Advantages and Disadvantages of Public Issue – A Complete Guide

Savvy Midha | Updated: Oct 05, 2019 | Category: SEBI Advisory

Companies rely on various sources of funds to meet their financial needs for day to day expenses or to meet its working capital requirements. The fund required can be for the long-term or short-term needs of the company.

A company obtains funds from various sources such as debenture issue, issue of shares, loans, and financial assistance from banks, etc., depending upon the type of project for which it needs the fund.

The share issue is the most common method of raising the fund and can be done through the following alternates:

Private Placement
Right Issue
Bonus Issue
Preferential Allotment
Public Issue

Section 23 of the Companies Act 2013, governs the issue of shares for subscription by the public through the issue of prospectus. The public issue is the selling and marketing of the company’s shares to the public. A company, by way of a public issue, gets to list itself on a recognized stock exchange in India.

Table of Contents

Regulation governing public issue

Following acts and regulations govern the public issue:

Provisions of the Companies Act, 2013.
SEBI rules & regulations
Other regulations, such as the Securities Contract (Regulation) Act, 1956, regulations of RBI, etc.

Types of Public Issue

SEBI regulates the entry norms of the public issue through (Disclosure of Investor & Protection) Guidelines, 2000. These guidelines have been updated from time to time by SEBI for better transparency and protection of investors for the development of Capital Market. The public Issue can be classified into the following three categories:

Initial Public Offer (IPO) for unlisted entities
Further Public Offer (FPO) for listed entities
Offer for Sale.

IPO

Unlisted companies are the Public companies which are not listed or traded in any of the stock exchange. Such companies enter the public market through IPOs. IPO is when a company offers shares to the public for the first time. In general, IPOs are riskier as compared to FPOs because a company goes public for the first time and has started raising capital via public investment.

FPO

Listed companies are those which are listed on the stock exchange and have already complied with the procedures of IPO. Listed companies can raise funds through public issues for subsequent public investment. As the investors have a fair idea of the company and its growth prospects, FPOs are less risky than an IPO.

Offer for Sale

Members of a company can offer a part of their entire holding to the public in consultation with the Board of Directors^[1] Offer document for an offer for sale is deemed to be the prospectus. The members of the Company will reimburse any expenses concerning the offer. Any dividend declared or payable on these offered shares will be paid to the transferee.

Prerequisite for an IPO

Following are the conditions to be fulfilled by the companies before making an IPO:

Company shall have Net Intangible Asset of minimum INR 3 Crore for the preceding 3 years.
The monetary asset should not be more than 50% of such net intangible assets.
The Company has incurred profit for 3 years out of immediately 5 preceding years.
Pre-issue net worth for the previous 3 years shall be at least INR 1 Crore.
The Company shall keep the issue size not exceeding 5 times its pre-issue net worth.

If the company doesn’t satisfy the conditions mentioned above, it can make IPO only if it meets the following terms:

a) At least 50% of the IPO shall be allotted to Qualified Institutional Buyers.

At least 15% of the issue shall be issued to Financial Institution, and 10% shall be issued to Qualified Institutional Buyers.

AND

b) Minimum face value capital of the company shall be INR 10 Crore after issue

Minimum 2 years of compulsory market-making shall be there. Market making means marketing or selling of the shares or securities of a defined set of companies to the broker those are the members of such exchange.

If the company fails to comply with this, it has to refund the entire amount of subscription.

The Procedure of Initial Public Offer

Following is the list of steps to be followed by the company to raise funds through the initial public issue:

a) The company starts the process by hiring investment banks to seek their advice and guidance for public offers. There is an underwriting agreement signed between the parties.

b) Then the company has to file a registration statement with the Securities & Exchange Commission. This statement contains the complete details of the business plan of the Company, along with the declaration about how the company is going to utilize the funds raised through the IPO.

c) The company has to issue the initial prospectus that contains the details such as a number of shares, the price of the shares, etc. It is known as red herring prospectus.

d) The issuer, then, in consultation with investment banks, decides the price for the issue. Such price is based on the rate that prevails in the market. The company also uses other methods for fixation of the cost, such as EPS, PE multiple, return on net worth, etc.

e) Application form and prospectus are made available to the public for the subscription of shares. These forms are made available either online through its website or offline in which the investors can get the form from the designated bank.

f) After the price is fixed for the issue, the company then decides about the minimum post-issue holding of an investor.

g) The company can trade on the stock exchange once the shares are allotted to the investors, and such shares are credited to the Demat account of the investors.

Advantages of public Issue

Repayment of capital: There is no question of repayment of capital except when the company goes into liquidation.
Interest rate: There is no fixed cost bearing interest payment, unlike debentures.
Enhancing value: The company’s value increased when its shares are traded on the stock exchange, as it reflects more transparency on the company’s part.
Transferability: Ownership is easily transferable as shares are freely transferable as compared to debentures.
Liquidity: Shares are more liquid as compared to other forms of securities.

Disadvantage of Public Issue

Lengthy procedure: The public issue of shares is a lengthy, complex procedure and is quite time-consuming.
Expensive: Shares are costlier as they involve dividend payments in comparison to low interest-bearing debentures.
Complex: Public issue is a very complex procedure and attracts plenty of legal rules and regulations.
Control: There will be a dilution of control over the company with the addition of the new shareholders who would be involved in the affairs of the company.
Less Privacy: There are several transparencies required that lead to a minimization of the privacy of the company.

FAQs

What is the Lock-in requirement for IPO?

The promoter shall contribute at least 20% of the post-issue capital. Such a promoter’s contribution shall be locked-in for 3 years. However, the pre-issue capital of the promoter shall be locked in for 1year. For calculating the lock-in period of 3 years or 1 year, as the case may be, the later of the following dates shall be considered: