Beyond IPOs: Other mechanisms to raise money from stock market and how can investors take part

In the previous chapters of this module, we saw the various ways in which a company can raise funds. We also took an in-depth look at how a company utilises the Initial Public Offering (IPO) process to gain access to capital from the public.

That said, an IPO is not the only way in which a company can raise funds from the public. So, in this chapter, we’ll be delving into 4 other mechanisms that can be used by a company to raise capital from the stock market. And, we’ll also briefly look at how you, as an investor, can participate in these processes.

Follow-on public offer (FPO)

A follow-on public offer is very similar to an IPO. The only difference between the two is in the timing of the issue of shares. As you already know by now, when a company issues its shares to the public for the very first time, the issue is termed as an IPO. Any further issues of shares to the public after the IPO are all termed as follow-on public offers. There’s actually no limit to the number of public issues of the shares of a company. 

So, an FPO is effectively a fresh issue of shares by a company that’s already listed on the stock exchange. It is done to acquire additional capital. However, since the company issues fresh shares in the FPO, the issue tends to dilute the ownership and control of the existing shareholders. It also has the capacity to reduce the earnings per share. 

The process for issuing an FPO is very similar to that of issuing an IPO. A company again enlists the services of lead managers and other associated parties, just as we already discussed in the previous chapters. It also has to go through the entire process all over again. Right from the drafting of the red herring prospectus and getting it approved from the SEBI and stock exchanges down to the marketing and the book building process - it’s the same routine all over again.

As an investor, how can you take part in an FPO? 

This is probably the question that you’ve been itching to ask, right? Whether you opt for applying for an FPO through the ASBA facility or through your trading account, the process is exactly the same as that for an IPO. 

FPO: An example

The public offer of Yes Bank that opened for subscription on the 15th of July, 2020 is the perfect example of an FPO. The shares of Yes Bank were already trading on the stock exchanges when the company decided to issue more shares to the public to fund its capital requirements. Here’s a brief look at some of the important details of the FPO.   

Here’s another fact. The FPO issue of Yes Bank was under-subscribed with the company only receiving bids for 95% of the total issue size. In such a situation, the book running lead managers to the issue would come to the rescue and underwrite the remaining unsold portion (5%) of the issue size. 

Rights issue

Another easy way in which a company can raise funds is through a rights issue of shares. Here, the company doesn’t approach the general public, but rather, its own existing shareholders. As the name itself signifies, a rights issue gives the existing shareholders the right to purchase additional shares of the company at a discounted price that’s lower than the current market price. 

Generally, the number of shares issued through a rights issue tends to be on a proportionate basis to the existing holdings of shares. For instance, in a 1:2 rights issue, a shareholder gets to purchase 1 share for every 2 shares held in the company. A major advantage of this method is that the process is far easier than an IPO, with less regulatory approvals involved.  

However, it is not without drawbacks. The primary disadvantage of a rights issue is that it limits the scope of fundraising since only the existing shareholders can subscribe to the shares issued by the company. Also, there’s always a risk of the shareholders choosing not to exercise the right to buy additional shares of the company, in which case, the company either fails to raise any funds or collects funds that are way below the target. The secondary drawback that a rights issue has is that it dilutes the ownership and control of the existing shareholders, since fresh shares are created and issued. 

As an investor, how can you take part in a rights issue? 

Participating in a rights issue of shares requires you to be an existing shareholder in the company. If you satisfy this criteria, there you can adopt any one of the three following ways to invest in the issue. 

• Through the ASBA facility provided by your bank
• Through the trading account that you hold with your stockbroker
• Through the website of the Registrar & Transfer Agent (RTA) of the company 

Rights issue: An example

The recent rights issue of shares by Reliance Industries that opened on the 20th of May, 2020 is the ideal example of a rights issue. The company decided to issue around 42.26 crore equity shares to its existing shareholders on a 1:15 ratio. This effectively meant that existing shareholders could buy 1 equity share of Reliance Industries for every 15 shares held by them. Here’s a brief look at some of the important details of the rights issue.

 In an amazing turn of events, the rights issue of Reliance Industries was exceptionally well-received by its existing shareholders and was completely subscribed. The company defied all odds and managed to raise the entire Rs. 53,124.2 crores with 2 days to spare.   

Bonds issue

Till now, we’ve only been looking at ways in which companies can raise capital for their operations through equity. However, some companies that wish to prevent dilution of ownership and control prefer to raise capital through debt. Companies that wish to take this route may do so by issuing bonds or debentures. The capital that is raised via the issue of bonds is generally treated as a type of loan that a company avails from the public. 

This is how it works. An investor agrees to invest a portion of his money in the company for a specified period. The company, in return for the investment, pays a predetermined rate of interest on the principal amount till the date of maturity. Upon reaching the maturity date, the company then returns the principal amount back to the investor.   

One of the main advantages of raising capital through bonds is the cost associated with the issue. Bonds issues are much more cost-effective than equity. However, there’s also a drawback. Since the capital raised through this method is essentially a loan, the company has to strictly adhere to the repayment schedule. Any default in the interest payments can prove to be very costly for the company. Also, at the end of the specified period, there’s the repayment factor that has to be considered.

With respect to bonds issue, the most popular form preferred by companies in India is the issue of non-convertible debentures (NCDs). An NCD is a corporate bond that comes with a fixed rate of interest and tenure and is very similar to a bank FD. NCDs are typically rated by credit rating agencies according to the quality and the stability of the bond and the company.  

As an investor, how can you take part in a bonds issue? 

A company that wishes to issue bonds typically does so via a public issue. Subscribing for the debentures of a company is almost similar to subscribing to an IPO. Since debentures are now held electronically, you’re required to possess a demat account. Once you’ve set up your demat account, you can proceed to invest in an NCD through either of the following two ways. 

• Through the ASBA facility provided by your bank
• Through the trading account you hold with your stockbroker

Similar to equity shares, NCDs are also listed on the stock exchange after they’re issued and subscribed. So, even if you’ve missed the initial public issue of debentures, you can simply pick them up from the secondary markets just like you do for shares.

Bonds issue: An example

A very good example of a bonds issue is the Tata Capital Housing Finance Limited’s NCD issue on January 07, 2020. The company issued non-convertible debentures worth Rs. 500 crores. The NCD issue offered by Tata Capital Housing Finance possessed flexible tenures ranging from 36 months to 120 months. Here’s a brief look at some of the important details of the bonds issue.

Here’s another fun fact for you. The NCDs of Tata Capital Housing Finance Limited were listed on both the BSE as well as the NSE after the initial public issue. 

Bonus read: Offer for sale (OFS)

Apart from an IPO, an offer for sale (OFS) is another method by which the promoters of the company can sell their shares to the public. Here, the promoters or initial investors of the company are the ones selling their shares, and not the company itself. Therefore, the proceeds from the sale of such shares do not go to the company, but rather to the entities putting them up for sale. A major benefit of OFS is that there is no dilution of ownership or control since the shares that are being sold are not freshly issued. Rather, they are owned by the initial investors. 

Here’s a fun fact for you. The OFS route of selling shares to the public was introduced by SEBI very recently, in the year 2012. 

The OFS process provides the promoters with a way to exit the company that they’ve invested in by selling their shareholdings. A dedicated window is created by the stock exchanges to enable the sale. This route is most preferred by promoters intending to sell out their stake since the process is far simpler and doesn’t require too many approvals or the satisfaction of stringent requirements. However, there’s a slight drawback to this method. The OFS option is made available to only the top 200 companies (based on market capitalisation) in the share market. 

Unlike an IPO or an FPO, an offer for sale does not consist of a price band. Instead, it comes with a floor price. And investors intending to buy the shares can place bids at or above the floor price. The cut-off price is then calculated after the end of the OFS. The price point at which the maximum number of bids are received is generally chosen to be the cut-off price. 

As an investor, how can you take part in an OFS? 

Buying shares through the OFS of a company would require you to possess a demat account and a trading account with a stockbroker. Since this is not a fresh issue of shares, you cannot apply for an offer for sale through either the offline mode or through the ASBA facility. You need to log into your trading account and place your bids for an OFS just like how you would do for an IPO. 

OFS: An example

The recent offer of GTPL Hathway Limited that opened for subscription on the 28th of February, 2020 is a great example of an offer for sale. The promoter of the company (Jio Content Distribution Holdings Private Limited) decided to reduce its stake in the company by 3.83% by offering the shares held by it for sale. Here’s a brief look at some of the important details of the OFS.   

Wrapping up

We’ve finally come to the end of the chapter. We learnt so much about the way companies utilise the stock market to raise funds for their operations. In the next chapter, we’ll take a look at one of the most important and fundamental accounting concepts - the going concern principle. As always, keep reading.   

A quick recap 

• When a company issues its shares to the public for the very first time, the issue is termed as an IPO.
• Any further issues of shares to the public after the IPO are all termed as follow-on public offers. 
• An FPO is effectively a fresh issue of shares by a company that’s already listed on the stock exchange. It is done to acquire additional capital.
• An FPO tends to dilute the ownership and control of the existing shareholders. It also has the capacity to reduce the earnings per share.
• In a rights issue of shares, the company doesn’t approach the general public, but rather, its own existing shareholders.
• A rights issue gives the existing shareholders the right to purchase additional shares of the company at a discounted price that’s lower than the current market price.
• The number of shares issued through a rights issue tends to be on a proportionate basis to the existing holdings of shares.
• For instance, in a 1:2 rights issue, a shareholder gets to purchase 1 share for every 2 shares held in the company.
• The rights issue process is far easier than an IPO, with less regulatory approvals involved.
• The primary disadvantage of a rights issue is that it limits the scope of fundraising since only the existing shareholders can subscribe to the shares issued by the company. 
• Some companies that wish to prevent dilution of ownership and control prefer to raise capital through debt. 
• Companies that wish to take this route may do so by issuing bonds or debentures. The capital that is raised via the issue of bonds is generally treated as a type of loan that a company avails from the public. 
• With respect to bonds issue, the most popular form preferred by companies in India is the issue of non-convertible debentures (NCDs). 
• An NCD is a corporate bond that comes with a fixed rate of interest and tenure and is very similar to a bank FD. 
• NCDs are typically rated by credit rating agencies according to the quality and the stability of the bond and the company.  
• An offer for sale (OFS) is another method by which the promoters of the company can sell their shares to the public. 
• Here, the promoters or initial investors of the company are the ones selling their shares, and not the company itself.   
• A major benefit of OFS is that there is no dilution of ownership or control since the shares that are being sold are not freshly issued.
• The OFS process provides the promoters with a way to exit the company that they’ve invested in by selling their shareholdings.
• The OFS option is made available to only the top 200 companies (based on market capitalisation) in the share market.