An IPO underwriter is a financial institution or investment bank that provides professional expertise to the company planning to go public. IPO Underwriting is much more important for SMEs as legal regulations require SME IPOs to be 100% underwritten.
Underwriter's work is to buy securities from the IPO issuer company at an agreed rate and sell them to potential investors via the underwriter's distribution network. Thus, they serve as a financial intermediary who works closely with the SME IPO issuer company to issue shares to the public.
SME promoters planning to launch an IPO in the market must be aware of the process of IPO underwriting, the role or key functions of underwriters in an SME IPO, and the costs or fees charged by them.
Who are IPO Underwriters?
Underwriters are investment bankers who specialize in the issuance and allocation of securities. For an SME IPO that must be fully underwritten with 15% from the merchant banker account, underwriters provide a guarantee that all of the shares will be subscribed, or if not, underwriters will buy them.
Underwriters are not merely engaged in the process of IPO underwriting but do a lot more work to assist the issuer company throughout the IPO process. They assist companies preparing for the IPO by considering issues such as how much capital sought to be raised via IPO, how it will be raised or the number of securities or shares to be issued, what will be the price per share, what are the regulatory compliance, how to drive demand for the IPO, and more.
Key Role of Underwriters in SME IPO
Underwriters play a critical role in the IPO success as they analyze the risks associated with the IPO, help in due diligence, assist company promoters to comply with SEBI and SME exchange requirements, help in company valuation to determine IPO issue price, gauge investors' interest in the IPO issue and many more.
Let’s discuss some important roles and responsibilities of underwriters in SME IPO:
1. Check Due Diligence in the IPO process
Underwriters conduct extensive due diligence for the IPO process. They investigate and assess the company’s financial health, all materialistic contracts, business models, management representation, and industry dynamics, and analyze the potential risks in the business. Checking process due diligence is not only a liability of underwriters but also has a great impact on their reputation so they take it very seriously.
An indicated list of due diligence activities undertaken by SME IPO underwriters includes:
- Prepare extensive document request list i.e., material customer contracts, contracts with suppliers, list of all IP rights owned by the company, documents for owned property or property leased by the company, insurance policies, etc.
- Check management calls and customer & supplier calls.
- Auditor calls.
- Meeting with key employees of the company.
- Requests sources for evidence.
- Regulatory review.
2. Pricing the SME IPO
Pricing the IPO is a crucial factor of success because an IPO should neither be undervalued nor overvalued and must represent the true value of the share. But how to find the appropriate price of shares sound challenging. Here, underwriters assist the issuer company in determining the IPO share offering price. To find out the correct value of the company, underwriters consider several factors while pricing the IPO including:
- Company’s financial performance and growth prospectus: What underwriters look for is how well the SME is performing currently in the market. They analyze revenue, profitability, cash flows, and future growth potential of the company. SMEs with a solid track record of performance and high growth prospectus can ask for higher prices or vice-versa.
- Market conditions: Market timing for IPO is important because, in a bull market where investors' sentiments are positive, companies can set aggressive prices. But at times when market sentiment is negative, underwriters follow a conservative approach.
- Industry trends: The current industry and sector dynamics or trends SMEs are operating in also affect the pricing. If the industry is likely to have strong growth, underwriters may ask high price as investors will be ready to pay a premium to get high returns.
- Comparison with peers: Underwriters also look at key comparable metrics such as the price-to-earnings ratio (P/E), and price-to-book ratio (P/B) of peers when setting the IPO price.
3. Ensure Regulatory Compliance in the SME IPO Issue Process
Underwriters advise the issuing company for regulatory compliance with SEBI and SME exchange. They make sure that SME complies with all the regulatory requirements: disclosure of audited financial statements, timely submission of required data, submitting the exchange fee on time, and more.
4. Assist in preparing IPO DRHP and RHP for Exchange Filling
Underwriters help SMEs prepare for the IPO in various regulatory filings. The issuer company in consultation with the underwriter prepares and files DRHP and prospectus to the SME exchange (NSE Emerge or BSE SME).
Underwriters guide companies to provide a comprehensive business overview, business strengths and strategies, the objective of the IPO offer, and other details in the IPO prospectus. This document is used to pitch potential investors and to drive public demand for the IPO.
5. Marketing the SME IPO Issue
Underwriters help SMEs market the IPO to generate demand for the company’s shares. They publicize the issue through various means such as business presentations, and roadshows, and meet with potential investors to solicit preliminary interest in the IPO. As an SME IPO needs 100% underwriting, underwriters give the best possible efforts to attract more and more investors to the IPO.
6. Distribution of SME Shares
As underwriters purchase all the shares from the SME IPO issuer company, they are responsible for selling them to prospective investors. So, underwriters distribute or allocate shares to institutional buyers, non-institutional investors, and retail investors.
7. Aftermarket Stabilization
The role of underwriters does not end with IPO listing, as sometimes, they also help to stabilize the stock price in the secondary market in the initial days after listing. Underwriting agreements may have certain provisions to obligate underwriters to purchase shares in the secondary market if the price falls below a certain price.
Types of Underwriting Agreements
Underwriters and the IPO issuer company enter into an agreement, known as an underwriting agreement that clearly sets forth the underwriting terms and conditions. Here are the types of underwriting agreement:
- Firm commitment: In this, the IPO underwriter guarantees to buy all the shares offered by the company and take full risk to resell them to the public. As 100% underwriting is required for SME IPO thus, if underwriters fail to sell all the shares offered, they are responsible for getting the unsubscribed shares.
- Best efforts: Underwriters try their best to sell the maximum shares at an agreed price but at no guarantee so the risk is borne by the company.
- All or None: Either underwriter will sell all the shares issued or sale nothing. In case of no share sold out, the IPO will be withdrawn.
- Syndicate agreement: Public issues where a group of underwriters work together to sell shares to distribute risk among them, such underwriting agreement is called syndicate agreements.
What is the Cost of underwriting an SME IPO?
Now after knowing the key functions of underwriters, you might be worried about the investment bankers’ fee for IPO underwriting.
Underwriters charge a fee or commission as compensation for the services rendered. The cost of underwriting an IPO typically depends upon the investment banker’s reputation, the size of the IPO offering, and the complexity of the IPO.
Let’s unveil various fees charged by underwriters:
- Underwriting fee: It is the direct cost of underwriting an IPO which includes the underwriter's commission, management fee, and selling concession. Merchant bankers usually charge a fee of 4 4%-5% of the IPO size.
- Legal Fees: As underwriters perform due diligence on the company’s management, operations, and other matters, hence charge legal fees.
- Accounting fees: Companies incur accounting fees in working with accounting advisors and auditors to prepare audited financial statements and other material disclosures.
- Regulatory filing fees: It includes document processing and management expenditures for filing to exchange.
- Marketing costs: SME promoters incur expenditures on roadshows, promotional material marketing campaigns, and others.
- Miscellaneous expenditures: Other expenditures associated with the IPO underwriting process include administrative expenses, printing expenses, fees paid to the registrar and transfer agent, etc.
Deciding Factors for Selection of the Best Underwriter
As underwriters play a crucial role in the IPO success, it is important to check a few factors while selecting an underwriter for the issue. Here are a few important checkpoints for approaching an underwriter:
- Investment Bankers reputation.
- Industry Expertise.
- Quality of Research.
- Relationship and Networking.
- Underwriter's view align with the management’s views.
Our SME IPO Consultants can help you find the best underwriting partner for your SME IPO.
