NISM Series IIA: Chapter VII — Public Offer of Securities
Companies raise capital at various stages of their growth cycle to fund business expansions, capital expenditures, or long-term operational activities. Public offers represent a critical primary market mechanism where promoters dilute their ownership to allow the general public to participate in corporate equity.
1. Categorisation of Capital Issues
A company has multiple options for structuring capital raises. These issues are categorised based on timing, the category of target investors, and the allotment methodology.
Classification Framework for Capital Issues
| Dimension | Category | Definition / Operational Description | Source Impact |
|---|---|---|---|
| Based on Timing | Initial Public Offer (IPO) | The first public sale of shares by an unlisted company. | Triggers compulsory listing and entry of the company into the stock market. |
| Follow-on Public Offer (FPO) | A further sale of shares to the public by an already listed company. | Can be a fresh issue or an offer for sale (OFS). | |
| Based on Target Investors | Private Placement | Allotment of shares directly to a selected group of private investors. | Carries much lower regulatory requirements than public issues. |
| Preferential Allotment | A private placement made specifically by a listed company. | Governed by SEBI and Companies Act regulations. | |
| Qualified Institutional Placement (QIP) | Private placement made specifically to Qualified Institutional Buyers (QIBs). | Company's shares must be listed on stock exchanges for at least 1 year. | |
| Rights Issue | Fresh capital offered to existing investors in a specified ratio. | Ownership proportion remains unchanged if investors subscribe fully. | |
| Based on Allotment Method | Fixed Price Offer | The company determines the exact price per share in consultation with its lead manager before the issue opens. | Investors apply at a single pre-determined price. |
| Book-building Offer | A price-discovery mechanism where investors bid within a designated price band or above a floor price. | Bids are collected to determine the final market-clearing price. |
2. Public Offer of Shares: Structural Foundations
In a public offer, a company issues equity shares to a large number of new investors from the general public.
Key Characteristics and Implications
- Primary Market/Offer: The market for the first offer of shares is termed the primary offer. It is the pathway through which retail investors participate in the ownership of a corporate entity.
- Ownership Dilution: A public offer results in a reduction of the proportional holding of promoters and pre-existing large investors in the company.
- Regulatory Safeguards: Due to public participation, companies must satisfy rigorous regulatory requirements set by SEBI and the Companies Act to protect the financial interests of public investors.
- Shareholding Pattern Shift: Every public offer of shares fundamentally changes the shareholding structure and pattern of the issuing company.
Standard Safeguards Mandated by SEBI & Companies Act
Companies must implement specific institutional and operational arrangements:
- Continuous Disclosure: Listed entities must disclose all relevant information at the time of the issue and periodically thereafter so investors can evaluate the ongoing viability of their investment.
- Dematerialisation: Companies must make arrangements for the allotment of shares in electronic or dematerialised form.
- Compulsory Listing: Shares must be formally listed on a recognized stock exchange to provide secondary market liquidity to the investors.
- Promoter Commitment: SEBI requires the active participation of the promoters in the business, enforced through a lock-in on promoters' holdings.
- Price Determination: The final issue price is decided by the company in consultation with the lead manager to the issue.
3. Initial Public Offer (IPO)
An Initial Public Offer (IPO) is the first public offer of shares made by an unlisted company.
| Component | Fresh Issue of Shares | Offer for Sale (OFS) |
|---|---|---|
| Meaning | Company issues new shares to the public. | Existing shareholders sell their existing shares to the public. |
| Share Capital | Increases the company's issued/share capital. | No change in the company's share capital. |
| Shares Allotted | New shares are created and allotted to investors. | Existing shares are transferred to public investors. |
| Promoter Ownership | Promoters' percentage ownership may be diluted because new shares are issued. | Ownership is transferred from existing shareholders to public investors. |
| Funds Received | Funds are raised by the company. | Sale proceeds generally go to the selling shareholders, not the company. |
| Purpose | Can be used for expansion, working capital, debt repayment, acquisitions, etc. | Allows existing shareholders to monetise their holdings. |
Components of an IPO
A. Fresh Issue of Shares
- Capital Impact: A fresh issue of shares results in a direct increase in the authorized, issued, and paid-up share capital of the company.
- Allotment: New shares are created and allotted directly to the applying investors.
- Holding Impact: While the absolute number of shares held by existing investors prior to the issue remains unchanged, their percentage holding in the total share capital of the company is diluted.
B. Offer for Sale (OFS)
- Capital Impact: Unlike a fresh issue, an OFS involves the sale of existing shares owned by pre-IPO shareholders. It does not increase the share capital of the company.
- Ownership Impact: The shares of existing holders are transferred directly to public buyers.
4. SEBI Eligibility Requirements for Public Issues
To protect public funds, SEBI has laid down strict financial and operating eligibility criteria that an unlisted company must meet before accessing public markets:
- Net Tangible Assets: The company must possess net tangible assets of at least Rs. 3 Crores in each of the preceding 3 full years. Out of these assets, not more than 50% can be held in monetary assets.
- Pre-tax Operating Profits: The company must have minimum average pre-tax operating profits of Rs. 15 Crores (calculated on a restated and consolidated basis) during the 3 most profitable years out of the immediate preceding 5 years.
- Net Worth Standard: The company must maintain a minimum net worth of Rs. 1 Crore in each of the preceding 3 full years.
- Issue Size Cap: The proposed public issue, combined with all other capital issues made by the company during the financial year, must not exceed 5 times the pre-issue net worth of the company.
5. Reservations and Pricing in Public Offers
A public issue of shares through the book building process can incorporate specific allocations and price-adjustment mechanisms:
A. Reservations
Companies are permitted to reserve a specific portion of the shares in a book-built public issue for designated categories of investors, including:
- Permanent and full-time employees of the company (or promoting companies in the case of a new issuer).
- Specified shareholders.
- Persons associated with the issuer as depositors, bondholders, or subscribers to the services of the issuer.
- Retail individual investors.
B. Differential Pricing
- Price Disparity: Offers can be made at different prices to different categories of investors, provided the company strictly adheres to the regulatory norms prescribed for differential pricing.
6. Follow-on Public Offer (FPO)
A Follow-on Public Offer (FPO) is an issue of shares made to the public by a company that is already listed on a stock exchange.
Operational and Exemption Rules
- Issue Types: Like an IPO, an FPO can be structured either through the issuance of additional fresh shares or through an offer for sale (OFS).
- Exemptions: Because FPO issuers are already listed and actively traded, they can be exempted from the promoter contribution and promoter lock-in requirements.
- SEBI Exemption Criteria: The contribution of the promoter and the lock-in of promoters' holdings are exempted under FPOs if the company meets the following criteria:
- The company's shares have been listed and not infrequently traded on a recognized stock exchange for a minimum of 3 years.
- The company possesses a track record of paying dividends for at least the immediately preceding 3 years.
7. Buyback of Securities
A buyback is a process where a company purchases its own outstanding shares or other specified securities from its existing security holders on a proportionate basis.
Regulatory Controls & General Rules
- Board Approval: A formal Board resolution must be passed in all cases of a buyback.
- Public Notification: The company is legally required to publish a public notice of the buyback in a nationwide newspaper.
- Notice Details: The public notice must contain specific, exhaustive disclosures, including the reasons for the buyback, the total number and percentage of shares to be bought back, the buyback price, the process and funding mechanism, the specified date, and the detailed timetable.
The Three Methods of Buyback
| Buyback Method | Key Requirements / Features |
|---|---|
| Tender Offer | • Maximum buyback price is disclosed.• Promoter holdings and relevant transactions during the preceding 6 months are disclosed. |
| Stock Exchange | • Company must appoint a merchant banker.• Buyback is carried out through nationwide trading terminals. |
| Book Building | • Company must appoint a merchant banker.• Applicable to listed companies.• Book-building details are provided in the public notice. |
A. Buyback through a Tender Offer
- Price Disclosure: The company must disclose the maximum price at which the buyback of shares will be executed.
- Promoter Participation: If the promoters intend to tender their shares in the buyback, the corporate proposal seeking shareholder approval must disclose:
- The exact quantum of shares to be tendered by the promoters.
- The details of all transactions and holdings of the promoters in the company's securities in the six months prior to the special resolution authorizing the buyback.
B. Buyback through Stock Exchange
- Management: The company must appoint a registered merchant banker to manage the buyback process.
- Broker & Exchange Disclosures: The public notice must declare details of the specific brokers and stock exchanges through which the buyback will be conducted.
- Trading Platform Restriction: The buyback can only be executed on stock exchanges equipped with nation-wide trading terminals.
C. Buyback through a Book Building Process
- Management: The company must appoint a merchant banker to manage the issue.
- Listed Status Restriction: Only listed companies are permitted to use the book-building process to execute a buyback.
- Procedural Disclosures: The public notice must provide explicit details of the book-building process to be followed.
Glossary of Key Terms
- Primary Offer: The first offering of a company's shares to the public in the primary market, allowing retail participation in ownership.
- Dematerialised Form: The electronic format in which securities are allotted and held, replacing physical paper certificates to reduce risk and enhance liquidity.
- Promoter Lock-in: A regulatory period during which promoters are prohibited from selling or transferring their shareholdings, ensuring their continued interest in the business.
- Follow-on Public Offer (FPO): A fresh or secondary offering of shares to the public by a company that is already listed on a stock exchange.
- Offer for Sale (OFS): A public issue mechanism where existing shareholders sell their holdings to the public. It does not lead to any new share capital generation for the company.
- Net Tangible Assets: The physical and monetary assets of a company (excluding intangible assets like goodwill) used as an eligibility threshold for IPOs.
- Buyback: A corporate action where a company repurchases its own shares from the market, reducing the outstanding share capital.
Chapter Key Takeaways
- Multiple Avenues of Capital Raise: Capital can be categorised based on timing (IPO vs FPO), investor category (Private, Preferential, QIP, Rights), and pricing method (Fixed vs Book-building).
- Strict IPO Financial Hurdles: Unlisted companies must meet three key historical 3-year targets—Rs. 3 Crores in net tangible assets (with <50% held in monetary form), Rs. 15 Crores in restated pre-tax operating profits, and Rs. 1 Crore in net worth.
- Capital Safeguard Limits: An IPO size cannot exceed 5 times the company's pre-issue net worth.
- Listed FPO Relaxation: Listed companies making an FPO can skip promoter contribution lock-ins if they have been listed for at least 3 years and have a 3-year dividend payout track record.
- Three distinct Buyback Paths: Buybacks require a Board resolution and can be structured via a Tender offer, open market stock exchange trades, or a book-building process, with the latter restricted exclusively to listed entities.