Equity IPO Vs Debt IPO
Companies need money for many reasons, such as maintaining operations, settling debt, or supporting development efforts. While companies can borrow funds from financial institutions, firms also look at raising money from the public. If it is an unlisted company, i.e., a company whose stocks are not listed on stock exchanges, they would frequently use IPOs (Initial Public Offerings) to generate funds for their operational needs.
A business has two options for raising capital: equity and debt. Money is raised through the equity market by asking investors to become the company's shareholders. It incurs debt by borrowing money from investors by giving them a fixed rate of return.
What is a Debt/NCD IPO?
Businesses can get debt from investors through private debt placements or bond IPOs (public issues). These private placements are typically out of reach for individual investors who might not have access to the timing or specifics of such issuances since they are primarily for large institutional investors. Additionally, a corporation is subject to limitations imposed by the regulator Securities and Exchange Board of India on:
Instances of private placements per year
High required minimum investment. As a result, the private placement market is restricted to institutional investors.
By using fixed-term instruments, the business can borrow money from the general public in the form of loans at a fixed rate of return. Since they cannot be converted into shares, these are known as Non-Convertible Debentures. They come in two categories:
Secured NCDs: The company's assets serve as security for this type of NCD. Hence, if the business cannot pay back its debtors, the assets may be liquidated, and the proceeds may be used to cover the debt.
Unsecured NCDs: They are not backed by the company's assets. As a result, they are riskier and provide greater returns than secured NCDs to make up for the risk that the borrowers bear.
NCD holders' interest rate is noticeably higher than other convertible debentures or fixed deposits.
What is Equity IPO?
Private limited companies or unlisted companies issue their shares to raise capital from the stock market. The business extends an invitation to potential investors to invest money and become a shareholder. After the IPO is issued successfully, the company is listed on an exchange, and its stocks can be traded.
Based on how the price is issued, there are two types of equity initial public offerings:
Fixed Price Issue: The company sets the price per share in a fixed price IPO issue prior to the issuance.
Book Building Issue: In a book-building issue, the corporation specifies a price range, and investors must submit bids that fall within that range. After the bidding process is complete, the firm chooses a price based on the response to the offering, and shares are distributed in accordance with that price.
Difference between Debt IPO and Equity IPO
The main difference between a debt and equity IPO is the instruments used to raise capital. With a debt IPO, the company issues debt instruments such as Non-Convertibles Debentures (NCD), whereas with an equity IPO, the company issues shares.
Definition: In the case of debt IPO, capital is raised by borrowing money from the public. However, in the case of an equity IPO, the capital is raised by selling shares of the company.
Allotment: The funds are raised from investors on a first-come, first-serve basis. However, in the case of equity IPO, the allotment takes place through a computerised system if the IPO is oversubscribed.
Change in ownership: There is no change in ownership in the case of a debt IPO. It is because it is more like a borrower and lender relationship. On the other hand, IPO investors become part owners of the company. So, there is a change in ownership.
Returns: Investors of the bonds receive a fixed rate of returns at regular intervals. However, in the case rate of equity IPO, returns are not fixed and depend on the market.
Cost: The cost of debt is lower than the cost of raising funds from equity IPOs. Equity IPOs can be costly as the company must undertake multiple steps and pay fees associated with the IPO.
Risk: In the case of debt IPO, the risk is moderate, and so the returns are also moderate. Equity IPO comes with higher risk but also with the potential for higher returns. Therefore, investors should carefully assess their risk appetite and potential returns before making any decisions.
Timeframe: The tenure of equity IPO is not fixed. After the IPO, investors can decide when to sell their shares. However, the debt IPO comes with a fixed timeframe as debt papers have a maturity date.
Conclusion:
Equity IPOs and Debt IPOs are two different methods of raising capital for a company, and each has its own unique characteristics, advantages, and disadvantages. So, it would be best to do proper research before investing in an equity or debt IPO.