IPO grading is made mandatory for all unlisted companies wishing to come for public issue. IPO grading process is compulsory by amending SEBI (Disclosure and Investor Protection) Guidelines 2000. The purpose of such step is to provide investors additional information to assess company fundamentals before investing.
IPO grading means relative assessment of company by Credit Rating Agencies (CRA) like CARE, CRISIL who are registered with SEBI for this purpose. Grading by CRA’s represents relative assessment of fundamentals of IPO in comparison to other listed securities in Indian stock exchanges. Issuer has option to choose CRA as per their choice. They can opt for IPO grading from more than one agency. But 
minimum rating from one agency is mandatory. Moreover, if they opt for grading from more than one agency, ALL such grades with justification given must be published in prospectus, abridged prospectus, issue advertisements and in all other places where the issuer is advertising for the IPO.
Credit Rating Agencies assess the issue, in a scale of 1 to 5 based on the fundamentals of the company coming for IPO. This rating is valid for one time during the Initial Public Offer and should not be used on forever basis as fundamentals keep changing with time. In the scale of 1 to 5, 1 represents poor fundamentals and 5 represents Strong fundamentals.
IPO grading in the scale of 1 to 5 – what they mean?
Grade1 : Poor fundamentals
Grade 2 : Below Average fundamentals
Grade 3: Average Fundamentals
Grade 4: Above Average Fundamentals
Grade 5: Strong Fundamentals
It should be noted that IPO grading is only assessment of fundamentals and not a recommendation to subscribe or not for the IPO issue. It does not take price of the issue into consideration and does not make any assessment of price of the issue. So even if Grade 3 IPO with reasonable price may be a good choice for investors. At the same time if IPO is priced exorbitantly, even a Grade 5 may not be a wise choice in short term. In any case, in long term fundamentals play crucial role and this factor must be considered before investing. For investors looking for listing gains from IPO, this may not be a more reliable indicator to subscribe. As IPO grading gives indication how the company is performing fundamentally, Demand for the public issue gives better idea about possible listing gains.
In regard to disclosure of IPO grading issuer has no choice other than disclosing all grading whether they like them or not. All the expenses related to grading must be borne by issuer.
Download Amendments to SEBI DIP guidelines in pdf