It is the season of IPOs in India. The country is one of the toppers on the global IPO chart, with 184 IPOs so far in 2023.
But have you wondered why so many companies are going public? Going public means being in the public’s eye at all times. Despite the constant scrutiny and risks, why do companies issue shares?
If you have these questions, too, this article is for you. Let us discuss in detail the objectives of an IPO and its benefit.
You may also like: Demystifying offer for sale (OFS): A wild ride for share prices!
What is a public company?
The simplest way to understand a public company is that it is not private.
A public company is one that is listed on the stock exchange and whose shares are held by multiple public shareholders.
Private companies are generally owned by the owners and founders, whereas, public companies list themselves in the market for the general public to invest money and become part owners of the companies.
Why do companies do IPOs?
Businesses operate in various forms based on their requirements and goals – like sole proprietorship firms, partnership firms, companies, etc.
Companies also have different formats based on various factors like capital, number of employees, nature of business, etc. Public companies are one of them, usually large in size, as compared to other forms of business.
Companies become public from private by announcing IPOs (Initial Public Offering). IPO issue is the process of putting the company’s shares out in the market for the first time for the public to buy. So, an IPO is the first step towards a company becoming a public limited.
Objectives of IPO
The objectives of IPO determine why companies decide to go public:
The first and foremost reason to issue an IPO is to raise additional capital. Before a company goes public, it is owned and run by a limited set of owners. It also means that the capital available for the business is finite.
Inviting capital from the public requires parting with the company’s ownership. But it also gives businesses access to huge capital, which helps them in expansions, acquisitions, clearing debts, etc.
Sometimes, the original investors and founders look for options to step out of the existing business. This can happen due to different reasons, like better opportunities, disputes, etc. Similarly, employees who hold shares of their employer companies may also look to sell their stocks.
In the case of private companies, existing shareholders may face difficulties looking for buyers interested in the company’s shares, given the restrictions. Public companies make this process easier since shares in the stock market are highly liquid and are accessible to the general public.
Going public means listing the company’s shares in the open market. So, every change in the market impacts the share’s prices. As per the efficient market hypothesis, the price of a stock is expected to capture all market conditions and adjust its prices accordingly.
So, listing in the stock market offers companies one of the ideal and fair means of valuations.
Listing a company involves publishing its financial statements from time-to-time, to let the public know of its performance. So, the process of going public acts as an advertisement to build a brand image and credibility to attract more investors to invest in a company’s shares.
Mergers and acquisitions
IPOs favour mergers and acquisitions from two perspectives. One, it helps in fair valuations of companies while it is being merged or acquired. Two, the excess funds collected during an IPO are used for these activities and their related expenses.
Pros and cons of public companies over other forms of business
Public companies must meet several eligibility requirements to issue IPOs and be listed. So, all public companies don’t have to issue shares to the public.
Hence, every listed company is a public company, but every public company need not be a listed company.
Also read: A guide to FPO and its various types
Irrespective of IPO to raise capital, some companies go from other forms to public, given the distinct features of public limited companies, like:
- Separate legal entity – Where the company and its owners are separate, and the company’s liabilities are not passed on to the owners.
- Limited liability – The liability of every owner is only restricted to the extent of shares held by them.
- Perpetual – The company’s life goes on until all shareholders decide to dissolve it. Hence, the company’s life is not affected by the life and death of current owners.
- Regulations – Companies are thoroughly regulated under the Companies Act. While businesses like sole proprietorships do not follow regulations, the Companies Act mandates public companies to go through various statutory requirements, ensuring fair trade and transparency.
- Separate management – Companies allow owners to hire a separate team to manage the business, thereby freeing owners from the burdens of running the business.
Despite the benefits associated with public companies, some businesses prefer holding on to other forms, given the limitations of a public company, like:
- A public company is subject to constant judgment and scrutiny. A minor issue in its functioning can flare up and impact its shares and goodwill adversely.
- Public listed companies part with their ownership for capital. This leads to losing control over the management and its decisions. It can also cause delays, disputes and disagreements in decisions, leading to loss of opportunities.
- The cost of issuing an IPO is expensive.
- The legalities and related expenses involved in going public are high.
Offer for sale
Offer for sale is another process through which the public can invest in a company’s shares.
It is where large existing shareholders of a company, like promoters and institutional investors, offer their shares for sale in the stock market, to the general public.
- Offer for sale vs IPO
Though they seem similar, OFS and IPO are different from each other in every way.
- While IPO involves issuing fresh shares, OFS involves selling existing shares to new shareholders.
- The proceeds from an IPO act as capital for the company. OFS proceeds act as profits to existing shareholders.
- Issuing an IPO increases the company’s capital, whereas OFS has no material impact on the company’s capital. It only changes the ownership.
OFS is an alternate method for companies to offer their shares to the public at lesser regulations and cost.
Companies going public is one of the ways for businesses to expand their horizons. While some companies stop at registering themselves as public limited, others go ahead to issue IPOs and invite the public to be part of their operations.
As investors, we actively trade in the stock market, buying and selling shares of different companies. Understanding the objectives of a company’s IPO and its fund utilisation plan can help investors make wise decisions while investing.