2020 was a great year for Initial Public Offering (IPO) debuts. It saw the likes of Mrs Bector, Burger King, Happiest Minds in the Indian stock markets leading to a great amount of confidence building in the Indian start-up scene. If the buzz in Silicon Valley is to be believed, then at least 10 Indian start-ups like Zomato, Delhivery, Policybazaar, Freshworks, Flipkart, Nykaa, BYJU’S, etc could go public in the next 2-3 years. For most start-ups, IPO seems to be their de facto objective.
The Indian government is in the process of easing overseas listing norms for domestic companies. India’s market regulator Securities and Exchange Board of India (SEBI) has also set up an Innovators Growth Platform (IGP), and has introduced a consultation paper seeking feedback for new rules. This step is likely to encourage more and more start-ups to head for IPO. And more the number of IPOs being issued, better the signs of the stock market and the economy doing well.
The more number of IPOs being issued, is an indicator of stock market and the economy doing well.
What is an Initial Public Offering?
Simply put, an Initial Public Offering (IPO) is the first time that the stock of a private company is offered to the public for purchase. More often than not, IPOs are issued by smaller companies seeking more capital and grow further. IPO is considered a way for small companies to generate the capital required to expand. Sometimes, they are also done by larger private firms looking for trading publicly. Whether it’s in order to expand for an established company or a nascent company trying to generate more revenue, the bottom line is that companies seek an IPO to raise money.
At Bengaluru Tech Summit 2020, even Sequoia Capital India’s managing director Rajan Anandan is known to have called 2020 a big year for start-ups in India. The best form of exit for the promoters and investors in start-ups is through the IPO route as the stock market will test the strength of these companies, he said. “However, the goal of the start-up is to create an enduring company which is also very valuable and interesting.”
Typically, a firm launches an IPO when it reaches a stage where it’s difficult for it to expand using private capital.
The Process and the Purpose of Initial Public Offering
The process of an IPO known as “going public” in common parlance. Due to a lack of historical data on whether a company will perform well or not, investing in an IPO can be full of risk for an investor. However, it’s an opportunity to become shareholders in the company and earn dividends if the company profits for an investor.
There are two key purposes for launching an IPO. The first one is to raise capital and the second one is to boost prior investors. When a firm goes public, it gets access to a host of investments possible. And that is almost always way more capital than what firms can get through private shareholding or venture capitalists.
IPOs are generally known to have volatile opening day returns. This can attract investors looking to benefit from the discounts available. But it’s a different picture in the long term. Over the long-term, an IPO’s price settles into a steady value.
An IPO requires a certain process to be undertaken by the issuing company with the help of an underwriting firm. The first step is to determine the type of security to issue, what is the best offering price, the number of shares to be issued, and the right time to bring it to the market. There are other nuances to be kept in mind for each of these steps. For example, IPOs are often under-priced to ensure that the issue is fully subscribed/oversubscribed by the public investors. The investors of an IPO expect a rise in share prices on the offer day in case it is under-priced. It increases the demand for the issue.
There are a number of metrics for judging a successful IPO process and its performance. An IPO is considered to be successful if the company’s market capitalisation is equal to or greater than the market capitalisation of its competitors in the industry within 30 days of the initial public offering. If this doesn’t happen, then the performance of the IPO is in question. Another way to determine whether an IPO is successful is to look at its market price. An IPO is considered to be successful if the difference between the offering price and the market capitalisation of the issuing company 30 days after the IPO is less than 20%.
Companies planning to go for an IPO also need to look at the criteria for listing, its advantages and disadvantages beforehand. According to Bombay Stock Exchange, the start-up platform will facilitate the listing of companies in sectors such as IT, ITES, biotechnology and life science, 3D printing, space technology, ecommerce, hi-tech defence, drones, nano-technologies, artificial intelligence, big data, virtual reality, e-gaming, exoskeleton, robotics, holographic technology, genetic engineering, variable computers inside body computer technology, and any other hi-tech company. Here are some of the key advantages and disadvantages that can help you decide better:
Advantages of going public
There are a host of reasons behind a company’s decision to go public. It could range from the company getting cheaper access to capital to improving the credibility of the company.
A private company finances its operations through private funds from its shareholders, investors, venture capitalists, etc. But it needs a constant infusion of capital to keep growing and scaling up and only private funds aren’t always enough. Banks are an obvious first choice but that also comes with a limit cap. Then, the only other option is to go public and it goes a long way in ensuring that the company has enough funds to keep going.
Helps gauge the market worth of the company
Listing your company’s stick on the exchanges can help access its market worth. There’s a simple way how this happens. When a stock is listed, it is worth what an investor agrees to pay for it. If the company has a good market worth, it can attract better investment which can in turn provide better opportunity for future acquisitions and/or mergers. Hence, an IPO can provide a great insight into the company’s market worth.
Makes the company look more credible
When a company is listed on stock exchanges, one can be assured of the fact that there will be transparency of financial data and this helps increase the credibility of the firm in the eyes of the company. Regulatory body SEBI mandates that all listed companies must report all financial data in a periodical manner. It is often observed that the company that’s listed follows better management practices and its credibility tends to improve once it’s listed.
More business opportunities
The primary reason why a company decides to go public is to raise capital easily and quickly by having access to a larger number of investors. This cash can further be used to scale-up your business and push it further by making significant investments in research and development, human resource, infrastructure, marketing, etc. It is also a way for lesser known and relatively newer entities to form a good public image. It can also help growth-stage companies to attract a fresh pool of talent by offering them perks in the form of stock options.
Mergers and acquisitions become easier
And IPO and also help with mergers and acquisitions. Whenever, a publicly-traded company enters into a merger or an acquisition, say, with a smaller competitor, the terms and conditions of that deal usually include its shares as well. This helps in making the process of cash flow more effective, smooth and uncomplicated.
The primary reason why a company decides to go public is to raise capital easily and quickly by having access to a larger number of investors.
Disadvantages of going public
Listing on stock exchanges is not a cakewalk. When a company decides to go public, it’s hardly a box of roses. There are a huge number of downsides as well.
There is a huge amount of initial cost involved while launching an IPO. These include underwriting charges, registration fees, advertising costs, legal fees, accounting costs, etc. to name a few. There’s also an extra cost of manpower. The company needs a special resource that is an expert in the IPO process. This adds to the overall cost of launching an IPO which is already pretty high. Not just that, there’s a significant legal, accounting, and marketing cost that arise and are not one-time but an ongoing affair.
One of the major drawbacks of turning into a public-listed company is that it is now required to follow certain standards mandated by a regulatory body and this increases its compliance requirements. Some of these compliance requirements include things like conducting audits regularly and publishing financial reports every quarter. This not only leads to increased auditing costs and hiring a specialised workforce but also ensures that all regulatory requirements are met and this process can prove cumbersome. There is also an increased risk of legal or regulatory issues, for example, private securities class action lawsuits.
A fundamental difference between a private company and a publicly-listed company is control. The shareholders of a private company have more autonomous power and control over the operations of the business whereas, that control is lost as soon as the company goes public. Even if the majority shareholding is within the company, the minority shareholders can also influence a lot of decisions.
Counter-productive in the long-term
Why do investors buy shares of a company? The obvious answer is that they want it to perform well and make money off them. More often than not, this leads to them wanting a good return on investment keeping a short-term view of profit in mind. This can prove to be counter productive when it comes to the long-term view of the performance of the company. The company is forced to look at its short-term growth and if it fails to do so, then it could drive the stock prices down which may also impact overall sales and revenue.
While an IPO can let you be more transparent, it can also help your competition gain an insightful knowledge about your operations and finances. Since the company is mandated by a regulatory body to disclose information related to finances, taxation, accounting, etc., it may also sometimes end up revealing trade secrets and business methods that could help completion study your company and change their business plans accordingly.
Stock price of a company may or may not be reflective of its real financial results of the company. Hence, the fluctuation in the prices of a company’s share can prove to be a major distraction for the company and its shareholders. It is important to maintain that distinction by the management once the IPO goes through. In conclusion, there are many advantages and disadvantages of going for an IPO. It depends on the company’s long-term goal and vision of what it wants to go for. Whenever a company is going for an IPO, it’s management should realise that it’s not an easy investment of time and money. Generally, an IPO can take anywhere from 6-9 months and even longer. The management also needs to make sure that other areas of the business don’t suffer when it’s focussed on the IPO. The management also needs to be comfortable with the fact that shareholders gain a significant ownership stake in a company once a company goes public and they may also sometimes override decisions taken by the management.
An initial public offering can also be a significant exit opportunity for stakeholders, which can allow them to get cash in return. At the very least, they would be able to liquefy the capital that is tied up in the company. An IPO may or may not be the right trajectory for the company. It is imperative to measure all advantages and disadvantages before taking a final call on considering an IPO.