Why companies are choosing the IPO route

3.8

01 Aug, 2021

9 min read

1515 Views

icon
You're hearing about all of these upcoming IPOs from brands that you know of and probably also use - Zomato, where you place your food orders; Paytm that you make payments with; Ixigo that you may have used for a travel booking… you probably also heard about the Burger King IPO last year.

In fact, beyond these names that you might recall or recognise, plenty of IPOs happen in a year. But what is an IPO and why do companies choose to host them?

An Initial Public Offering - abbreviated as IPO - is an offer to the public to become shareholders of the company. There are two broad reasons why a company might choose to host an IPO and within these, 4 possible goals; let's explore:

1. When companies host IPOs to raise capital

This is the main reason for companies to host an IPO. Within this, the need for capital might be prompted by a wide variety of goals and purposes. The commonest three among these are debt settlement, expansion & acquisition and managing corporate expenditure. Banks and Non Banking Finance Corporations additionally host IPOs to expand their capital base.

The best way to understand this is to observe a few recent and upcoming examples.

Goal #1 To expand one's capital base

Let's start with the banks - who often want to expand their capital base in order to fund future capital requirements:

  • Fincare Small Finance Bank is scheduled to host an IPO during 2021. In its Red Herring Prospectus, the bank has stated that the proceeds of the IPO will be used towards expanding its Tier 1 Capital Base in order to fund any capital requirements that arise in the future.
  • This isn't a "small banks only" objective of hosting an IPO. Another example is SBI Cards, that held an IPO last year, that is in 2020 that mentioned the same plan for IPO proceeds in its Red Herring Prospectus, that is to expand its capital base in order to meet future capital requirements.

Goal # 2: Debt settlement

Companies might also allow the public to become shareholders in exchange for capital that can get them out of the proverbial hot water.

However, a large chunk of potential investors might feel a bit wary of parking investment capital with a company that needs to be bailed out. They want their capital to grow after all - they don't want to play savior to some corporation. Companies will usually bundle in expansion plans or some other purpose for the IPO proceeds to make their IPO a more appealing investment proposition. Some companies however have so much brand recognition and (sometimes perceived, sometimes genuine) potential that they quite openly say that IPO proceeds will be used for debt settlement.

Have a look at these examples:

  • Pizza Hut, Costa Coffee and KFC's largest franchisee is a company called Devyani International. According to the company's Red Herring Prospectus, IPO proceeds will be utilised to fund corporate expenditures and also for debt settlement. 
  • Go Airlines with its widely recognised name,  openly stated in its Red Herring Prospectus, that IPO proceeds devoted to debt settlement. It is common knowledge to the common man that airlines bleed money and take up huge debts. 
  • There is a pharma company, called Supriya Lifesciences, that also recently applied for an IPO. Very much like Devyani International, their Red Herring Prospectus mentioned that IPO proceeds would be divided up between debt settlement and for funding capital expenditure.

Goal # 3: For expansion & acquisition

Companies might be doing fairly well, but in order to do even better they might need to make a huge investment. The company might choose to pump existing profits into the current business and might want investor capital to fund expansion.

A good example of this is Zomato. The food delivery service provider in its Red Herring Prospectus mentioned that three quarters of  IPO proceeds would go towards expanding the business.

2. When companies host IPOs to allow initial investors and promoters to exit

This also doubles up as goal number 4.

Goal # 4: OFS for existing investors

Some IPOs include an Offer for Sale and others are entirely Offer for Sale. Why would investors want to back out? Is it a bad omen?

Not necessarily: the investors might have other priorities, might have met their targets, might want to diversify … it could be anything. These are private equity investors - maybe they found some other exclusive, exciting opportunity to put their capital into.

For example: 

The much talked about upcoming Paytm IPO is reportedly going to be for an amount of USD 3 billion, out of which USD 1.6 billion will be an OFS by existing promoters and shareholders who are ready to exit.

The small finance bank that we referred to earlier - Fincare Small Finance Bank - is largely OFS. Of the Rs 1330 crore IPO amount, the larger chunk of Rs 1000 crore will be an offer for sale.

CAMS held an IPO in 2020 that was entirely OFS. It was specified in CAMS' Red Herring Prospectus that the entire proceeds of the IPO would be devoted to selling shareholder NSE investments, giving them the opportunity to exit.

If you intend to invest in an IPO, you must definitely: 

  1. Go through the company's financial track record
  2. Study the company's Red Herring Prospectus in detail and watch for red flags like pending legal cases etc 
  3. Track news and public sentiment about the company online

Always remember to conduct sufficient research and take appropriate precautions when investing. Read our other blogs to develop your understanding of the stock market.

That said, risk is a given in any stock market investment - IPOs included. There is no guarantee of which direction the stock price will move, once the company is listed on the stock market. There is also no guarantee at what rate a price increase - if any - will progress. Always consider your risk appetite and investment horizon before investing.

FAQs

Is IPO a profitable investment? 

There is no way to guarantee whether a stock market investment will be profitable. Investors need to study each IPO-hosting company individually to determine whether the company displays potential for growth.

Is IPO more risky or less risky than buying stocks on the open market? 

There is no way to make such a comparison as risk depends on the company and the ability to accept that risk, depends on the investor. However, companies already listed do have historical stock prices that can be used to evaluate potential. Additionally, when purchasing shares on the open market, the investor had the option of setting  a stop loss, that sells off his shares if prices fall below the set stop loss amount. This option does not exist in an IPO.

How would you rate this blog?

Comments (1)

R c

30 Jul 2021, 06:22 PM

Good effort to elaborate

Add Comment

Related Blogs

  • icon

    Income Tax in India -...

    02 Oct, 2021

    7 min read

    READ MORE
  • icon

    Should you invest in the Paytm IPO?

    31 Jul, 2021

    9 min read

    READ MORE
  • icon

    LIC Seeks to Appoint CFO

    13 Oct, 2021

    6 min read

    READ MORE
  • icon

    Margin Trade Funding (MTF)

    21 Aug, 2021

    8 min read

    READ MORE
  • icon

    Options Trading Explained:...

    01 Oct, 2021

    8 min read

    READ MORE
  • icon

    The Success Story of Pharmeasy

    08 Jul, 2021

    10 min read

    READ MORE
  • icon

    Tax free Interest Income in India

    22 Aug, 2021

    6 min read

    READ MORE
  • icon

    Byju’s IPO Plans

    06 Oct, 2021

    5 min read

    READ MORE
  • icon

    Trading Strategy for...

    24 Jul, 2021

    11 min read

    READ MORE
  • icon

    All About Commodity Market In India

    25 Jul, 2021

    12 min read

    READ MORE
  • icon

    IPO Advantages and Disadvantages

    03 Oct, 2021

    7 min read

    READ MORE
  • icon

    Top 10 Cryptocurrency to...

    12 Jul, 2021

    10 min read

    READ MORE
  • icon

    What is Guerrilla Trading?

    01 Nov, 2021

    7 min read

    READ MORE
  • icon

    Clean Science, GR...

    23 Aug, 2021

    6 min read

    READ MORE
  • icon

    Pair Trading Logic

    26 Aug, 2021

    6 min read

    READ MORE
  • icon

    How are Dividends on Stocks Taxed?

    29 Jul, 2021

    8 min read

    READ MORE
  • icon

    Success Story of Jeff...

    27 Jul, 2021

    9 min read

    READ MORE
  • icon

    Success Story of Elon...

    28 Jul, 2021

    9 min read

    READ MORE
  • icon

    All you need to know about...

    16 Jun, 2021

    8 min read

    READ MORE
  • icon

    Go Air IPO: Go Air looks...

    11 Jul, 2021

    11 min read

    READ MORE
  • icon

    What is CMP in the Stock Market?

    20 Jul, 2021

    8 min read

    READ MORE
  • icon

    Success Story of Paytm -...

    02 Aug, 2021

    10 min read

    READ MORE
  • icon

    What are ELSS Funds?

    20 Aug, 2021

    8 min read

    READ MORE
  • icon

    Warren Buffett's Portfolio...

    26 Jun, 2021

    9 min read

    READ MORE
  • icon

    Should you Invest in the...

    30 Aug, 2021

    7 min read

    READ MORE
  • icon

    What is Momentum in Stock Trading?

    26 Jul, 2021

    9 min read

    READ MORE
  • icon

    Taxation on Mutual Funds

    04 Oct, 2021

    6 min read

    READ MORE
  • icon

    Ixigo IPO: Ixigo Plans a...

    07 Jul, 2021

    10 min read

    READ MORE
  • icon

    What is Capital Gain Tax...

    30 Jul, 2021

    11 min read

    READ MORE
  • icon

    IPO Alert! Devyani...

    09 Jul, 2021

    9 min read

    READ MORE
  • icon

    Success story – Anil Ambani

    23 Sep, 2021

    6 min read

    READ MORE
  • icon

    Laurus Labs Share: More...

    23 Jul, 2021

    8 min read

    READ MORE
  • icon

    OYO Success Story:...

    22 Jul, 2021

    8 min read

    READ MORE
  • icon

    Simple trading strategies...

    06 Jul, 2021

    9 min read

    READ MORE
  • icon

    The Success Story of Jack...

    22 Oct, 2021

    5 min read

    READ MORE
  • icon

    The buy-and-never-sell...

    27 Jun, 2021

    8 min read

    READ MORE
  • icon

    Introduction of Artificial...

    10 Jul, 2021

    8 min read

    READ MORE
  • icon

    Stocks to Watch: NMDC,...

    24 Aug, 2021

    5 min read

    READ MORE
  • icon

    Things to know before...

    30 Jun, 2021

    9 min read

    READ MORE
  • icon

    Forex Trading: A Beginner's Guide

    27 Aug, 2021

    6 min read

    READ MORE
  • icon

    Double Taxation Hangs On...

    01 Dec, 2021

    8 min read

    READ MORE
  • icon

    Indian Railways Share...

    24 Sep, 2021

    7 min read

    READ MORE
  • icon

    How to make money in the...

    29 Jun, 2021

    9 min read

    READ MORE
  • icon

    Gold Bond Investment in India

    07 Oct, 2021

    6 min read

    READ MORE
  • icon

    Commodities Trading: An Overview

    25 Aug, 2021

    9 min read

    READ MORE
  • icon

    Blue Chips Fuel Record

    25 Oct, 2021

    6 min read

    READ MORE

Translate the power of knowledge into action. Open Free* Demat Account

* T&C Apply

Latest Blog

Get Information Mindfulness!

Catch-up With Market

News in 60 Seconds.


The perfect starter to begin and stay tuned with your learning journey anytime and anywhere.

Visit Website
smartbuzz_logo smartbuzz_promotion_img

Get Information Mindfulness!

Catch-up With Market

News in 60 Seconds.

smartbuzz_logo

The perfect starter to begin and stay tuned with your learning journey anytime and anywhere.

smartbuzz_promotion_img

Ready To Trade? Start with

angleone_itrade_img

Subscribe to #SmartSauda Newsletter

Open an account