What is IPO Grading?

It is a rating assigned by the Securities and Exchange Board of India-registered credit rating agencies to initial public offerings (IPOs) of various firms. The grade indicates an assessment of business fundamentals and market conditions in comparison to other listed equities at the time of the issuance. These ratings are generally assigned on a five-point scale, with a higher score indicating stronger companies. IPO grading can be done either before filing the draft offer documents or thereafter. However, the red herring prospectus must have the grades given by all the rating agencies.

A company which has filed the draft offer document for an IPO on or after May 1, 2007, must be rated by at least one agency. Companies cannot reject the grade. If dissatisfied, they can opt for another agency. But, all grades obtained for the IPO must be disclosed to the regulator and the investors.

Why is it important?
IPO grading was introduced to make additional information about unlisted companies or those without any track record of their performance available to the investors, helping them assess the issue before investing and burning their fingers. Grading is additional investor information and assistance to enable informed investment decisions and more realistic pricing of shares. It helps issuing companies in that if they are given a higher score — indicating stronger fundamentals — they command a higher premium for their issue.

Which factors determine the grade?
IPO grading covers both internal and external aspects of the issuing company. Internal factors include the competence of the management, promoters’ profile, marketing strategies, growth prospects, competitive edge, technology, operating efficiency, liquidity and financial flexibility, asset quality, accounting quality, profitability and hedged risks. External factors would be the industry and economic, or, business environment for the company. It does not take into account the issue price. Therefore, investors needs to make an independent judgement on the subscription price.

Where can one see IPO grades in the offer document?
All grades, along with a description of the same, can be found in the issue prospectus, abridged prospectus and the issue advertisement. Further, the grading letter of the credit rating agency, which contains the detailed rationale for assigning the grade, is included with the documents available for inspection.

How does it help?
IPO grading by a professional credit rating agency informs investors about the issuing company after analysing factors like business and financial prospects, management quality and corporate governance practices etc. The grade is not a recommendation to subscribe to the IPO. It needs to be read with the disclosures, including risk factors.