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Understanding the Role of Underwriters

10 Aug 2023

Introduction:

Issuing an Initial Public Offering or IPO allows a company to raise funds for business expansion, debt repayment, cashflow requirements, and general corporate purposes. Launching an IPO can be a make-or-break situation for the issuing company, and its success or failure can have serious consequences. But before a company can float its IPO in the market, it must select an underwriter. An underwriter has a crucial role to play in the success of an IPO.

In this article, we will discuss what an IPO underwriter is, its roles and responsibilities, and the different types of underwriters. Keep on reading.

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What is an underwriter in an IPO?

An IPO underwriter is a specialist who works closely with the issuing company and helps satisfy all regulatory requirements of the Securities and Exchange Board of India (SEBI). An underwriter in an IPO also acts as an intermediary between the issuing company, investors, and the market regulator. It can be an investment bank or a financial institution. Depending on the size of an IPO, the issuing company can hire one or more underwriters.

An underwriter's exact roles and responsibilities depend on the underwriting agreement signed between the issuing company and the investment banker. Generally, it helps a company prepare for the IPO, analyse factors such as the amount of money that can be raised, and decide on the valuation of the IPO and the types and quantity of securities that can be issued.

What are the roles and responsibilities of an IPO underwriter?

Some typical roles and responsibilities of an IPO underwriter are as follows:

  • Ascertain the risks associated with an IPO

One of the primary roles of an IPO underwriter is to determine the risks associated with a public issue. The success or failure of an IPO can have long-term ramifications on the issuing company’s operations and business. For example, it may not be able to generate the required amount and may suffer a loss of face.

Also, when a company goes public, the owners have to dilute their stake and also become more transparent and accountable. They no more can take corporate decisions of their own will.

An IPO underwriter analyses and discusses all such risks with the issuing company. Upon discussion with the underwriter, a company decides whether or not to float an IPO.

  • Helps in preparing the DRHP

Once a company decides to go ahead with the IPO, it must file a Draft Red Herring Prospectus (DRHP) with the market regulator. This DRHP is prepared only after consultation with the IPO underwriter.

The issuing company needs to specify several crucial details in the information, including the expected IPO size, number of equity shares that would be sold, objectives of the offer, strengths and weaknesses of the company, etc. If the SEBI doesn’t find these details satisfactory, it can reject the IPO application.

  • Provides a guarantee to the issuing company

After thoroughly assessing the issuing company’s fundamentals, objectives, and business plan, an underwriter guarantees the minimum number of IPO shares that will be sold. Alternatively, IPO underwriters assure issuing companies of a certain revenue by selling a specific quantity of shares to public investors.

However, in some cases, the underwriters are not supposed to guarantee minimum sales. Instead, they need to put their best effort into selling as many shares as possible.

  • Ensuring regulatory compliance

IPO underwriters specialize in their jobs. Through their expertise, they guide the issuing companies on how they can ensure regulatory compliance with the market regulator SEBI. For example, the underwriters advise issuing companies so that their IPOs are neither undervalued nor overvalued. 

They also ensure that the issuing companies pay the required charges in time and release the necessary data on their websites for investors’ perusal.

To conclude

An IPO underwriter needs to play several roles throughout the IPO cycle. In return for their services, they charge a designated fee from the issuing company. Furthermore, underwriters can be classified into various types depending on their precise capacity. Some common types of underwriters are mortgage underwriters, insurance underwriters, equity underwriters, and debt security underwriters.

If you plan to invest in IPOs, you can open a free Demat account with Motilal Oswal and enjoy seamless investing.

 

Related Articles: What is the Roles of IPO In Stock Market | What Happens to Your Money Once You Bid For an IPO | Understanding All that a Prospectus Entails | What Are the Different Types of IPO | Understanding The Different Forms of Prospectuses

 

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