IPO grading is a process in which a grade or rating is assigned to Initial Public Offering(IPOs) of companies in India by credit rating agencies that are registered with the Securities and Exchange Board of India. The grade reflects the company’s business fundamentals and market conditions, as compared to other listed equities during issuance. IPO ratings are generally based on a five-point scale. A higher score indicates a stronger company. IPO grading is usually done before the filing of the draft offer documents or post the same. The red herring prospectus, however, must contain the grades assigned by all the rating agencies.
How does IPO grading work?
Any company that has filed the draft offer document for an IPO on or after May 1, 2007, should be rated by a minimum of one rating agency and the grades cannot be rejected. If a company is dissatisfied with the grading, it can choose another agency. All grades assigned to the IPO should be disclosed by the company to the regulator and investors.
Credit rating is mandatory and the Red herring prospectus of a company must compulsorily contain the rating provided to the issuing company by all the credit rating agencies consulted by the company for IPO grading.
IPO grade represents an assessment of the issue fundamentals in comparison to the other listed stocks in India. The scoring is based on a five-point grading scale, as mentioned below:
- Grade level 1 ‐ Poor fundamentals
- Grade level 2 ‐ Below average fundamentals
- Grade level 3 ‐ Average fundamentals
- Grade level 4 ‐ Above average fundamentals
- Grade level 5 ‐ Strong fundamentals
Credit rating was introduced as an effort towards providing additional information to the investors and thereby facilitating the assessment of equity issues being offered via an IPO. It is aimed at providing the investor with a calculated and objective opinion put forth by a professional rating agency after considering factors such as business and financial prospects, quality of management, corporate governance practices, etc.
Why is IPO grading important?
IPO grading was first introduced to make additional information about unlisted companies or companies without any past track record available to investors. The idea was to help investors in assessing the issue before taking an investment decision. Grading acts as additional investor information, primarily assisting in making an informed investment decision and indirectly arriving at realistic share pricing. If an issuing company gets a higher score, it indicates stronger fundamentals and the company can therefore command a premium for the IPO issue.
Which factors influence IPO grading?
IPO grading encompasses both internal and external factors surrounding the issuing company. Internal factors primarily include the management competence, promoters’ profile, company’s marketing strategies, competitive advantage, growth prospects, technological initiatives, operational efficiency, liquidity, asset quality, accounting ability, and hedged risks, etc.
External factors comprise the industry scenario combined with the economic situation or the business environment of the company. These do not take into account the issue price. Therefore, investors must ensure to take an independent decision as far as the subscription price is concerned.
Where to find IPO grades in the offer document?
IPO grades, along with the description, can be referred to in the issue prospectus, abridged prospectus or the advertisement of the IPO issue. The credit rating agency’s grading letter, which contains the detailed explanation for assigning a particular grade, is also included along with the documents that are available for inspection.
Conclusion
IPO grading is a conclusion of a detailed analysis conducted by a professional credit rating agency. It gives investors a quick insight into the issuing company. The credit agency may analyse factors such as business and financial prospects, management professionalism and corporate governance practices, etc. Since the IPO grade is not a recommendation for subscribing to an IPO, it needs to be considered in combination with other disclosures by the company while analysing other risk factors involved.
FAQs
Irrespective of whether the company issuing IPO finds a grade given by a credit agency acceptable or not, the IPO grade must be disclosed as per ICDR Regulations. The IPO rating cannot be rejected by the issuing company.
An IPO grade is in no way a suggestion or recommendation to subscribe to an IPO issue. IPO grade must be considered along with the other disclosures made in the prospectus. Investors must look at the risk factors and pricing of shares offered in the issue before taking an investment decision.
IPO, or Initial Public Offering, is the selling of securities by a company to the public in the primary market. Once listed on the stock exchange, the company becomes a publicly traded company and its shares can be freely traded in the open market.
No, it is not mandatory for an issuer to get its IPO issue graded. The process was made optional with effect from February 04, 2014.
Since the grading process of an IPO is expected to run in parallel to the issuance, it is not expected to delay the issue process.
