Understanding the Role of Underwriter in IPO Process

The Initial Public Offering (IPO) process is one of the most critical milestones in a company's lifecycle. But behind the scenes of any successful IPO is a key player—the underwriter. Acting as the bridge between a private company and public investors, underwriters play a strategic and regulatory role that helps ensure the smooth issuance of shares.

An IPO underwriter is typically an investment bank or a financial institution that serves as an intermediary between a company going public and the investing public. Their role includes managing the IPO process end-to-end, from due diligence and regulatory filings to pricing and marketing.

They commit—either fully or conditionally—to sell the IPO shares to the public, helping the company raise capital while assuming certain levels of risk.

Underwriters aren’t just financial middlemen—They act as intermediaries, assisting with the process of bringing the IPO to market. Their core responsibilities include:

• Valuation & Price Setting
  

• Regulatory Compliance
  

• Marketing the IPO
  

• Distribution to Investors
  

• Risk Management
  

Each of these duties requires coordination with company management, regulators, legal counsel, and market analysts.

Valuation and Price Determination

A key function of the underwriter is to evaluate the company’s worth and set the Public Offering Price (POP). This involves analyzing the company's financials, industry trends, growth potential, and comparable companies. The aim is to strike a balance—a price attractive to investors but fair to the company.

The relationship between a company and its underwriters is formalized through an underwriting agreement, which outlines the terms of engagement, risk sharing, and commitment levels. Common types include:

• Firm Commitment: The underwriter buys all shares and resells them, assuming full risk.
  

• Best-Efforts: The underwriter agrees to sell as many shares as possible, without guaranteeing full subscription.
  

• All-or-None: The issue proceeds only if all shares are sold.
  

• Standby (Devolvement): Often used in rights issues; the underwriter agrees to buy unsubscribed shares.
  

Understanding these models allows companies to select a structure based on risk appetite and market confidence.

• All IPOs must be fully underwritten, ensuring the entire issue is subscribed.
  

• The lead manager is required to underwrite at least 15% of the issue from their own funds.
  

• A formal undertaking confirming the underwriting commitments must be submitted to SEBI before the issue opens, along with details of all underwriters and their quotas.
  

• Underwriters and sub-underwriters, except the lead manager and nominated investors, cannot subscribe beyond their underwriting obligations.
  

• Offer documents must clearly disclose all underwriting and subscription arrangements.
  

• If any underwriter or nominated underwriter defaults, the lead manager is responsible for meeting the shortfall.

The underwriting spread is the difference between the price paid by investors and the price paid to the issuing company. It serves as the underwriter’s compensation and typically includes:

• Management Fee
  

• Selling Concession
  

• Underwriting Fee
  

The gross spread usually ranges from 3% to 7% of the total IPO size, depending on the issue's risk profile and size. Fee splits may vary among syndicate members if multiple underwriters are involved.

The IPO underwriting process involves a series of steps to ensure the issue is subscribed and listed smoothly:

• Appointment of Underwriters – The company selects investment banks or financial institutions to manage and underwrite the issue.
  

• Due Diligence & Valuation – Underwriters assess the company’s financials, risks, and determine the price band for the IPO.
  

• Drafting the Prospectus – The draft red herring prospectus (DRHP) is prepared and filed with SEBI for approval.
  

• Marketing & Book Building – The issue is marketed to potential investors, and bids are collected during the subscription period.
  

• Allotment & Listing – Shares are allotted based on demand, and the stock is listed on the exchange.
  

• Underwriting Obligation – If subscriptions fall short, underwriters purchase the remaining shares as per their commitment.

While underwriters facilitate capital raising, they also bear significant responsibilities and risks:

• Unsubscribed Shares: If demand is low, they may be forced to purchase unsold shares.
  

• Legal Liability: They are legally bound by SEBI or SEC regulations (in India or the US respectively) and can be held accountable for misstatements in the prospectus.
  

• Reputation Risk: Failure to manage a smooth IPO can damage the underwriter’s credibility.
  

Due diligence and transparency are crucial to mitigating these risks.

Experienced underwriters are associated with market confidence, offering regulatory knowledge and distribution networks in the IPO process. They contribute to the IPO process in the following ways:

• Enhance investor confidence through effective branding and financial vetting.
  

• Ensure regulatory compliance to prevent delays or penalties.
  

• Facilitate efficient share distribution through their investor network.
  

• Manage pricing expectations, balancing market demand with issuer goals.
  

• Handle logistics like roadshows, book building, and application processing.
  

Underwriters help simplify the IPO process by coordinating compliance, pricing, and distribution, which can otherwise be complex for companies to manage alone.”

The choice of underwriter may affect IPO outcomes. Factors such as industry experience, investor reach, risk management practices, and fee structures are considered in the selection process.

• Track record in similar industries
  

• Investor reach and syndicate strength
  

• Ability to manage risk and pricing
  

• Transparency of fee structures
  

Clear communication, mutual trust, and goal alignment are key elements in a successful partnership.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.