IPO: Meaning and Reasons Why Companies Go Public

Did you know there are over 15 lakh registered companies in India, but only about 2,100 companies are publicly listed on the National Stock Exchange (NSE)? 

In the upcoming chapters, we will learn all about the process of going public - Initial Public Offer or IPO and also ask a few important questions to understand why companies go IPO and how you can invest in IPOs.

Journey of a Company Going Public

Companies generally start with a few or even just a single shareholder who runs the business. However, as a company grows, it adds more shareholders who can provide some value to the company in the form of capital or skill. At this point, the company is said to be a private limited company as only a closed group of people hold shares of the company. 

Now, as the company scales even further, capital requirements can get pretty hefty. Therefore, the company then chooses to offer shares to the general public and thus becomes a public company. This is also referred to as going public.

To understand the reasons behind going public, we must undertake the journey experienced by a business.

Imagine you and one of your friends want to start a new business with a unique idea, but you don’t have the capital. 

To understand the nuances better - alongside this example, let us imagine an actual business being built: a fast-food restaurant.

Let’s say one day, you pitch this idea to some more friends, and one of them decides to give you  ₹1 cr to start this business. This money is called seed capital, and the friend who gave this money is called an Angel investor.

In return, you give him a part of your business or equity, also known as common shares. We won’t go into how equity is calculated, but just remember that one of the ways a business can raise capital is by equity funding.

So, all this turns your business idea into an actual business, and you celebrate the opening of your brand-new restaurant! 

Soon enough, it starts doing decently well and gaining social media traction. 

Now, there are two ways to go about it, like the red pill and blue pill from the matrix - you can either be happily satisfied as this can drive your business sustainably for some time or capitalise on this opportunity and expand around the city. 

Both of these ways come with their own risks and rewards. 

For simplicity, let’s say you decide to expand. For the next step, you need capital again; however, you do not have enough saved through internal accruals, which means your company does not have enough money saved from the profits that you have made. So, what do you do? 

Well, by now, you are an experienced business professional or entrepreneur and your business has earned quite the fame. This now gives you access to smarter investors called Venture Capitalists or VCs. 

VCs invest in startups or businesses that have been running for just a couple of years and have the potential for high growth. In corporate lingo, VCs are looking to invest in scalable businesses. 

So, moving further, let’s say a VC now likes your business idea and offers to invest 10cr in your business. When you accept funds from the VC in exchange for shares in your company, it further dilutes your equity. 

Using this capital, you open up 6 new restaurants and also start to tinker with packaged products that can be sold in supermarkets or retail stores.

Fast forward 5 years, and your food business seems to be doing reasonably well and you are now starting to get noticed by people from different cities through the internet and slowly building a fan following.

Again, you have two choices - either become a local competitor and build a reputation to become a local classic or take your chances to go countrywide and start expanding to other states. 

And again, both these choices have their own risks and rewards. 

But you want to go countrywide. Now, you sit with your accounts team and calculate the capital required. You conclude that about 50 Cr is required. 

You can now fund this using multiple sources, but for the sake of continuity, let us say you go and pitch to Private Equity investors or PE firms. 

These firms invest in private limited companies and generally come in at the time of scaling or expansion. They mainly invest in mature businesses compared to VCs, who invest in budding new startups.

One such PE firm now gives you a cheque worth 50cr, but along with equity, they also take a seat on the board and express their interest in overseeing business operations. This is generally how most PEs function. 

Let’s move along and say with this capital, you now start to expand geographically to other states with both restaurants and packaged food products. And let’s say, through some miracle after some years, your business is loved by everyone around the country and starts to now push the big boys of the industry.

Now, you see an opportunity to increase your footprint by setting up new outlets around the country and even going abroad. 

However, how much capital would this venture require? And what are ways I can get it? 

Well, you calculate the amount, and let's say it comes to about ₹500 crore. Now, let’s first look at the way in which you can raise this capital: 

• Raise from internal accruals
• Raise another round from a PE fund
• Borrow from banks 
• Issue Bonds 
• File for an Initial Public Offer (IPO)

For the interest of this chapter, let us say you go through the process of IPO or initial Public offer.

An initial public offer is the process by which your company offers shares to the general public at a specific price. 

Post this, your company will be listed on a stock exchange. 

So, why did your company go public? 

Theoretically speaking, the business required capital to further its growth. 

However, the reality could be quite different. Before looking at the reasons for IPOs today, let's answer another question - Why do some companies choose to remain a private Ltd company? 

Businesses have a personality of their own, and if the nature of business is such that it can depend entirely on its internal accruals. It has no need to raise much capital. Hence, IPOs don’t seem likely for such businesses.

One such example is the Serum Institute of India (SII). Despite being a large corporation, much like a large-cap company, they have not gone public. 

Now, let’s dive further into the reasons for IPOs today.

Reasons Companies Go Public

The concept of Initial Public Offerings (IPOs) is often backed by images of glitz and glamour, but beyond this facade lies a more strategic reality. 

Companies don't go public for flashy headlines; instead, they undertake this significant step due to practical necessities and long-term ambitions.

Let's delve into the pragmatic reasons behind companies deciding to go public using a simple analogy for each reason. 

1. Fueling Growth

Imagine your small business as a backyard garden. You have dreams of cultivating rare flowers and expanding your green space, but your limited budget holds you back. An IPO is like winning a gardening contest that provides a cash prize. Suddenly, you can invest in better-advanced soil equipment and even hire expert botanists. This influx of capital acts as fertiliser for your business, allowing it to grow and bloom beyond your initial limitations.

2. Ditching Debt

Visualise your company as a cyclist struggling uphill with a heavy backpack filled with rock representing high debt. Pedalling becomes challenging, and progress is slow. Going public is similar to shedding a few rocks in this scenario. The funds raised can be used to pay off debts, making your journey smoother and allowing you to ride the business terrain more efficiently. 

3. Spreading the Risks and Rewards

Consider your business as a solo superhero movie, say Spiderman, for example. Compare that to a movie with a team of superheroes like the Avengers. Going public is like going from a solo superhero movie to a star cast of superheroes. The odds of success are far higher for the latter. By selling shares to the public, you diversify ownership and gain support from a broader audience. It's similar to receiving feedback from multiple experienced mentors, ensuring that your business decisions harmonise with various perspectives.

4. Rewarding Early Believers

Remember the early days when your business was just a small garage band and you have made the big leagues. In this journey, some friends and investors believed in your potential and stayed through all the difficulties. An IPO is like hitting the big stage, allowing those early supporters to cash in on their belief, meaning they can now sell their shares. This is also called offer for sale (OFS) but we’ll get into the details of this topic later on. 

5. Applause for the Team

Think of your company as a sports team, with dedicated players putting in their best efforts. An IPO is like recognising their hard work by offering them a piece of the pie. Many companies provide stock options to employees, turning them into stakeholders. When the company goes public, these options become a tangible reward, like handing out medals to the team. Picture the elation in the locker room as everyone realises they're now part owners of the team they've helped build.

6. Stepping into the Spotlight

This is the difference between playing music at your local pub vs playing at the opening ceremony of IPL. The increased visibility attracts more fans, enhances your brand recognition, and makes it easier to recruit top talent. It's akin to transitioning from the local level to a national stage – suddenly, everyone is tuning in to your music, and you have the opportunity to become a household name.

How To Apply for IPO on Angel One?

•  Login to the Angel One App or website and click on ‘IPO’ on the homepage.
• Select the IPO you are interested in.
• Go through the IPO details like maximum quantity, maximum investment, about the company, etc.
• Click on ‘Apply Now’ to apply and enter the number of lots and bidding price along with your UPI ID.
• Confirm your bid and accept the payment mandate sent to your UPI App for successfully completing the IPO application.

That’s it! Your IPO order is placed. You can check the status of your IPO in the ‘Order Book’ section.

Conclusion

In conclusion, an IPO is not just about making a splash in the headlines. It's a strategic move aimed at achieving sustained growth, rewarding early supporters, and stepping into a more prominent business stage. Each IPO narrates a unique ambition, resilience, and tangible progress story. 

In the next chapter, we’ll dive into more questions about the process of IPOs and further investigate the nature of businesses.