When a company decides to go public, the process involves far more than simply offering shares to investors. Behind every Initial Public Offering (IPO) sits a team of financial intermediaries who assess the issuer, price the shares, and ensure the issue is distributed in an orderly manner. Among these intermediaries, the underwriter plays one of the most important and most misunderstood roles.
This article explains, in plain terms, what an IPO underwriter does, how underwriting works under SEBI's regulatory framework, and why this role matters to anyone tracking IPO investment opportunities in India.
Quick Answer
An IPO underwriter is a SEBI-registered merchant banker or intermediary that agrees to subscribe to the unsold portion of an issue if it is not fully taken up by the public. In practice, underwriters also evaluate the issuer, help structure the offer, coordinate distribution through a syndicate, and take on a defined financial obligation to make up any shortfall.
In India, this role is typically performed by the Book Running Lead Manager (BRLM), along with other syndicate members, under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
Key Takeaways
- An underwriter's core function is to absorb the risk of under-subscription by agreeing, in advance, to buy shares that investors do not.
- Underwriting in India is governed by the SEBI (ICDR) Regulations, 2018, and by the SEBI (Underwriters) Rules and Regulations.
- For mainboard IPOs, underwriting is not mandated by SEBI and is typically arranged as part of issue management; for SME IPOs, 100% underwriting is mandatory, and the lead merchant banker must underwrite at least 15% of the issue size on its own account.
- The Book Running Lead Manager (BRLM) is the lead underwriter and is legally responsible for due diligence and the accuracy of the offer document.
- Underwriting is a risk-transfer and distribution mechanism; it is not a guarantee of listing gains or share price performance.
What Is an IPO Underwriter?
Under the SEBI (Underwriters) Rules, an underwriter is a person or entity engaged in the business of underwriting an issue of securities. In simple terms, underwriting means agreeing, before the IPO opens, to subscribe to shares that are left unsold after the public issue closes.
Underwriters must be SEBI-registered; in mainboard IPOs, the underwriting function is typically performed by SEBI-registered Category I merchant bankers (often the BRLM), along with other eligible intermediaries. Stockbrokers and other SEBI-registered intermediaries may also participate as underwriters or syndicate members, depending on how the issue is structured.
It is worth noting that an underwriter is not simply a distributor of shares. Distribution is one part of the role; the defining feature is the contractual obligation to step in financially if demand from the public falls short of the offer size.
What Does an Underwriter Do?
An underwriter's responsibilities span the entire life cycle of an IPO, from the initial assessment of the company to the final allotment of shares. Broadly, these responsibilities fall into five areas.
Evaluates the Issuer:
Before agreeing to underwrite an issue, the underwriter examines the company's financial statements, business model, promoter background, and corporate governance record. This assessment helps the underwriter decide whether the issue is viable and at what valuation it can reasonably be priced.
Conducts Due Diligence:
The underwriter, typically through the BRLM, carries out detailed due diligence on the issuer's operations, litigation history, related-party transactions, and use-of-proceeds plan. This due diligence feeds directly into the Draft Red Herring Prospectus (DRHP), which is filed with SEBI and the stock exchanges for review.
Structures the Issue:
Underwriters work with the issuer to decide the size of the issue, the price band, the mix of fresh issue and offer for sale, and the reservation of shares across investor categories such as Qualified Institutional Buyers (QIBs), Non-Institutional Investors (NIIs), and Retail Individual Investors (RIIs).
Manages Distribution:
Once SEBI clears the offer document, the underwriter, often working with a syndicate of brokers and sub-brokers, markets the issue to institutional and retail investors. This includes organizing roadshows for institutional investors and coordinating with the syndicate to widen the retail investor base.
Takes On Underwriting Obligations:
This is the defining function: the underwriter contractually commits to subscribing to a specified number of shares, or the entire unsold portion, if public demand does not fully cover the issue. This obligation is disclosed in the offer document, along with the identity of each underwriter and the extent of their commitment.
How Does IPO Underwriting Work?
The underwriting process runs alongside the broader IPO timeline and generally follows these stages:
- Appointment of underwriters: The issuer, in consultation with the lead manager(s), appoints one or more SEBI-registered merchant bankers or intermediaries as underwriters.
- Due diligence and documentation: Underwriters, led by the BRLM, review the company's financials and business operations and prepare the DRHP for filing with SEBI.
- Regulatory review: SEBI examines the offer document and may seek clarifications before granting observations, after which the issue can proceed.
- Price band and issue structuring: The price band and lot size are finalized based on valuation, investor demand estimates, and market conditions.
- Underwriting agreement and confirmation: Before the issue opens, the lead manager files the underwriting agreement(s) and submits an undertaking to the stock exchanges/SEBI confirming that underwriting arrangements are in place, along with each underwriter’s commitment.
- Bidding and book-building: The issue opens for bidding, and underwriters, along with syndicate members, canvass demand from institutional, non-institutional, and retail investors.
- Allotment and devolvement, if required: Once bidding closes, shares are allotted based on demand. If the issue is under-subscribed in a category where underwriting applies, the underwriters step in to subscribe to the shortfall - a process known as devolvement.
What Do Underwriters Evaluate?
Before agreeing to underwrite an issue, underwriters typically evaluate:
- Financial health - Revenue trends, profitability, debt levels, and cash flows over recent years.
- Regulatory eligibility - Whether the issuer meets SEBI's eligibility norms for a mainboard IPO under Regulation 6 of the ICDR Regulations, such as net tangible assets and net worth thresholds, or qualifies through the alternative route requiring a minimum allocation to Qualified Institutional Buyers.
- Business and industry outlook - The company's competitive position, growth strategy, and sector dynamics.
- Corporate governance - Promoter track record, board composition, and related-party transactions.
- Legal and compliance history - Pending litigation, regulatory actions, and disclosure compliance.
- Demand indicators - Anchor investor interest and early feedback from institutional investors during pre-marketing.
Types of IPO Underwriting
Underwriting arrangements can differ in the extent of risk the underwriter agrees to take on. The commonly referenced types include:
1. Firm commitment underwriting:
The underwriter agrees to subscribe to the entire unsold portion of the issue, effectively guaranteeing the issue size regardless of investor demand.
2. Best-efforts underwriting:
The underwriter agrees to use its best efforts to sell as many shares as possible but does not commit to purchasing the shortfall itself.
3. Standby underwriting:
The underwriter commits to purchasing only the shares that remain unsold after the public offering, acting as a backstop rather than a guarantor of the full issue.
4. Syndicate underwriting:
Multiple underwriters, a lead underwriter along with co-underwriters and syndicate members, share the underwriting commitment for a large issue, spreading the risk across several intermediaries.
The type of underwriting used, and the extent to which the issue is underwritten, is disclosed in the offer document and depends on the issue size, category of listing (mainboard or SME), and the issuer's negotiation with the lead managers.
In Indian book-built IPOs, the typical arrangement is that lead managers and syndicate members underwrite the unsold portion; the exact structure and extent of underwriting are disclosed in the offer document.
Who Are the Key Participants in an IPO?
An IPO typically involves several intermediaries working together, each with a distinct role:
- Issuer company - the entity raising capital through the public offer.
- Book Running Lead Manager (BRLM) - the principal merchant banker responsible for structuring, due diligence, pricing, and coordinating the entire process.
- Underwriters - entities that commit to subscribing to unsold shares, as described above.
- Syndicate members and registered brokers - intermediaries who help distribute the issue and collect bids from investors.
- Registrar to the issue - the entity responsible for processing applications and finalizing the allotment of shares.
- Legal counsel and auditors - professionals who verify disclosures and certify financial statements included in the offer document.
- SEBI and the stock exchanges - the regulator and listing venues that review the offer document and approve the listing.
Underwriter vs Lead Manager/BRLM
These two terms are often used interchangeably, but they are not identical.
The Book Running Lead Manager (BRLM) is the merchant banker appointed to manage the IPO from start to finish - preparing the offer document, coordinating due diligence, managing the book-building process, and liaising with SEBI and the stock exchanges. The BRLM is legally accountable for the accuracy and adequacy of disclosures in the offer document.
An underwriter, by contrast, refers specifically to the entity that takes on the contractual obligation to subscribe to unsold shares. In many Indian IPOs, especially book-built issues, the BRLM also acts as a lead underwriter, often with co-underwriters sharing the commitment. In other words, every BRLM typically performs an underwriting function, but not every underwriter carries the full range of responsibilities that a BRLM does.
What Happens If an IPO Is Undersubscribed?
Under Regulation 45 of the SEBI (ICDR) Regulations, 2018, a public issue must receive at least 90% subscription of the offer through the offer document. If this threshold is not met (even after counting any devolvement by underwriters), no allotment can be made, and the issuer must refund all application money within the timelines prescribed by SEBI.
Where the issue is underwritten, and a specific investor category falls short of subscription, the underwriters are obligated to subscribe to the shortfall themselves, up to the extent of their underwriting commitment. This is known as devolvement. It allows the issue to still reach the minimum subscription threshold without automatically triggering a refund, provided the underwriting commitments are sufficient to cover the gap.
If underwriting commitments are insufficient to meet the minimum subscription requirement even after devolvement, the issue is treated as undersubscribed, and application money is refunded to investors as per SEBI's timelines.
Hypothetical Example
Consider a hypothetical mainboard IPO of ₹500 crore, where the issuer has entered into an underwriting agreement covering the entire issue size. During the bidding period, the retail and non-institutional portions receive strong demand, but the QIB portion is only 80% subscribed.
Under the underwriting agreement, the underwriters responsible for the QIB portion would be required to subscribe to the remaining 20% themselves, provided the terms of the agreement extend to that category. This development ensures the issue still meets the minimum subscription requirement, allowing the listing to proceed as planned.
This example is illustrative only and does not represent any actual IPO, company, or transaction.
Why Is Underwriting Important?
Underwriting serves several purposes in the IPO ecosystem:
- Reduces execution risk for issuers: Companies can plan their capital-raising with more certainty, knowing that a shortfall in public demand will be absorbed up to the underwritten amount.
- Signals confidence to the market: When credible, SEBI-registered merchant bankers underwrite an issue, it reflects a degree of diligence and confidence in the offer's structure and pricing.
- Supports orderly price discovery: The due diligence and pricing input from underwriters helps ensure that the issue price reflects a reasoned assessment rather than an arbitrary figure.
- Protects the minimum subscription requirement: Underwriting, combined with devolvement, helps issues meet SEBI's minimum subscription norms, reducing the likelihood of a refund scenario that can disrupt an issuer's fundraising plans.
What Underwriting Does NOT Mean?
It is equally important to understand what underwriting does not guarantee:
- Underwriting does not guarantee listing-day gains or post-listing share price performance.
- Underwriting does not mean the underwriter endorses the investment merits of the company for retail investors.
- Underwriting does not eliminate market risk - share prices can still be volatile after listing, regardless of underwriting arrangements.
- Underwriting does not replace the need for investors to read the offer document and assess the issue on its own merits before applying.
- Understanding this distinction is important for anyone evaluating IPO investment opportunities on the share market; underwriting is a structural safeguard for the issue process, not a signal about future returns.
