Role and Responsibilities of Merchant Bankers in SME IPO

When a SME decides to go public, the first step is to hire a Merchant Banker who lays the groundwork for the IPO by preparing the DRHP. Merchant Bankers play an important role in any public offering of shares by providing strategic, financial, and valuation advisory services. They act as intermediaries between the company going public and prospective investors.

In a SME IPO, merchant bankers not only play the traditional role of managing and underwriting the issue, but are also involved with market-making arrangements for three years after the shares are listed on the SME exchange. In this way, merchant bankers play a pioneering role during the pre-issuance and post-listing periods. Read on for full details on the role of merchant bankers in SME IPO issue management.

Who are Merchant Bankers?

Merchant Bankers are financial institutions that act as intermediaries between investors and the company. SEBI defines a merchant banker as any person who is engaged in issue management, either by making arrangements or subscribing for shares or by acting as an advisor or manager or by providing corporate advisory services for the issue management of the IPO.

From due diligence to drafting DRHP and RHP, obtaining stock exchange approval, setting the issue price SME IPO, marketing the issue, promotional activities, and even market-making arrangements after listing - all these are done by merchant bankers.

Roles and Responsibilities of Merchant Bankers in SME IPO

Despite the fact that the market regulator SEBI has granted some leniency in the regulations for share issues for small and medium enterprises, the process of issuing SME IPO issuance is quite challenging. Therefore, Merchant Bankers provide a suitable solution and assist them in getting their securities listed on the SME Exchange. The responsibility of Merchant Bankers becomes too much for the successful listing of SME companies on one of the most popular stock exchanges in India.

1. Educating the Applicant Company

In the first step, Merchant Bankers assist SMEs in preparing for IPO preparation to create an IPO-ready company. During the pre-IPO phase, Merchant Bankers help companies create a suitable capital structure, comply with corporate governance practices, create an IPO plan, and obtain ISIN from the depository (CDSL and NSDL). Merchant Bankers provide detailed information in minute detail on the process of a successful listing on the SME exchanges and the applicable capital market rules and regulations for regulatory compliance.

2. Appointment of Intermediaries

The merchant banker gets the company in contact with other intermediaries. They are required to assess the ability and independence of the intermediaries or service providers. The issuer company selects all intermediaries in consultation with the merchant bankers. A preliminary list of intermediaries participating in the IPO includes;

• Underwriter
• Banker to the issue
• Registrar to the issue
• Compliance officer
• Depository
• Legal advisor
• Statutory auditor

3. Due Diligence Check

Merchant bankers are primarily responsible for due diligence in an IPO process. They conduct the necessary research to ensure that the documents and information provided by the company or other publicly available information are true.

They are required to verify compliance with the eligibility criteria for an IPO on the SME Exchange in terms of minimum assets, net worth, operational existence, profitability record, etc. They also perform due diligence to ensure that all material facts and figures are disclosed in the IPO offering documents. Merchant Bankers conduct meetings and discussions with many intermediaries such as managers, auditors, legal advisors, etc. to prepare and submit the due diligence report to the regulators.

4. Preparing DRHP and Prospectus

Merchant Bankers prepare the DRHP (Draft Red Herrings Prospectus) report by carefully reviewing the company's financial records and visiting the company's site or manufacturing facilities. Once the DRHP is approved, they prepare a final prospectus that incorporates all proposed changes and submit it to the exchange for review. They must also post the IPO offering documents on their website.

DRHP and RHP are important legal documents that contain information about the company's business model, operating mechanism, financial performance, future plans, issuance objectives, and risks. For this reason, the prospectus and DHRP become a single source of information about the company that investors review to decide whether or not to purchase shares of a company.

5. IPO Issue Pricing

Merchant bankers conduct a careful analysis of the company's financial reports and IPO demand in the market. They review the company valuation taking into account key metrics such as earnings per share, net value added and so on. The valuation review also includes a comparative peer analysis of other publicly traded companies. Then, in consultation with the company's management, it is the merchant banker or lead manager who fixes the IPO issue price.

Broadly, there are two methods for setting the security price: the fixed-price method and the book-building method.

1. Fixed price: as the name suggests, the price of the shares for the IPO launch is set at a specific price. Suppose an SME company issues shares at Rs 50 /-, the face value of which is Rs 10 /-, the IPO is a fixed price IPO.
2. Book-building Technique: In book building technique, an SME company fixes a price range for the shares. The lower price is called the minimum price and the upper price is called the maximum price. When the IPO starts, investors offer their shares at the price they expect within the set price range. And the companies create a daily book in which the share price is entered according to the public demand. For this reason, it is called the book-building price.
   Let one company issue a share at a price band of Rs 25 - Rs 32 per share, here the floor value is Rs 25 and the cap value is Rs 32. So the price range from Rs 25 - Rs 32 set for the stocks.

It is the duty of lead manager to disclose complete details on the basis for the issue price in the IPO bid documents. The DRHP and RHP document provides extensive information on both the quantitative and qualitative factors considered by merchant banker to fix the offer price.

6. Issue Underwriting

Underwriting is the process of getting SMEs out from the risk of under subscription. Most SMEs are not known to the public and to maintain investor confidence, underwriting is mandatory. SEBI's regulation mandates that each SME IPO must be 100% underwritten. Merchant Bankers appoint the underwriters and ensure that the issue is fully underwritten and 15% of the subscription amount should come from the merchant bankers' accounts.

The underwriters guarantee to the issuing company that all or a portion of the shares issued that are not subscribed by the public are owned by the merchant bankers themselves. Thus, the most important role to be played in a typical underwriting process is to transfer risk from the company to the merchant banker by providing insurance on the unsubscribed shares.

7. Issue Advertisement and Marketing

Merchant bankers play a critical role in creating demand by generating public attention. Marketing the IPO is the job of the lead manager. They assist small and medium-sized companies in going public through public announcement of the IPO, public advertising, PR, road shows and other promotional activities.

The main goal of advertising is to attract investors' attention and create demand for the specified securities. Lead managers take full advantage of their market connections, relationships with institutions, and networking with the public.

8. Market Making

In the post-issuance phase, merchant bankers play a central role in market development. Many SMEs suffer from a "liquidity" problem," so market makers are required to address liquidity problems. Market makers are required to provide two-way quotations for both (i) bid price and (ii) ask price for 75% of the time in a day from the day of listing. The minimum depth of quotation shall be Rs 1 lakh and one lot. For this purpose, Market Makers are required to reserve at least 15% of the shares as per SEBI guidelines. In this way, Market Makers ensure that the order is executed at the quoted price and quantity. In all these activities, Market Makers will work with SMEs for at least three years and continue to provide them with liquidity.

Wrapping up

Merchant Bankers take responsibility for the entire IPO issuance and listing process. They assist SMEs in raising funds at all stages, from the pre-IPO phase to the post-IPO phase. During the IPO issuance, merchant bankers ensure compliance with due diligence, preparation of IPO offering documents, setting the share price, underwriting, coordinating with other intermediaries, communicating with the exchange, and promoting and marketing the issue. However, once the SME securities are listed on BSE SME or NSE Emerge, the merchant bankers are involved in the market-making activities to provide 3 years of permissible 2-way listings.