WHAT IS THE BENEFIT OF AN EMPLOYEE IF THE COMPANY GOES TO IPO

The article discusses the steps involved in IPO by the underwriters listing down the red-herring prospectus contents. The details on an employee's benefits when the company goes for IPO have been crafted accordingly, following the conclusion part with suitable examples.
Estimated Reading Time: 10 minutes

Introduction

An initial public offering (IPO) represents the method adopted by corporate entities for marketing their securities in the new issues market; it is performed by participating in the primary and secondary market by becoming a publicly-traded company. Before an IPO, shares of companies are bought, sold, and transferred within private hands like venture capitalists, angel donors, loans, etc. These transactions have little or no transparency, and the corporation’s management control is sacrificed to the outsiders. With the evolution of the stock market worldwide, various concepts associated with it also began blooming; the Dutch East Indian Company made the first-ever Initial public offering in the year 1602 by issuing stocks and shares of its ownership. It was considered the first modern IPO; later, due to various market trend transitions, the IPO’s buzz started growing. 

Concerning India’s primary market, it has been busy in the past years with several companies rerouting to IPOs. Like the first time a company issues its shares to the general public, it registers a special place in investors’ memory. For example, the world’s largest coal miner and Navratna at the time (Coal India has since been conferred Maharatna status), the IPO of Coal India broke several records and made new ones. It raised a total of INR 15,200 crore – the most extensive sum so far in India. 

Initial public offering facilitates the public to buy shares of any listed company and gain ownership over its profits. Becoming public, the companies enter into a public domain where detailed information about all company activities will freely available to anyone and is maintained with a high range of transparency, reporting, and accountability. They are highly regulated and are subject to stringent rules and regulations on quarterly financial reporting requirements. Complying with all the laws and regulations and filing all the necessary reports are expensive and time-consuming endeavours, the private company will transform entirely into a publicly-traded entity.

However, the company can stop its IPO whenever they want and retain the share ownership and liabilities. They will not be held liable for the capital ownership of the shareholders. It is one of the most efficient methods of raising capital for private companies which are previously funded through venture capitals and angel investors. This method has proved to be a successful business mechanism for smaller companies who wish to expand the business and the larger companies that wanted to go public to raise their company profile. 

What is Initial Public Offering?

A financial Jurist Marc Deschenaux has defined Initial Public Offering as an event described as the first time that the shares of stock of a stock issuing private company called the “Issuer” are offered for sale to the public, the proceeds of the sale of the Issuer’s stock raise a significant equity financing for said Issuer.” 

An initial public offering (IPO) refers to offering shares of a private corporation to the public in a fresh stock issuance. Public share issuance allows a company to raise capital from public investors. IPO is a method followed under the new market issue of stocks when a private company wants to go public by selling its stocks in the capital market to general public investors. It is followed by new, young, and old companies who wish to diversify their stakeholders and the raised capital for business; they raise equity share capital by issuing new shares with considerate face-value after analyzing the market risks. The existing shareholders will also be given an option to sell their part of shares to gain high-returns.

Initial Public Offer Method

IPO is the first-ever public issue made by a corporate entity. Under this marketing method, securities are issued to successful applicants based on their brokers’ orders. When a company not following public trading in their stock wants to offer that stock to the general public, it takes the form of an initial public offer’. They entrust it to an intermediary in the capital market called the underwriter. The underwriter assumes and evaluates the market risks and performs the process involved in an initial public offering.

They determine the value of a company, creat public shares, and raise money by selling those shares to investors; this process in an IPO is called underwriting. They act on behalf of the Issuer and fix a specific price for a minimum number of shares and resells those shares to buyers, who are often the underwriting firm’s clients. The underwriters who perform the assessment and evaluation of the company’s intrinsic value prepare a red herring prospectus consisting of the company’s preliminary details, asset value, the face value of stocks, and other financial and business information regarding the Issuer corporation. It should be filed with the register of companies; it contains the following:

  1. A description of the Issuer’s business
  2. The names and addresses of the company officers, with salary and five-year business history
  3. Intrinsic value of the business, its profits and proceeds
  4. The description of the usage of the proceeds received from an initial public offering
  5. The amount of ownership of assets held by the key stakeholders in the corporation
  6. Legal and other financial liabilities of the company

The stocks are then issued to the underwriter after the prospectus issue, which is later released to the public trading platform. The issuer company will determine the new issue stock price after the underwriter assesses and evaluates the market risks. However, the red-herring prospectus’s face-value may or may not be the final issue price since it is an approximate price issued for the listed stock. The new issue stock will not be entirely available for the public; sometimes, they will be with-held by the employees and the other company stakeholders for a Lock-up period.

Steps involved in issuing the IPO stocks

A good relationship between the broker and the investor is a prerequisite for the stock being acquired. Full disclosure of all material information connected with the offering of new securities must be made as part of the latest offerings.

  1. Order: The broker receives the mandate to form the client and places orders on behalf of the corporation.
  2. Share allocation: The Issuer settles the allocation of shares and notifies the brokers.
  3. The client: After notification, the broker instructs the client on the share allocation and submission of the application form fr shares and to make payment to the issuer corporation to purchase the shares. 
  4. Primary issue account: As the issue runs in the primary market, the Issuer opens a separate primary market account. Later, the stock exchange’s clearinghouse debits the funds to the broker’s primary issue account and credits the Issuer’s account. 
  5. Certificates: After purchasing the IPO, the Issuer delivers the share certificate to investors. Otherwise, the depository account may be the creditor.

The investors make applications on their brokers’ advice who are intimated by the Issuer’s share allocation. The share purchase amount becomes payable to the Issuer through the broker only on the final distribution. The allotment is credited, and share certificates delivered to the depository account of the successful investor.

Employee Benefits on Initial Public Offering

SHARE QUOTA/RESERVATION

Share Quota or Shareholder’s Reservation Portion refers to the act performed by the companies going public where it reserves some shares offering available to the existing shareholders and the employees under the shareholding quota depending on the size of the initial public offering and the company’s past market profitability track. When purchasing stock under the reservation category, the employees provide them with an upper hand to benefit from the assured purchase of shares and other amenities.

For instances:

  1. IPO of IRCTC had a Net Offer of 20,000,000 shares with a specific reservation for QIB (50%), NII (15%) and RII (35%). The company earmarked 160,000 shares for allotment to its eligible employees, increasing the offered size to 20,160,000 shares. 
  2. SBI Bank’s IPO offered a reservation of 1.35% shares for its employees at a discount of Rs 75 when applying in the employee reservation category. An employee of India’s state bank has a limitation of purchase up to Rs 5 Lakhs in the employee category, which facilitates the employees to benefit from quick money-making through IPO purchase. In addition to the employee reservation category, SBI staff can also apply in Shareholders Category – If they hold SBI shares in Demat account as of Feb 18, 2020. General Category – Retail Category (<Rs 2 Lakhs) or Non-Institutional Investor Category (>Rs 2 Lakhs)

INCENTIVE STOCK OPTION

Incentive stock option is one of the corporate privileges provided to the employees who are facilitated to buy the company stocks at a discounted price and tax benefits. The stocks purchased by the employees will be taxed at a capital gains rate lower than the income rate. Incentive stock option is a legal obligation of the companies; they perform this act to encourage their employees to work long-term and contribute to its growth. The public companies and the private companies planning to go for IPO usually prepare a plan document on ISO outlining the discount rated stock options to its employees. 

Concerning the concept of Incentive stock option in the lines of IPO, it is one of the most underrated advantages of an employee being rewarded through IPO, companies who are going public often provide a stock option to their employees at a discounted price to motivate them and increase productivity, by offering shares at discounted prices which directly impact the growth and performance of the company. Whereas at the same time, the employees acquire massive benefit out of this option, the purchased stock shows an uptrend when released to the general public, and this provides the employees with high returns profit.

For instance: IndiaMART, India’s most comprehensive online B2B marketplace for business merchandises and services, announced an IPO of 4.89 million equity shares at face value of INR 10 each, on June 24, 2019. The IPO ran for three days, and the issue price of each share was between INR 970 and INR 973. 10,000 shares were reserved for employees at a discount of INR 97 per share. The IndiaMART stock shot up 40% on the listing, and today the stock is trading above INR 2000 per share. 

COMPENSATION PACKAGES

A study from Radford US Pre-IPO/Venture-Backed Survey on the company going public found that more than 90% of firms have introduced at least one new equity compensation plan at the time of their IPO. This includes both equity incentive plans (EIPs) and employee stock purchase plans (ESPPs). Companies usually provide equity as part of the employee’s compensation package by offering ownership of the company. In public companies, employee compensation packages generally comprise both cash and equity compensation.

For public companies, equity is readily available. The market determines its value through the company performance because of its public share trading. Post-IPO the company offers its shares to employees to facilitate liquidity. They are subject to lock-up period and securities exchange rules, for example, those against short-swing profits and insider trading. Often equity will be the most significant component of senior employee compensation packages; they are usually compensated based on performance, measured by multi-year financial market-based company objectives.

In private companies, equity compensation is often in the form of time-vested restricted stock and stock options, as well as performance-vested stock options. Private companies in the pre-IPO stage usually pay lower cash compensation because they are less well funded than the post-IPO company. The offered stocks are vested for, requiring to work for the company. Vesting is the process of earning an asset, like stock options or employer-matched contributions over time, which encourages the employees to stay longer at the company and perform well to achieve the award. Concerning IPO, the exception is that it was easier to exercise and sell the shares.

Vesting schedule will not be changed; however, once the employee’s stocks are vested post-lock-up period, they can look at the stock’s market price and exercise the stocks’ strike price to receive quick returns.

ESOP (EMPLOYEE STOCK OPTION PLAN)

Companies use employee stock option schemes as an effective method to boost the interest of the employees in business growth, enhance their interests with shareholders, reward their efforts, increase their loyalty towards the company, and motivate employees to perform better. An initial public offering (IPO) is one of the significant ways in which employees seek value appreciation in stock options and is also exercised under ESOP Schemes with their plans to undertake an IPO.           

CONCLUSION

The influential ending of 2020 rendered a good impulse for the IPO market for the current year. Global IPO markets have benefited through different IPO methods, resulting from sufficient liquidity into the primary market system. The records show that the levels of IPO activity in some significant markets showed a hike in the past 20 years with various IPO models that have evolved to adapt to the new ways of doing business, such as virtual roadshows, direct listings, special-purpose acquisition company (SPAC) mergers.

As reported by The Wall Street Journal, an analysis of 68 companies which gave its employees options for as much as $1.5 billion in shares over the year-long period that preceded their public offerings offered them roughly a 32 per cent discount off what the shares were “worth,” according to the data. Consider the case of Blue Apron, where insiders back in October sold their shares for more than $13 each upon the IPO, but options were granted at a bit more than $3.60. That means roughly $10 a share in profit. Some of the above instances show that the employee benefits from the company issuing Initial Public Offering more than an outside investor.

When a company starts its Initial public offering, the employees are often allowed to buy a limited number of shares at the initial offer price. They are also entitled to buy at that price for several months after the IPO in employee stock options. These reasons show that the company takes a stand on maintaining the liquidity of its shares in the market.

The remarkable view on the initial public offering is that if investors feel the underwriters of the IPO undervalued a company, the stock will immediately go up, i.e., if the $10 per share IPO may be trading at $11.50 the next that day, and whoever got the $10 shares makes a good profit. The employees who hold the pre-IPO stock benefit from its price trends in the market, gaining high returns. These incidences reveal that, besides the outside investor benefit, the company’s employees benefit more from the company going to Initial Public Offering.

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