What is IPO Grading?

Introduction:

IPO grading is nothing but conducting extensive due diligence through a SEBI approved credit rating agency. The process has various checkpoints such as industry positioning; the issuing companies’ management, suppliers, and customers; any pending or potential lawsuit evaluation; corporate documents analysis; compensation plan & intellectual property analysis; etc. The article gives an overview of grading.

What is an IPO Grading and Rating?

An IPO is graded by a credit rating agency (CRA) registered with SEBI. The grade represents the relative fundamental assessment concerning the other listed equity securities in India. The grade is assigned on a five-point scale, with the highest most node indicating the solid fundamentals and the lowest most node marking the poor fundamentals.

• IPO Grade 1 denotes Poor Fundamentals.  
• IPO Grade 2 indicates Below-Average Fundamentals.
• IPO Grade 3 represents Average Fundamentals.
• IPO Grade 4 means Above-Average Fundamentals.
• IPO Grade 5 denotes Strong Fundamentals.

Through this gradation system, investors can access additional information that helps them assess the IPO issuing Companies before investing in it.

However, investors should know that an IPO grade is not a complete suggestion for an IPO subscription. IPO grade needs to be read together with the disclosures made in the prospectus. It also includes the risk factors and the price at which the shares are offered in the issue.    

When should this gradation be completed?

The IPO issuing Company needs to acquire it before filing the draft offer documents with SEBI or after that. However, irrespective of the time of filing, the IPO prospectus / Red Herring Prospectus should include the grade obtained.

Now the next point to know is: is the grading mandatory or optional for an IPO issuer?

Although previously it was a mandatory protocol for an IPO issuer to obtain, it has become an optional requirement from February 04, 2014. That is because, once assigned, even when it was not in the issuer’s favour, the issuer had to disclose it as per ICDR guidelines. IPO grades cannot be rejected. What the issuer could do in the adverse scenario is to go for a second rating with a different credit rating agency. And even in that scenario, the IPO issuer was not allowed to suppress their unfavourable rating. All the ratings so obtained were needed to be disclosed. This information is available in Prospectus, Abridged Prospectus, Issue Advertisement, or any other advertisement place.  

The second point of concern is that the issuer carried a significant amount of cost to obtain the grading. 

What are the factorials contributing to the IPO grading?

The process is expected to consider:

• Business Prospects and Competitive Positioning
  • Industry Prospects
  • Company Prospects
  • Financial Position
  • Management Quality
  • Corporate Governance Practices
  • Compliance and Litigation History
  • Inherent Risks and How They Are Addressed To 
  • Opportunity Utilization

What Role Does SEBI Play in IPO Grading?

SEBI does not play any role in the assessment. The entire procedure reflects an independent and unbiased opinion made by the evaluating agency. SEBI also does not pass any judgement about the quality of the Issuer Company. SEBI’s observation on the IPO document is entirely an independent procedure. 

Additional Read: What is an IPO? How can I apply in an IPO with my demat account?

In Conclusion:

People invest their hard-earned money in the Capital Market with the intent of securing a handsome return. Therefore, they are needed to check the creditworthiness of the investment place before parking their money there. Creditworthiness is nothing but the ability and willingness of the business firms to pay their obligations and the net worth back to the investors. In that sense, credit rating establishes a link between risk and return. To sum up, it can be said that the investors see the gradation to link with the risk level involved.  

Additional Read:

• https://www.icicidirect.com/knowledge-center/article//what-is-an-ipo-how-can-i-apply-in-an-ipo-with-my-demat-account
• https://www.icicidirect.com/knowledge-center/article//how-to-track-upcoming-initial-public-offerings-ipos
• https://www.icicidirect.com/knowledge-center/article//what-happens-to-you-money-once-you-bid-for-an-ipo