IPO Basics

IPO stands for Initial Public Offering. In an IPO, a company offers its shares to the public for the first time via the primary market. A primary market, also known as a new issue market, is a place where securities are created or issued directly by issuers and made available for trading in the secondary market.

Common reasons for taking a company public

There are 3 main reasons why a company should go public:

1. The owners or investors of the company want to sell a significant stake and make money.
2. The company wants to raise fresh money to expand the business and build new production facilities.
3. The company wants to pay off accumulated debt and clean up its books.

Why does a Company Issues IPO shares?

A company issues an IPO for a number of reasons. Let us look at each of these reasons in detail:

1. Raising Capital

   One of the main reasons for IPO is to raise capital for expansion, growth, debt repayment, and for the future. A company needs capital at every stage of its life cycle. It cannot go public immediately after it is established. A company goes through various financing phases to meet its capital needs before going public.

   Funding stages in a company's life cycle:

   • Self-funding, funding from family and friends.
   • Angel Investors
   • Venture Capitalists
   • Private Equity Investors
   • Bank Loan

   When the above sources of funding have been exhausted, a company chooses an IPO over another source of funding for the following reasons:

   • Angel investors have already exhausted their capacity.
   • Raising more funds from Venture Capitalists or private equity investors would mean losing control over the company with the majority company stake going into their hands.
   • Taking a bank loan would mean an increase in debt for the company with the additional burden of interest and capital repayment.
2. Exit for early investors

   An IPO can be a Fresh issue, an Offer for sale (OFS), or a combination of both. The existing investors or promoters can reduce their stake in the company by selling their shares to the general public through an OFS. This makes it easier for the early investors/promoters to exit the company and seek other opportunities.

3. Business Expansion

   A company needs capital to expand its business and fund other projects. An IPO helps a company raise a lot of money to grow the business.

4. Repayment of loans

   Some companies may have large loans. Taking on more debt to pay off the existing ones would mean an additional interest and repayment burden. The proceeds from the IPO can help a company reduce its debt without having to worry about repaying the principal.

5. Enhanced credibility

   An IPO gives publicity to a company's profile through media coverage. IPO enhances the company's brand image. A listed company is required to be transparent about its business and operations. If the company's performance and prospects are good, this increases the company's credibility and name recognition.

IPO Advantages and Disadvantages

Like every coin has two sides, an IPO has pros and cons for the company and the investors.

1. IPO Advantages to the Company

• An IPO helps a company raise a large amount of funds to finance its growth, expansion, capital expenditures, repayment of loans, and more.
• IPO provides an exit route for the promoters and early investors.
• IPO is a cost-effective way to raise capital because companies do not have to pay interest on the funds raised from the public, nor do they have to return the capital raised.
• Public companies get easy access to finance compared to private companies. The reason is that public companies need to maintain transparency in their business operations which reduces the risk to lenders with all the information available for verification.
• IPO increases visibility and helps build a brand image for the company.
• IPO increases the prestige of employees and builds their confidence in the company. It helps to retain employees and attract new staff.
• IPO enables the correct valuation of the company.
• IPO encourages discipline in the management as the company is answerable to its shareholders for all their actions.
• By going public, a company gets to know the outsider's perspective. It helps them plan their actions for better prospects.

2. IPO Benefits to the Investors

• Zero cost investment , as there are no fees for applying for an IPO, unlike buying shares on the secondary market, where you have to pay brokerage and regulatory fees.
• Applying for an IPO is simple, easy and hassle-free.
• By applying for an IPO, investors get the opportunity to participate in profitable and high-growth companies.
• IPO offers the chance to earn high profits quickly in the case of a premium listing or allows wealth creation in case of long-term investment.
• Strict IPO norms make IPO markets more professional and secure.
• The Red Herring Prospectus (RHP) issued for the IPO contains all the necessary information about the company to help investors make informed decisions.
• In case of a successful allotment, investors will become shareholders of the company. Shareholders can participate in certain corporate actions and elect members of the Board of Directors through voting rights.

3. IPO Disadvantages for the company

• Preparing an IPO requires a lot of time from the promoters, management and employees of the company.
• Although the IPO is a low-cost method of raising capital, it can be expensive because of the fees payable to intermediaries and fund managers.
• The IPO may result in dilution of ownership among various shareholders that were previously limited to a few promoters and investors.
• A company conducting an IPO is required to file regulatory documents on a regular basis with the required disclosures. This increases administrative costs for the company , as it must hire a team to oversee and complete these tasks.
• By going public, the company becomes accountable to its investors and therefore must maintain relationships with investors and meet their expectations.

4. IPO Disadvantages for Investors

• Investors do not have any background information about the company doing the IPO as it is a new company going public for the first time. An investor has to go through the entire RHP to know all the details of the company.
• An investor may suffer losses in a discount listing if it is done with the goal of a quick return (listing profit).
• There is no guaranteed allotment in an IPO in case of oversubscription.

IPO Types (Mainline IPO and SME IPO)

An IPO is classified as either a Mainline IPO or an SME IPO based on the platform used by the issuer company for their IPO.

1. Mainline IPO (Mainboard IPO)

A Mainline IPO, also known as Mainboard IPO, is a regular IPO issued by large companies that have an extensive track record and meet the IPO eligibility criteria set by SEBI.

The minimum paid-up capital of a Mainboard IPO after the issue should be Rs 10 crores.

2. SME IPO

A SME IPO is an initial public offering of small and medium enterprises (SME) or start-ups. The post-issue paid-up capital of SME IPO should not exceed Rs 25 crores.