It is well understood that funds are required to run a business, no matter how large or small it is. In the case of corporations and larger firms, the funds may be required for cash flow needs or to maintain and expand their operations. To raise new capital, businesses can either go the debt or equity route. Initial public offer (IPO) and follow-on public offer (FPO) are two fundamental ways for a company to raise funds from the equity market. In this blog, we differentiate between these two ways of raising equity.
Meaning of IPO
When we say a company has gone public, we mean that it has offered its shares to the general public and is ready to be listed on the stock exchanges of the country.
An Initial public offering (IPO) is a new stock issue where a private company’s shares are offered to the public for the first time. When a new, young, or old company decides to be listed on the stock exchange, it leads to the transition of its status from a private to a public company.
As a result, the first time a company is listed on the BSE, NSE, or both and offers its shares for public trading, the offering is known as an IPO.
Why does a company go for IPO?
When a company is formed, it receives funding from a variety of corporations, investors, angel investors, venture capitalists, and, in some cases, the government. However, when the company reaches a larger stage of expansion and these funds run out or are insufficient, it launches an IPO, goes public for the first time, and is listed on the exchanges.
It not only means that the company will receive funding if you invest in it, but it also comes with a great deal of responsibility to run the company efficiently so that its shareholders do not suffer losses.
An IPO brings the following list of advantages to a company:
- It allows entrepreneurs to raise capital from public investors to expand and improve their businesses.
- After IPO, the entity’s shares are traded in an open market. Thereafter, they can be bought and sold by investors through secondary market trading.
- It leads to increased liquidity of the business.
- An IPO also opens door to employee stock ownership plans (ESOPs). A company may provide stock ownership to its employees, which may also include benefits such as profit sharing.
- It shows that the brand has gained success, credibility, and pride.
- An IPO also opens the way for mergers and acquisitions.
Should you invest in an IPO?
Purchasing a share or a number of shares in a company entitles you to a portion of the company’s ownership. Further, when you invest in an IPO of a particular brand, you are exposed to the fortunes (success and loss) of that company. When such a company gains, you gain and when it loses, you lose.
Hence, before deciding whether to put your money into an IPO of a relatively new company, one should check the following:
See IPO details: Check Red herring prospectus (RHP) which is a preliminary registration document that is filed with SEBI. One must also gather some information about the fund management team and their plans for fund utilization.
See who is underwriting: An IPO with a success potential is usually backed by big investment banks.
Watch out for the Lock-up period: This is the period when investors are disallowed to sell off their shares; when it ends, the share price experiences a fall.
No indebtedness: You should know that a company that offers its shares to the public is not indebted to reimburse the capital.
Financial advisor: You can also weigh up your potential risks and rewards by seeking help from an expert/ wealth management firm/ personal financial advisor.
What is the Meaning of FPO?
An FPO stands for Follow on Public Offer. A company that is already listed on the stock exchange (after it has gone through the process of IPO) may decide to further issue its shares.
Thus, an FPO means any public offerings made after IPO. It represents the sale of shares by a publicly-traded company for the second or third time or consecutive time. It is normally offered at a discounted price than the current market price.
In layman’s terms, an FPO is an additional issue while an IPO is an initial/ first issue.
Two Types of FPO
The two major types of FPOs are dilutive (meaning new shares are added) and non-dilutive (meaning existing private shares are sold publicly).
The first is dilutive to investors because the entity’s Board of Directors resolves to increase the share float or the number of available shares. This kind of follow-on public offering seeks to raise funds to pay off debt or expand the business, which results in an increase in the number of shares outstanding.
As the number of shares increases, the earnings per share (EPS) falls. However, the value of the company remains unchanged. This reduces the price of shares.
The other kind of follow-on public offer is non-dilutive. Non-diluted follow-on offerings take place when substantial holders of existing, privately-held shares bring previously issued shares to the public market for sale. The cash proceeds from non-diluted sales are distributed directly to the shareholders who sell the stock on the open market.
In many cases, these shareholders are founders of the business, board members, or pre-IPO investors. Because no new shares are issued, the company’s earnings per share (EPS) remains unchanged. This method has no direct impact on a company’s share price or EPS (Earnings per share).
But, shares in a follow-on offering are typically sold at a discount compared to the current market price of shares already in the market. This is done to entice potential subscribers to buy the shares offered.
The non-dilutive FPO provides no material benefits to the company. Mostly it is used to change the shareholding or ownership pattern.
Why does a company go for FPO?
Reasons, why businesses go for FPO, are:
- An FPO allows a company to issue new shares to the investors or the existing shareholders.
- A company may decide to make more of its shares available to the public.
- It allows an organization’s shareholders to diversify their equity base and to reduce their stake in the company (ownership structure changes).
- It further acts as a means of raising additional equity to meet the company’s need for running its operations.
- It also allows one to raise capital to expand or pay off debt.
Should you invest in an FPO?
Investing in FPO is less risky than IPO. This is so because the investors are much aware as the company is already listed on the stock exchange. Investors have access to annual reports and investor presentations provided by listed companies.
Thus, before investing, you should be informed about the company’s performance in the past and its future goals. Investors should carefully study past performance and make assumptions about the company’s future growth prospects. The likely risk-reward ratio should be assessed.
Comparison table – Difference between IPO and FPO
|Offered by the previously unlisted company; Issuer – Unlisted company||Offered by a publicly trading company; Issuer – Listed company|
|The investor knows little about the company; no previous guidance or track record; may want to subscribe based on performance outlook, management, etc.||Investors have some track record of previous public issues; Previous sales of equity stakes, etc.|
|The primary objective of an IPO is to raise capital (capital infusion) by allowing people to buy stock in a company.||The objective of an FPO is to diversify public ownership, dilute the shareholding of the promoters, or secure more funds for expansion, etc.|
|Investing in an IPO is relatively riskier.||FPOs are comparatively less risky since there is more information available about the company.|
|It is less predictable.||It is more predictable than IPO.|
|In an IPO, we have a price band or a fixed price for the share sale, which is determined by the merchant banker and the company during the filing process.||In the case of an FPO, however, the price of shares is driven or determined by the market as well as the number of shares being increased or sold (depending on whether it is a dilutive or non-dilutive FPO).|
|The company’s share capital rises as it issues new capital to the public for listing.||The number of shares increases in dilutive FPO, but remains the same in non-dilutive FPO.|
Because you don’t know much about the company, your risk levels must be extremely high if you invest in an IPO. Individual investors and new investors, on the other hand, are better off with an FPO, and it is relatively a safer bet for them. Moreover, investing in an IPO necessitates more research than investing in FPO.
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