As an informed investor, you must know various terms associated with the stock markets. This article discusses two such terms – spin-off and Initial Public Offering (IPO). Both these terms are related to the issuance of the shares of new companies. However, the difference lies in the process used to create a company and distribute its shares.
While you must have heard of the term “IPO” several times, spin-off might be a new concept. Let’s start by discussing the meaning of the two terms before moving on to their differences. Continue reading.
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When the shares of a private company are made available for public sale for the first time, it is known as an IPO. In other words, the IPO is the process through which a private company becomes public.
There are several reasons for companies to issue their IPOs. The primary reason is to raise capital from public investors and use it for the expansion of the business. The issuing company can also use IPO funds to clear its debts, manage day-to-day business operations, and meet general corporate requirements.
When a company plans to go public, it hires the services of an underwriter to analyze the financials and create a red herring prospectus (RHP). The RHP contains all crucial details about the offer, including the prospective price band, issue size, etc. It then approaches the Securities and Exchange Board of India (SEBI) to seek approval for the IPO.
Upon approval, the issuing company calls for bidding from investors. As an investor, you can bid for the IPO as per the price band within a specified time frame. After successful bidding, the requisite amount gets blocked in your bank account.
Once the bidding process is over, the issuing company determines the issue price of its IPO before allotting shares to eligible investors. If allotted, you will receive the shares in your Demat account, and the blocked amount in your bank account will get deducted automatically. In the case of non-allotment, your bank will remove the block.
The spin-off is a process through which an existing company gets split into two separate firms. After a spin-off, the parent company and the subsidiary become independent business entities and acquire dedicated management teams. Then, the new company's shares are distributed to the existing shareholders on a pro-rata basis in the form of a special dividend.
Thus, the parent company's shareholders benefit by acquiring shares of two companies without paying anything extra.
Usually, companies opt for the spin-off when it feels best to establish a separate entity to handle a profitable business. A spin-off can also help a company come out of a merger or an acquisition, where the requirements of the acquired company do not match the parent company’s core competencies.
Deciding to split into two separate firms is pretty much a company’s internal matter. It is not required to take approval from the SEBI or other regulatory authorities for this. The decision is taken after discussing with the company’s current stakeholders, promoters, and leadership team.
However, once a new company is formed, the parent company needs to follow the due procedure to allot the shares of its subsidiary to the existing shareholders.
By now, you must know the fundamental difference between an IPO and a spin-off. The table below depicts a thorough comparison between the two methods:
|Definition||When a company’s shares are issued for public sale for the first time, it is known as an IPO||When a company splits into independent companies, it is known as a split-off|
|Share distribution||Shares are given to investors who subscribe to the IPO||Shares are distributed to existing shareholders|
|Company status||A private company transforms into a public company||A public company divides into two separate public companies|
|Capital raised||Is used for business expansion||No capital is raised|
Hopefully, after reading this article, you have a clear understanding of the difference between an IPO and a spin-off. Companies use these strategies to issue shares to investors in different situations. If you haven’t yet invested in the share markets, you can do so worry-free with the help of a Motilal Oswal Demat Account.