initiating the regulatory filings:

The underwriter and the issuing entity then create a registration statement. The SEBI then does its due diligence on the required details in that document. While the SEBI reviews it, the entity and underwriters will issue DRHP that includes more details about the issuing company. They use this prospectus to pitch the company’s securities to investors. These processes usually last for 3-4 weeks and are mandatory to comply with the regulatory requirements.

Pricing the IPO:

Once SEBI gives a go ahead to the IPO, the underwriters decide the effective date of the issue. The day before this date, the private entity and the underwriter meet to set the price of the securities. Underwriters often underprice the issue to ensure that they sell all their shares, even though that means less money for the issuing entity.

Aftermarket Stabilization:

The underwriter's responsibilities continue even after the issue. They provide analyst recommendations and create a secondary market for the securities. The underwriter’s stabilization responsibilities only last for a short time period.

Transition to market competition

The final step of the process begins 25 days after the IPO issue date which is the end of the quiet period, required by the SEBI. During this phase, company KMPs can not share any new information about the entity, and investors go from trading based on the company's regulatory disclosures to using market forces to make their decisions. After this phase ends, underwriters can give estimates of the stock price and earnings of the company. Some companies also have a lock-in period after and even before they go public, in which early investors and employees are not allowed to trade or sell their shares.

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THE CRUX

Underwriters play a very important role in the process of making a company a public entity. IPOs are a significant part of the stock exchange and they present an opportunity for investors to get in on a company that may be entering a growth phase by allowing them to buy IPO securities.