Understanding IPO 1:

It’s high time to understand the reason behind companies going public! Only if you comprehend this topic in detail, will you be able to discover the other topics relevant to IPOs.

In this effort to learn the reason, we are also set to go through a lot of financial concepts.

The business origin

Fundamentally, we need to understand the origin of any typical business. Say you have a ‘hit’ concept that is certain to win the hearts of customers, and you wish to kick-start the journey. While you are confident of the product and your marketing skills to take it to the customers, the first and foremost question of paramount importance is funding. For a person who doesn’t have any family background of business, there is evidently no chance of attracting investors. The only option left is to seek their friends and family to share their ideas and collect money. On the other hand, if you have the possibility of approaching Angel investors, you may get their funding as well.

At this juncture, the one or two people who have shared a potential sum of money for investing is termed as “Angel Investors.” This sum thus received is considered as an investment and not a loan of any kind. This first sum of money shall be assumed as Rs 2 crore. This sum is termed as the “Seed Fund”. The entrepreneur is not supposed to reserve this amount in his individual bank account, rather deposit it in the business account opened in the company name.

Coming on to what is to be done in return to the investment sum received, the entrepreneur is supposed to give ‘share certificates’ to the people who have invested their money. For a company who has received Rs 2 crore sum as investment. That way, you share a certain portion of the company ownership to the people who have invested. The next question now is ‘how?’

How are the shares divided among investors?

Let us assume that each share of the company is of Rs 25 worth. The overall capital amount is Rs 2 crore. This is called the share capital. By dividing Rs 2 crore by Rs 25 share value, we get a total volume of 8,00,000 shares. This value of Rs 25 per share is called the Face Value or FV.

Note that this FV could range anywhere starting from Re 1 to Rs 10 or beyond as fixed by SEBI to ascertain investor welfare. Depending on the face value of shares, the total volume of shares varies, practically.

In the lookout for a Venture Capitalist

Now that the business is all set up and running, the founder is gradually absorbing experience and has gained hands-on knowledge in 1 to 2 years of operations. Importantly, the company has achieved break even in business. Now, let us assume he is now at the stage of expanding his presence by setting up another production unit in his city. This invites the need for another chunk of fresh investments.

Now, the entrepreneur has to invite investments. This time, it is way better and easier as he can show his success record and the inflow of money the business is able to make. The investor who steps in at ‘this’ particular stage of the venture is called a Venture Capitalist or the VC. The funding this received from VC is called “Series A fund”.

When the business attracts a potential VC to expand its growth, there is going to be an obvious dilution of its shares with corresponding business improvement. At the same time, the investors would reap their notional profits towards investment.

As VS invests their money, there is a surge in notional value which indeed increases notional wealth. Parallelly, there is substantial growth in the business in terms of production or service with sufficient manpower to handle the core business processes and marketing.

The next stage - Banker

As the company grows thereafter, the company wants to hit another milestone  by expanding their geographic presence to two or three more cities with increased production capacity and increasing number of manpower resources. Funds needed at such times when the company eyes on expanding its overall business is called Capital Expenditure or ‘CAPEX.’

How is this fund accumulated?

First and foremost, the company can invest its own business profits to gather CAPEX. This is called internal accruals. Following this, it is time to seek VCs for another chunk of investment to expand the arena. This time, we call it ‘Series B Funding.” In return, the company allot shares.

At this juncture, banks will also show interest in giving you loan amounts as you have a good track record of company history. Such a loan is called ‘Debts.’

Now, as the company increases its valuation through Series B funding, there is going to be an increase in notional profits for the investors.

Private Equity

Assume that the business is running successfully and eight years have passed by. They now have plans to make a giant leap by branching out nationally. Parallelly, they also plan to diversify their production by expanding them to premium products.

At this juncture, the total sum needed as CAPEX is minimum 30 crore. As a constantly growing company, chances are high that they might not be interested in opting for debts. This is because of high finance charges. Say, the brand makes Rs 500 as profit and they ought to pay Rs 100 towards finance charge, the overall profit they make becomes just Rs 400 which is substantially low. This shall be explained in detail in the future chapters.

This is when there is a need for Series C funding wherein, we go for Private Equity. This is because we cannot rely on VC funding any longer. We shall assume PE or Private Equity as a higher version of VC. While VC gives out cheque values in smaller chunks, PE makes it larger.

Setting against each other, VC comes into the picture during the budding phase of any business which is riskier compared to PE. Contrarily, as PE comes after the business is fully up and running with a consistent flow of revenue, the risk factor is substantially low. Furthermore, PE overlooks the business operations and functioning as they pitch in with bulky investments which are towards CAPEX needs. However, for a company to grow into this state will certainly take a couple of years! Now, let us consider such a growth to our company.

Stepping into the “Initial Public Offering”

After receiving PE investments, let us assume we have progressed for about 3 to 5 years. This has widened the business reach and the brand has its presence across diverse geographies in the city. Despite all these and being able to produce hefty revenues, the brand desires to step further and expand itself in the global market.

The brand is desirous of making themselves available in the major noteworthy cities across the globe - to start with, at least in two or three such cities. At this point, the CAPEX requirement is hefty! The possible sources of CAPEX investments are as below:

●      CAPEX sourced out of internal accruals

●      By raising debts from bankers

●      One more form of debt i.e. to float a bond

●      Yet another Private Equity

●      Opt for IPOs – Initial Public Offer

Any one or few of the above options will be viable to gather such lumpsum amounts.

Let us consider, the company goes for IPOs. This invites the need for the brand to take itself public. If and only if this is done, the common public can get their shares by paying a price. This is why we literally call the concept “Initial Public Offer” wherein the public offers their money for the first time ever to a brand.

Now, as a public who is stepping in to invest, there are a few questions that need to pop in mind (or obviously, will!). A few of those could perhaps revolve around:

●      The reason for the company’s decision to opt for IPOs.

●      What refrained them from not filing for IPO during Series A, B or C?

●      What could possibly happen to the company when it opens up to the public?

●      What exactly is the process of IPO?

●      What sort of financial scenarios could happen when the company steps into the IPO market?

●      What could be the anticipations and expectations of a common man in an IPO?

All these above questions shall be discussed in detail in the coming chapters with deeper insights on IPOs and IPO market.

This part on IPO is believed to have given you the route map for a brand from its very beginning to stepping into the IPO market for a reason.