IPO Basics

IPO Basics

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

The history of modern IPO dates back to March 1602, when the Dutch East India Company¹ made a debut by offering its shares to the public to raise funds.

Why a Company Issues IPO Shares?

A company issues an IPO for a variety of reasons. Let us have a look at each of them in detail:

1. Raise Capital

   One of the main reasons behind launching an IPO is to raise capital for its expansion, growth, repayment of debts, and prospects.

   A company needs funds at each stage of its business life cycle. It cannot directly launch an IPO as soon as it begins operations. A company goes through various funding stages for its capital requirement before going public.

   Funding stages in the life-cycle of a company:

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

   Once the above funding sources get utilized, a company opts to issue an IPO over any other funding source on account of the below reasons:

   • Angel Investors would 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 added 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 in an IPO through OFS. It helps the early investors/promoters exit from the company and options to look for other opportunities.

3. Business expansion

   A company needs capital to expand its business and finance other projects. An IPO helps a company raise a lot of money required for the growth of the business.

4. Repay loan

   Some companies may have heavy loans. Taking more debt to clear the existing ones would mean additional interest and repayment burden. The IPO proceeds can help a company cut down its debt levels where there is no worry about capital repayment.

5. Enhanced credibility

   An IPO gives publicity to a company through media coverage. IPO enhances the brand image of the company. A listed company is required to maintain transparency in its business and operations. If the company's performance and prospects are bright, it enhances the credibility and visibility of the company.

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

• IPO helps a company raise a huge amount of fundsto finance its growth, expansion, capital expenditure, repayment of loans, and much more.
• IPO provides an exit route for the promoters and early investors.
• IPO is a low-cost capitalraising option as the companies do not have to pay any interest on the funds raised from the general public nor have to return the capital raised.
• Public companies get easy access to financecompared 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 enhances the company's visibility and recognition and helps build a brand imagefor the company.
• IPO increases the prestige of employees and boosts their confidence in the company. It helps retain employees and also attracts new staff.
• IPO enables the correct valuation of the company.
• IPO inculcates 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 charges to apply for an IPO, unlike when one purchases shares from the secondary market where one needs to pay brokerage and regulatory fees.
• IPO application is a simple, easy, and hassle-free process.
• By applying for IPO, investors get an opportunity to be a part of profitable and growth prospective companies.
• IPO offers a chance to earn handsome and quick rewards in the case of premium listing or allows wealth creation in case of long-term investment.
• Stringent IPO Norms make IPO markets more professional and safer.
• The Red Herring Prospectus (RHP) issued for the IPO has all the required details of the company that helps investors make an informed decision.
• In case of successful allotment, investors become company's shareholder. Shareholders could participate in certain corporate action matters and elect members to the board of directors by voting rights.

3. IPO Disadvantages for the company

• Launching an IPO is a time-consuming process as it takes lots of time and effort from the management.
• Though IPO is a low-cost capital raising method, it can turn out to be expensive based on the cost of the investment banker, lead manager, and underwriters.
• IPO can lead to dilution of ownership among various shareholders which was earlier restricted to a few promoters and investors.
• A company launching IPO becomes liable to do regular regulatory filing with required disclosures. It adds to the administrative cost for the company as the firm needs to hire a team to monitor and complete these tasks.
• By going public, the firm becomes accountable to its investors and thus needs to maintain investor relations and expectations.

4. IPO Disadvantages to Investors

• Investors do not have any background of the company launching IPO as it is a new company coming into the public for the first time. An investor needs to go through the entire RHP to know all the company details.
• An investor can face losses in the case of discount listing when applied with an aim of quick returns (listing gain).
• There is no guaranteed allotment in an IPO in case of oversubscription.

IPO Types (Mainline IPO and SME IPO)

An IPO is classified either as a Mainline IPO or an SME IPO based on the post-issue paid-up capital of the company.

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 satisfies the required IPO eligibility criteria of SEBI.

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

2. SME IPO

An SME IPO is an IPO by Small and Medium Enterprises or startups. The post-issue paid-up capital of SME IPO should not be more than Rs 25 crores.