Why Do Companies Issue IPO?

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Why do companies issue IPO ie. Initial Public Offering? In this article, we will discuss key objectives and advantages of IPO. with examples.

Key Objectives & Advantages of IPO

Introduction

Why do companies issue IPO ie. Initial Public Offering? In this article, we will discuss key objectives and advantages of IPO. with examples. An initial public offering refers to the process of offering shares of a private corporation to the public in a new stock issuance.

Detailed Stock Analysis by Invest Yadnya
Detailed Stock Analysis by Invest Yadnya

Why Do Companies Issue IPO?

Lets discuss in detail the key reasons and advantages of issuing IPO with examples.

Why Do Companies Issue IPO?
Why Do Companies Issue IPO?

1. Raising Capital for Business

  • When companies require capital for new business or expanding existing business, primary source of funds is loans from Banks.
  • However, after raising funds from banks in the form of loans, interest is to be paid out to the banks.
  • In case of IPO, funds are raised from public. There is no commitment for any fixed interest payout to the shareholders of the company.
  • Profits are shared among the shareholders in proportion to the number of shares held by them.
  • There are 2 ways in which companies share the profits among its shareholders :
    1. Dividend Payout
    2. Capital Appreciation (Rise in share price on account of high earnings visibility and future growth potential of the company)
  • Thus, raising equity capital is the primary and foremost objective of issuing IPO.

2. Liquidity for Private Equity Investors

  • As we know, SBI cards IPO is coming soon. SBI Card & Payments Services Ltd, the credit card subsidiary of State Bank of India (SBI).
  • Through IPO, SBI Card aims to raise Rs.8,000-9,000 Cr capital. SBI and Caryle to sell stake of 4% and 10% respectively in SBI Cards.
  • For Credit Cards, there is a lot of under-penetration in the Indian market. The Number of credit cards per 100 population in India is just 3, while the number is almost 300 in US. It means there are 3 credit cards per user in US.
  • So, there is lot of room for Credit card growth potential. As India is a consumption based economy, so the credit card segment is going to see a predominant growth in Indian market.
  • As mentioned above, Caryle Group, which is a private equity investor in SBI Cards is planning to exit from it. So, IPO can create enough liquidity for existing private equity investors in the company.

3. Liquidity for Employees

IPO for Creating Liquidity for Employees
IPO for Creating Liquidity for Employees
  • Third reason for issuing IPO would be creating liquidity or provide exit opportunity of existing investors like company’s employees.
  • Many unlisted companies offer ESOPs (Employee Stock Option Plans) to its employees. Under these type ESOPs schemes, restricted share units (RSU) are offered to the employees for the long-term association with the company in future ie. retention.
  • But, What is the valuation of such ESOPs in case of unlisted companies? There is uncertainty regarding it among such unlisted companies’ employees.
  • In such situations, company issues IPO. Through IPO, company offers exit opportunity for employees to liquidate their ESOPs. Listing of shares will be executed via IPO route.
  • In this way, there would be ease of selling listed shares and have the liquidity for the employees of listed companies.
  • Example : Avenue Supermarts, here the share certificate offered by the company under ESOP scheme is an asset and created a great value for its employees.
  • RIL and Reliance Retail Swap Offer is an another example of the same.

4. Currency for Merger & Acquisition

  • Forth reason for IPO is currency for mergers and acquisition.
  • In case of Gruh Finance and Bandhan bank merger. 1000 shares of Gruh Finance are converted into 568 shares of Bandhan Bank. (swap ratio was 1000 : 568).
  • There is no exchange of capital in case of such mergers. Gruh Finance shareholders have become shareholders of Bandhan Bank after share swap execution.
  • Newly allotted shares are in accordance with the currency.
  • Another example, is merger of Capital First and IDFC Banks to became IDFC First Bank.

5. Branding & Visibility

  • In order to offer the branding and visibility for the products and services of the companies, they issue IPOs.
  • Mr. Mukesh Ambani has said to come up with its 2 big IPOs by 2024 in its Reliance Industries AGM, held in August 2019. Reliance Retail and Reliance Jio can be example for it.

Summary

  • Public share issuance allows a company to raise capital from public investors.The primary objective of an IPO is to raise capital for a business.
  • It can also come with other advantages. The company gets access to investment from the entire investing public to raise capital.
  • IPO also facilitates easier acquisition deals (share conversions)

Frequently Asked Questions (FAQs)

What IPO means?

IPO stands for Initial Public Offering. An initial public offering is when a private company or corporation raises equity capital by offering its stock to the public for the first time. It could be a new, young company or an old company which decides to be listed (to become publicly traded) on an exchange and hence goes public.

What is Rights Issue?

A rights issue is a way by which a listed company can raise additional capital. However, instead of going to the public, the company gives its existing shareholders the right to subscribe to newly issued shares in proportion to their existing holdings.

What is FPO?

FPO stands for Follow on Public Offer. If even after Rights Issue, the company couldn’t raise the capital or still has more capital requirement then the company can use the FPO source to raise funds.

Why is IPO done?

There are 3 key reasons why companies take out an IPO or Initial Public Offering – 1) Raise Capital for the Business, 2) Liquidity for Private Equity Investors, 3) Liquidity for Employees, 4) Currency for Merger & Acquisition, 5) Branding and Visibility

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