To fund a new business idea, a typical entrepreneur tries to attract investors. If he has no business background, then he might approach his family and friends to raise money or can approach the bank for a loan. Here are few more options to raise money for a new start-up;
- Angel investors – They are the one taking blind bets on the entrepreneur.
- Venture Capitalist – They are the investors who invest at the early stage of business.
- Private Equity – They invest large amounts of money in a start-up that already has a revenue stream. These people have an excellent professional background to support the company.
All these investors have their own limitations. After getting funds from a Private Equity, if the business needs more funds for expansion, then they might have less options available based on the business risk and fund requirements.
The main reason to raise funds is to fuel their capex requirement. When the company can not fund its expansion through internal accruals, or from another Private Equity fund or bankers, they prefer to go public.
To go public, the company will file for an initial public offer (IPO) by alloting shares from authorized capital.
As the company is offering the shares for the first time to the general public, it is called the “initial public offer” or IPO.
The IPO market is also known as the primary market. The moment the stocks get listed on the stock exchange and start to trade publicly, it is called the secondary market. In the secondary market people can buy and sell stocks daily on the stock exchange.
Based on business and market risk, there might be chances that the private equity participants want to decrease their holdings through initial public offering. In this way the promoters of the company are spreading their risk among a large group of people.
The biggest advantage of raising funds through equity participation is to avoid the need to raise debt, which means you don’t have to pay finance charges.
One more benefits of an IPO is that early investors (could be promoters, angel investors, Private Equity and VCs) can easily sell their shares in the open market after the shares of the company start trading publicly.
When a company files for Initial Public Offer (IPO), they have to offer their shares to the general public at a certain price.
Here are few questions that every investor should try to know before participating in an IPO;
- Why did the company decide to file for an Initial Public Offer (IPO)?
- Who are the existing shareholders and how will the new shareholding pattern be changed after the IPO?
- How does the company plan to utilize the funds?
- How much revenue does the company generate?
- What is the company’s operating and net profit margin?
- How does the company perceive the future business operating to emerge?
You should analyze the fundamentals of the company before applying for the IPO.
Here are the steps a company generally follow to go public;
- Appoint one or more merchant bankers.
- Apply to SEBI for getting initial go ahead approval.
- After getting an initial SEBI nod, the company prepares DRHP. This document gets circulated to the public. It has all the information that an investor wants to have before applying for an IPO. As an investor in the IPO, you should read through the DRHP to know everything about the company.
- Market the Initial public offering in order to build awareness about the company and its IPO offering.
- Company decides the price band between which they would like to go public. For example if the price band is between Rs. 500 to Rs. 550, then the public can actually choose a price they think is fair enough for the IPO issue. Instead of a price band, sometimes the company fixes the price of the IPO, such issues are called fixed price IPO.
- After fixing the price band, the company officially opens the window during which the public can subscribe for shares. Based on the price band, the general public participates in the IPO process. The process of collecting all these price points along with the respective quantities is called book building.
- Company decides the price point at which the issue gets listed. This process will be carried on after the book building window is closed.
- On the listing day, the company gets listed on the stock exchange. Listing price will be the price discovered through the book building process.
If in the book building process, less number of bids are received, then the issue is said to be under subscribed. For example, the company wants to offer 2,00,000 shares to the public, however during the book building process, only 1,80, 000 bids were received, it means the issue is under subscribed. Instead of 1,80,000 bids if the company has received 2,20,000 bids or any number more than 2,00,000, then the issue is said to be oversubscribed.