What is a Direct Public Offering?

With the recent IPO frenzy in the securities market, terms such as private placement, offer for sale, and direct public offerings are frequently discussed. The life cycle of a listed company begins with an IPO. FPO, OFS is the secondary phase of raising funds.

A Direct Public Offering (DPO) or Direct Placement is similar to an IPO. The definition of direct public offering allows a company to directly sell shares to the general public without any support or intervention from an intermediary. Intermediaries include investment banks, financial institutions, brokers, dealers, and underwriters. As a result, the cost of raising capital is reduced significantly. On the flip side, intermediaries tend to underwrite securities themselves i.e. underwriters may guarantee the sale of a specified number of securities.

How does a DPO work?

Direct Public Offering is not subject to any restrictions associated with intermediaries. The issuer has the prerogative to ascertain the terms of an issue for a DPO. The issuer may determine the offer price, offer period, the minimum permissible investment per investor, bid-ask spread, settlement dates, etc. The terms of the offer are such that they benefit the interest of the company. Thus, the DPO offers flexibility for the terms and conditions of the offer.

Since the restrictions placed on a DPO are comparatively lesser, the time frame to prepare for a DPO is equally less. Preparation of a DPO ranges from a few days to a couple of months. Before the issue, the issuer releases an offering memorandum. The offering memorandum introduces the issuer along with their brief background. Further, it also mentions the type of security offered for the subscription. The company then decides the medium for circulating the offering memorandum. Telemarketing, social media platforms, newspaper advertisements, and public meetings with the existing shareholders are some of the mediums for publishing the offering memorandum.

The issuer must ensure that the offering memorandum complies with the rules and regulations set forth by the relevant regulating authority. Further, before the publishing of the DPO, the issuer is required to file compliance documents with the concerned regulatory authority.

These may include the offering memorandum, articles of association, memorandum of association, and latest audited financial statements of the company among others. Once the company submits the relevant documents, the regulating authority analyzes the financial health of the company, compliance with applicable laws, etc. The regulatory authority then conducts a review of whether the DPO is appropriate and fair for investment. It may approve the DPO if it deems the issuer and offering fit to be made available to the public.

Upon receipt of the approval, the issuer company may roll out the offering memorandum. The issuing company begins with a tombstone ad to announce the DPO to the public. The issue is then open for sale to retail and HNI investors, and financial institutions. The securities may also be offered to other investors that the issuer already knows such as acquaintances, clients, suppliers, employees, and distributors of the company. However, such issuance must meet the requirements set forth by the regulating authority.

The issuer is required to furnish the closing date of the issue in the offering memorandum. Direct public offering closes when all the securities offered for sale have been sold or the closing date, whichever is earlier. The DPO also has a minimum and a maximum number of shares that are offered for sale. If the minimum number of shares is not sold then the issue stands canceled.

In this case, the funds received by the issuer instead of the security sold is to be refunded to the individual investors. Nevertheless, if the number of orders exceeds the maximum number of shares that may be sold then the issuer may allow the shares on a first-come-first-serve basis. Otherwise, the issuer may also allocate the shares on a pro-rata. This allocation implies comparing the shares applied for by an individual investor with the total application received to determine the allotment ratio.

How are DPO securities allotted?

The shares issued through a DPO are not listed on an exchange. Thus, DPO shares do not have any trading platform. Although, DPO shares may be traded in over-the-counter (OTC) markets. Shares allotted through a DPO may face liquidity issues during trading.

There are some cases wherein a direct public offering may prove to be a better alternative as compared to an IPO. For example, DPOs are best suited for small to medium-sized companies with a loyal base of subscribers. It allows them to directly raise capital from the community of operation. Thus, DPOs prove to be a better way to raise capital as compared to borrowing debt.

Who can apply for a DPO?

Companies that may want to go public but do not have the adequate resources to employ an underwriter may prefer DPOs. Alternatively, a company may not wish to dilute its existing holdings by creating new ones to meet compliance requirements. DPO is also preferred in cases where the promoter wants to avoid lock-in period agreements. In each of these cases, DPO is the ideal method to raise funds. The securities which may be offered in a direct public offering include shares, preferred stock, REIT, and debt instruments. It may be worthwhile to note that more than one type of security may be offered for sale through a DPO.

Process of a Direct Public Offering

There are three stages in the preparation of a DPO – the preparation stage, regulatory approval, and exemptions to regulations.

The preparation stage involves drafting the offering memorandum and deciding the appropriate medium for marketing the offering to the public. The regulatory stages include meeting the regulatory requirements and filing the requisite documents with the concerned authority.

The regulatory authority may prescribe exemptions for direct public offerings. In such a case, the issuer is exempt from some or most of the regulatory requirements. The governing body notifies the applicability of such exemptions periodically.

IPO vs Direct Public Offering

IPO and Direct public offering are similar because both are means to raise interest-free capital by issuing share capital. In an IPO, new shares are created and underwritten through an intermediary and then sold to the public. Whereas in a DPO, the existing shares are directly offered by the company to the public without any intermediary. The existing shares are sold to the public without any involvement from intermediaries. Parallelly, the issuer can also avoid the regulations of bank and venture capital funding. Hence, DPO offers flexibility to a greater extent as compared to an IPO.

The cost of DPO is significantly lower than that of IPO. On the other hand, DPO is privy to certain risks which are eliminated in an IPO. These include a lack of guarantee of sale of shares, and less promotion for sale. Further, the USP of an IPO such as the greenshoe option, book building process, etc. is not available in a DPO. Lastly, IPO shares are listed on the stock exchange (s) and may be traded through a platform. However, shares allotted in a DPO are traded in the OTC market. Thus, the trading of DPO shares may not be as liquid as IPO shares.