IPO Landscape: Creating Wealth, Mitigating Risks & Legal Complexities

The Navigation of the IPO Landscape: Creating Wealth, Mitigating Risks, and Understanding Legal Complexities

1. INTRODUCTION:

An Initial Public Offering (IPO) is a milestone event for a company that demonstrates a far greater purpose and vision than merely exchanging money for shares. The Transition from private to public businesses can access funding, expand their reach in the marketplace, and build credibility with investors. However, getting to this stage still presents many challenges, including being overvalued, unpredictable markets, closer regulatory scrutiny, and the relentless demands of shareholders.

IPOs have transformed economies worldwide while catapulting startups to household brand names and creating tremendous wealth. Listing activity in India, and companies like Zomato and Nykaa in particular, has recently put Indian entrepreneurship and start-ups into the spotlight. However, this path has obstacles, as seen in cases like WeWork and Paytm, demonstrating the risks associated with valuations and inadequate governance practices.

This article analyses the concept of IPOs, their dynamics globally and in India, how they function, the pros and cons of a firm going public, and how IPOs can be risky. For fast-growing businesses, an IPO represents a maturity milestone, offering opportunities for attracting capital and gaining relevance, thus opening doors for market growth options. It can be a moment of vindication for founders and early investors, but usually one that can also bring significant personal financial rewards. However, the allure of going public comes with its costs; not all initial public offerings (IPOs) are a ticket to long-term success. Problems — some, like valuations and governance lapses, compounded by marketplace pressure — often create troubles soon after IPO.

The IPO road offers abundant opportunity- and peril- for dozens of companies racing to list shares on stock exchanges. This article illuminates the intricacies of the legal, financial, and operational processes that leave many would-be successful entrepreneurs out in the cold. It examines the works of winners and losers to help readers learn from their IPO paths and outlines the modern-day features of initial public offerings.

2. WHY COMPANIES RUSH TOWARDS IPOS?

The primary motivation behind the IPO frenzy can often be boiled down to three essential drivers: capital, visibility, and wealth creation. Let’s examine each of these in greater detail:

a. Access to Capital (Capital Infusion for Growth and Expansion): For most companies, particularly startups and mid-sized businesses, access to significant capital is the main reason to consider an IPO. Going public allows companies to sell shares to a broader range of investors, leading to an immediate infusion of cash. This capital can be used to expand operations, invest in research and development, enter new markets, and acquire other companies. An IPO is a powerful way to raise funds quickly. The capital raised from an IPO can dramatically alter a company’s growth trajectory. For instance, companies like Zoom Video Communications and Airbnb successfully leveraged their IPOs to scale operations, expand their reach, and invest in technological innovations that solidified their leadership in their respective sectors. Despite pandemic disruptions, Airbnb went public in December 2020, raising $3.5 billion to bolster its global platform and business model. Rivian Automotive, the electric vehicle maker, raised over $11 billion in 2021 through its IPO, helping it compete against established giants like Tesla.

b. Market Recognition and Trust: An IPO raises capital and sends a powerful signal to the market[i]. A company that successfully goes public gains not only capital but credibility. Investors, partners, customers, and potential employees see a public listing as a sign of maturity and stability. Being publicly traded also increases visibility in the media, increasing brand recognition. After its IPO, Consider Beyond Meat became one of the most recognisable names in the plant-based food market. This exposure helped elevate the brand beyond niche audiences and positioned it as a critical player in the global food industry. Spotify leveraged its IPO in 2018 to establish itself as a dominant player in the music streaming industry, with increased international recognition.

c. Wealth Generation for Founders, Promoters, and Early Investors: An IPO is often the long-awaited payday for founders, promoters, and early-stage investors. These stakeholders can turn years of investment and hard work into substantial wealth by selling a portion of their shares during the public offering. Many startup founders who take their companies public become billionaires overnight as their once-private equity becomes tradable in the open market. Prominent examples of wealth creation through IPOs include Jeff Bezos (Amazon), Mark Zuckerberg (Facebook/Meta), and Elon Musk (Tesla). These founders saw their fortunes soar after their respective companies went public. The IPO process allowed these founders to unlock the value of their equity stakes, making them some of the wealthiest individuals in the world.

3. INDIAN IPO BOOM: How is the Indian Market Driving IPO Fever?

In recent years, the Indian IPO market has grown exponentially, driven by the surge in retail investors, favourable government policies, and booming sectors like tech, pharmaceuticals, and fintech. In 2021 alone, Indian companies raised over ₹1.2 lakh crore through IPOs, and many tech startups became household names.

1. Indian Retail Investors Leading the Charge: The rise of retail investors in India has been a critical factor behind the recent IPO boom. With increasing access to stock trading platforms like Zerodha and Upstox, more Indian citizens actively participate in stock market investments. The success of companies like Zomato and Nykaa highlights how the Indian middle-class retail investor has become a powerful force in the market. Paytm, India’s largest digital payments provider, raised ₹18,300 crore in its IPO, though it faced a bumpy start post-listing.

2. Government Initiatives Supporting IPO Growth: The Indian government has played an instrumental role in encouraging companies to go public. Regulatory frameworks, including those from SEBI[1], have simplified the IPO process, while programs like the Startup India initiative have bolstered entrepreneurial growth. For example, LIC[2], India’s largest insurer, recently went public in one of the country’s biggest-ever IPOs, backed by government support to bring public-sector companies into the open market.

3. Indian Unicorns Eyeing Global Markets: Many Indian startups, once limited by domestic market conditions, now use IPOs to fund global expansion. With their IPO capital, companies are better positioned to compete globally, particularly in the technology and fintech sectors. Ola, the ride-hailing giant, is preparing for an IPO to expand its electric vehicle and international market offerings.

4. WHY SOME IPO SUCCEED: Key Factors for Success

Despite the hype surrounding IPOs, not all companies emerge successfully. The key to a triumphant IPO lies in the company’s ability to manage investor expectations, corporate governance practices, and financial fundamentals.

1. Financial Stability and Proven Business Models: Successful IPOs are typically characterised by companies with solid revenue streams and proven business models. Investors are more confident in businesses with a clear path to profitability or consistent growth.

Example: Nykaa’s IPO success is rooted in its profitability and consistent revenue growth, unlike many tech companies that go public before profitability. Infosys’s historic IPO in 1993 set the stage for India’s tech dominance, thanks to its solid financials and market demand for IT services.

2. Governance and Transparency: Companies with a clear governance structure and transparent financial reporting are more likely to gain investor trust. Maintaining strong governance after an IPO is critical to sustaining shareholder confidence.

Example: TCS[3] has set the standard for corporate governance in India, ensuring transparency and protecting minority shareholder interests

3. Market Adaptability: Companies that successfully go public can manage short-term investor pressures while maintaining a long-term growth strategy. However, post-IPO, they must adapt to shareholder scrutiny and the demands of the open market.

Example: Zoom Video Communications, which went public in 2019, has successfully navigated market pressures, rapidly growing its user base while maintaining profitability.

5. WHY IPO FAIL: Missteps and Challenges

For every IPO success story, multiple companies must capitalise on their moment in the public markets. Failure often stems from overvaluation, lack of corporate governance, and regulatory challenges.

1. Overvaluation and Investor Backlash: Many companies that rush toward IPOs are overvalued due to market hype or inflated future growth projections. When these companies fail to deliver on their promises[ii], investors lose confidence, resulting in a sharp drop in stock prices. WeWork is perhaps the most infamous example of an overhyped IPO. Initially valued at $47 billion, the company’s valuation plummeted after concerns about corporate governance and profitability arose. The IPO was cancelled, and the company had to restructure entirely. Paytm, despite its dominance in the Indian fintech space, faced criticism for being overvalued during its IPO. After its listing, the stock plummeted, wiping out significant market capitalisation and leaving investors sceptical.

2. Poor Corporate Governance and Transparency: Many IPOs fail due to issues with corporate governance. Public companies are subject to far more scrutiny than private ones, and transparency or ethical leadership failures can severely damage investor trust. Luckin Coffee’s stock crashed after it was revealed that the company had falsified sales data. This scandal led to its delisting from the Nasdaq[4].

3. Regulatory and Legal Challenges: The IPO process is heavily regulated, and companies that fail to comply with legal and regulatory frameworks face significant risks. This includes ensuring that financial disclosures are accurate and transparent and that material risks are communicated to investors. Sterling Biotech ran into regulatory challenges after listing, leading to investigations by Indian authorities and accusations of fraud. Legal issues led to a rapid decline in its stock and delisting.

6. THE LEGAL FRAMEWORK AROUND IPO: Indian and Global Context

SEBI is the regulatory body overseeing IPOs in India. It has stringent guidelines for company disclosures, corporate governance, and investor protection. The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018[5], establish rules regarding public offerings and ensure that companies fully disclose their financials, risks, and use of proceeds. Companies must ensure complete transparency in their IPO documentation, or they could face severe penalties and legal action. Recent regulatory scrutiny has focused on startups for incomplete risk disclosures, particularly in the tech space.

In the U.S., companies looking to go public must file disclosures with the SEC[6]. Similar regulatory bodies exist worldwide, including the UK’s FCA[7] and ASIC[8] in Australia. These bodies ensure companies comply with transparency laws, investor protection, and financial disclosure requirements. Regulatory compliance in multiple jurisdictions, especially for companies expanding globally, can add to the complexity of the IPO process. For example, Chinese companies in the U.S., such as Alibaba, have faced additional regulatory scrutiny, making the listing process more challenging.

7. THE FUTURE OF IPOs: New Trends and Technologies

In recent years, SPACs[9] has become a popular alternative to traditional IPOs. An SPAC is a company with no commercial operations, formed solely to raise capital through an IPO to acquire an existing company. While this route is less common in India, it has gained traction globally, particularly in the U.S.

Another emerging trend is Direct listing, where companies go public without raising new capital, allowing shareholders to sell their stakes directly on stock exchanges. Spotify and Slack are notable examples of successful direct listings.

8. IPO FILLINGS IN INDIA: A Comprehensive Guide

Going IPO is a transformative step for any company, marking its transition from a private entity to a publicly traded one. In India, the SEBI governs the IPO process, ensuring compliance with regulatory requirements and investor transparency. This article provides a detailed breakdown of the IPO filing process in India.

The journey begins when a company decides to go public to raise capital for growth, repay debts, or increase market visibility. The company then appoints vital intermediaries, such as merchant bankers, underwriters, legal advisors, auditors, and registrars, to assist in the IPO process. Merchant bankers play a pivotal role in managing the offering, from drafting the offer document to marketing the IPO to potential investors.

The company then conducts due diligence to evaluate its financials, operations, and compliance status. This stage involves a comprehensive audit to identify any red flags that could hinder the IPO process. The financials must be prepared by Indian Accounting Standards (Ind AS), ensuring they reflect the company’s actual state of affairs.

Next, the company prepares a DRHP[10], a preliminary document detailing critical information such as the company’s business model, financial performance, risks, and objectives for the IPO. The DRHP is then submitted to SEBI for review and made publicly available for feedback. SEBI scrutinises the document to ensure compliance with regulatory requirements and verify that the disclosures are adequate and accurate.

After receiving observations and approvals from Sebi, the company finalises RHP[11]. This document contains the details, including the price band and issue size, and is sent to the investor. The company also seeks approvals from stock exchanges, usually the BSE[12] and the NSE[13], to list its shares.

The next step is to determine the price band for the IPO. This is often done through book building, where the company, in consultation with merchant bankers, assesses investor demand at different price points. The price band must be attractive enough to encourage investor participation while accurately reflecting the company’s valuation.

Following the price determination, the company announces the IPO dates and opens the subscription period. During this phase, institutional buyers, retail investors, and high-net-worth individuals can bid for shares within the specified price band. The shares are then allocated according to SEBI guidelines, ensuring the fair treatment of all investors.

Once the subscription period closes, the company allots shares to successful bidders and finalises the IPO pricing. Subsequently, the shares are credited to investors’ demat accounts, and the company prepares for its listing on the stock exchanges. The listing day is a critical milestone, where the shares are traded publicly for the first time. A successful listing often sees the stock price opening higher than the IPO price, reflecting strong market sentiment.

Compliance with SEBI regulations, stock exchange requirements, and the Companies Act of 2013 is paramount throughout the process. Companies must adhere to disclosure norms to maintain investor confidence, including reporting financial results and material events.

In conclusion, the IPO filing process in India is intricate but well-structured, aimed at safeguarding the interests of investors while allowing companies to access public capital. By navigating this process effectively, companies can achieve their growth objectives and establish a robust presence in the financial markets.

9. PROCESS MAP FOR IPO:

9.1. Preparation Phase (Setting the Foundation): A company must meticulously meet regulatory standards and market expectations before initiating the IPO process. This foundational stage focuses on structural, financial, and strategic readiness, comprising several critical steps:

9.1.1. Assessing Readiness: The first step involves a thorough evaluation of the company’s eligibility and preparedness:

• • Eligibility: To proceed with the IPO, the company must comply with SEBI’s requirements, such as profitability for at least three of the past five years, a minimum threshold for net tangible assets, and a specific net worth benchmark.
  • Audit of Financials: A detailed audit of the company’s financial statements for the past three years is essential to validate its financial health and build investor confidence.
  • Business Plan and Valuation: Developing a clear, robust business plan that highlights growth strategies and prospects is crucial. Engaging financial experts to perform a comprehensive valuation ensures the company sets realistic market capitalisation and share price expectations.

9.1.2. Appointment of Key Advisors: A successful IPO depends heavily on assembling a team of experienced professionals to navigate the complexities of the process:

• • Investment Bankers (Lead Managers) oversee the IPO process, including preparing the prospectus, ensuring compliance with SEBI regulations, and coordinating with stock exchanges. They also play a pivotal role in managing pricing and investor relations.
  • Legal Advisors: Skilled legal teams ensure the IPO adheres to all regulatory requirements, draft legal documents, and manage compliance.
  • Auditors: They perform due diligence to verify the accuracy and credibility of financial disclosures, which is critical for regulatory approval and investor trust.
  • Registrars and Transfer Agents (RTAs) manage critical aspects such as processing applications, maintaining shareholder records, and addressing investor queries, ensuring seamless interaction between the company and its stakeholders.

This preparation phase is the cornerstone of a successful IPO. It ensures that the company complies with all regulatory norms and is strategically positioned to attract investors and achieve favourable outcomes in the public market.

9.2. Regulatory Filings (The Core Process): The regulatory filing phase is the backbone of the IPO process, requiring compliance with SEBI’s rigorous norms. Below are the detailed core processes that the organisation need to follow:

9.2.1. Drafting and Filing the Draft Red Herring Prospectus (DRHP)

The DRHP is the initial, preliminary document a company files with the SEBI when it plans to go public. It serves as the foundation for the IPO process and contains the following:

• • Business Overview: The company’s business model, products, services, and industry outlook.
  • Financial Details: Audited financial statements and metrics.
  • Objectives of the IPO: Details about how the funds raised will be utilised.
  • Risk Factors: Disclosures of potential risks for investors.
  • Preliminary Offer Details: Tentative issue size and share allocation details.

The DRHP is made available to the public for feedback and scrutinised by SEBI to ensure that all regulatory requirements are met. Before approval, SEBI may suggest revisions or additional disclosures. The regulator reviews the DRHP to ensure accuracy, compliance, and adequate disclosure for potential investors. The regulator may issue queries, requiring the company to provide clarifications or amend the prospectus.

9.2.2. Filing of Updated Red Herring Prospectus (URHP)

The URHP is a lesser-known but crucial intermediary document filed after the DRHP and before the RHP. It incorporates:

• • Modifications based on SEBI’s observations and public feedback on the DRHP.
  • Updates to financials, if applicable, to reflect the most recent position.
  • Any significant changes in the company’s operations or risks since the DRHP filing.

While the URHP is not mandatory for all IPOs, it may be required in specific cases where significant updates are necessary.

9.2.3 Filing the Red Herring Prospectus (RHP): The RHP is the final version of the prospectus[iii], filed after receiving SEBI’s approval for the IPO. It is the official document provided to investors and contains the following:

• • Final Offer Details: Issue size, price band, and IPO dates.
  • Updated Financial Data: Reflecting the most current fiscal position.
  • Confirmed Use of Funds: How will the capital raised be deployed?
  • Investor Terms and Conditions: Rules and guidelines for participation.

The RHP is published before the IPO subscription opens and forms the basis of investor decision-making. Unlike the DRHP, the RHP cannot omit critical information, such as the price band or final details.

9.3. Pre-IPO Marketing (Building Investor Interest): Organizing domestic and international roadshows is a crucial step in the IPO process, aimed at pitching the investment opportunity to institutional and retail investors while showcasing the company’s strengths, financial health, and growth potential. These roadshows, led by critical executives and underwriters, involve presentations and Q&A sessions to build investor confidence and highlight the company’s unique value propositions. The feedback gathered during these roadshows helps determine the share demand and sets a price band, reflecting the company’s valuation and market sentiment. This is followed by the book-building process, where institutional and retail investors bid within the price band, enabling market-driven price discovery. Underwriters compile bids to assess demand at different price points, ultimately determining the cut-off price or the final IPO price based on the highest demand intersecting with the shares available. This structured approach ensures transparency and investor trust and enhances the chances of solid subscription levels and a booming stock market listing, benefiting the company and its shareholders.

9.4. IPO Launch and Subscription (Opening the IPO for Subscription): The allocation of shares during an IPO is a structured process aimed at ensuring fairness and efficiency among different categories of investors, including institutional investors, retail investors, and high-net-worth individuals (HNIs). The subscription window typically spans three to five days, allowing investors to place bids within the specified price band. During this period, demand is assessed, and the allotment process begins. If the IPO is oversubscribed, where demand exceeds the available shares, shares are allocated pro-rata, ensuring proportional distribution among applicants. However, in undersubscription cases where demand falls short, the IPO’s underwriters fulfil their obligation by purchasing the unsubscribed shares, ensuring the offering’s success and providing a safety net for the issuing company. This mechanism balances investor interests while ensuring the IPO meets its financial objectives.

9.5. Post-IPO Activities: After an IPO closes, several critical activities are undertaken to finalise the process and transition the company to public trading. First, shares are allotted to investors based on subscription data, ensuring fair distribution while refunds are processed promptly for unsuccessful applications. Next, the company’s shares are listed on the selected stock exchanges, such as NSE or BSE, on a designated date, marking the start of public trading and enabling shareholders to buy and sell shares on the open market. Underwriters may engage in market stabilisation activities in the initial trading days to maintain share price stability and investor confidence. Finally, the company assumes its new responsibilities as a publicly listed entity, adhering to regulatory requirements such as ongoing disclosures, quarterly financial reporting, and compliance with corporate governance standards, ensuring transparency and accountability to its shareholders. These steps are vital for ensuring the IPO’s success and the company’s long-term credibility in the market.

9.6. Legal and Regulatory Challenges: The IPO process in India is fraught with legal and regulatory challenges, requiring companies to navigate a complex landscape under stringent scrutiny. The SEBI plays a pivotal role in regulating the process. Noncompliance with its norms can lead to severe penalties, rejection of applications, or delays in the IPO timeline. Companies must ensure full transparency, as any failure to disclose material information or misrepresentation can result in legal action and loss of investor trust. Additionally, the IPO process is vulnerable to market volatility, where fluctuations in economic conditions, geopolitical factors, or investor sentiment can directly impact the subscription levels and success of the IPO. These challenges necessitate meticulous planning, adherence to regulations, and proactive risk management to ensure a smooth transition to public ownership.

10. CONCLUSION: Lessons from the Indian IPO Race and Success Stories

The road to an IPO offers both a chance and a challenge for companies looking to take their business to the next level. Though the prospect of capital infusion, increased market visibility, and wealth is enticing, some hurdles can only be overcome with strategic planning, good governance, and a person who knows the market inside out.

For example, in the Indian context, we have seen some excellent IPO success stories and the potential companies can unleash by taking this route.

Giants like Zomato and Nykaa have exemplified how a well-executed IPO can transform a business into a market leader while setting benchmarks for innovation and operational excellence. At the same time, the global context highlights how critical regulatory adherence and investor confidence are to sustaining long-term growth as a public entity.

However, the risks are equally significant. Overvaluation, poor governance practices, and an inability to navigate legal and compliance challenges can lead to swift and catastrophic failures. The scrutiny accompanying being a publicly listed company requires continuous transparency, robust financial performance, and alignment with investor expectations. Ultimately, the IPO race is a balancing act. The companies that will succeed can harmonise innovation with compliance, prioritise long-term sustainability over short-term gains, and deliver on their stakeholders’ expectations while navigating the complexities of a volatile market. As part of the broader global narrative, the IPO story in India reflects the evolving dynamics of business growth and capital markets, where the ability to adapt, strategies, and execute remains the cornerstone of success.

[1] Securities and Exchange Board of India

[2] Life Insurance Corporation

[3] Tata Consultancy Services

[4] Nasdaq Stock Market is an American stock exchange based in New York City.

[5] (2018, September 11). Issue of Capital and Disclosure Requirements. SEBI. Retrieved November 25, 2024, from https://taxguru.in/sebi/sebi-issue-capital-disclosure-requirements-regulations-2018.html

[6] Securities and Exchange Commission

[7] Financial Conduct Authority

[8] Australian Securities and Investments Commission

[9] Special Purpose Acquisition Companies

[10] Draft Red Herring Prospectus

[11] Red Herring Prospectus

[12] Bombay Stock Exchange

[13] National Stock Exchange