Big Deal about Pre- IPO Deals

Dalal StreetWhat is a pre-I.P.O deal? I know it sounds like a technical question to most of us, but the answer to it is, surprisingly, quite simple. When an Initial Public Offer [IPO] for subscription of shares is made to the retail investors, the company making the offer discloses the price band for each share. After which, retail investors send their respective applications for allotment of shares.

In case of a pre-IPO deal, an FII (Foreign Institutional Investment), a mutual fund, or for that matter, any third party makes an offer to buy a percentage of stakes in a certain company. This offer is made before the Initial Public Offer of the shares is made available for the retail investors. The price at which the stake is bought is a matter which is discussed by both parties amicably, and is usually favorable to the company coming out with the IPO.

A pre-IPO deal can work wonders for a company in the stock market, because it instills confidence in the mind of the retail investors and QIB’S (Qualified Institutional Buyers), who invest a lot of money in the IPO. For example, if a reputed mutual fund like Morgan Stanley buys a 2-3% stake in an unknown company offering an IPO, then investors and other institutions will pump in more money to invest in that particular company. The involvement of a big institution making a pre-IPO deal with a certain company generally means that the company has a strong background. Additionally, it also erases any doubt related to the stability of the company coming out with the IPO.

A party enters a pre-IPO stage 6 months, or maximum 1 year, before the initial public offer. The entry is either direct or through a merchant bank.

But at the same time, the presence of a party with huge stake in a particular company can create havoc in the stock market after it is listed on the BSE and NSE. Even if the party sells 1% of its stake in the company, there will be a great deal of negative momentum. Things could be worse if it is a large-cap stock, as it will cause the entire sensex to tumble along with that stock. This will trigger a selling among retail investors and many people will end up booking losses.

This is where the SEBI (Securities and Exchange Board of India) Rules and Regulations act as a boon for the stock market. According to the new SEBI rules and regulations, all pre-IPO deals shall be subject to a lock-in period of 3-5 years. The lock-in period is decided before the company makes an initial public offer. In simple words, the party involved in the pre-IPO deal will be barred from trading the shares acquired through the above mentioned procedure for a period of 3-5 years.

A pre-IPO deal strongly influences the mind of a retail investor and to safeguard their interests, SEBI has introduced strong rules and regulations so that the market remains stable.

Rajat J. Shetty

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