Initial Public Offering, or IPO, is a company’s attempt to sell its shares and securities to retail and institutional investors, resulting in the company getting listed on the stock exchange. After an IPO is concluded, the publicly offered stocks of the company get listed on the stock exchange and are publicly owned and traded.
Why do Companies Offer Stocks to the Public?
Before an IPO, the shares of the company are owned by the promoters and private equity investors. By offering a percentage of the shares to the public, the promoters and investors effectively sell their stake in the company. The primary reason for launching an IPO is to raise capital. The intention of raising capital can, in turn, be due to a variety of reasons.
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Why Companies Raise Capital Through IPOs?
Companies raise capital through IPO for one or more of the following reasons:
Improve financial position -
With the fresh capital raised through IPO, the company receives substantial liquidity in its books. This is utilized to finance the future growth of the company. With strengthened finances, the company appears stable to lenders and can negotiate better loan terms.
Liquidity for the investors and promoters -
Existing stakeholders, like company promoters and private investors, may wish to liquidate their stake in the company. They can propose an IPO so that they can sell their stake in the company, partially or fully. This process is called an Offer for Sale by the current stakeholders.
Liquidity for employees -
Employees of an unlisted company may be holding shares received under stock options. In the absence of a market, they may not be able to sell their holdings. With an IPO, the company enables its employee shareholders to sell their stakes in the stock market at a fair market price.
Price Transparency -
Once the stocks of the company are listed, the market demand and supply play their role and make the price of the share more transparent. The share price of a privately held company may not have the same price transparency.
Reducing existing debts -
Many companies opt for an IPO to utilise the IPO proceeds to reduce their existing debts. By clearing off debts, the company can bring in fresh working capital and improve its financial position.
Business Expansion -
With the fresh capital raised, a company can finance its expansion plans. Companies expand their product line, invest in research and development, increase their market presence through new offices and retail stores, etc.
Merger and acquisition -
Another way to expand a company’s business is to acquire other companies with growth potential. Companies can use the capital raised through IPO to undertake mergers and acquisitions of other companies.
Brand image and visibility -
IPO is a big event in the financial market, and is watched closely by investors and market watchers. It gives visibility to the company and its products. The IPO process must follow strict SEBI guidelines and regulations. So, the IPO also increases the credibility of the company.
A company launching an IPO must submit a Red Herring Prospectus with SEBI. Among other things, this document discloses the fund utility plan of the company once it receives the IPO proceeds. If you plan to invest in an IPO, make sure you have a look at the prospectus. Apart from the utilization plans of the company, you will know more about the company's financial strength, market presence, performance and growth over the years, and all other necessary details about the company.