Companies achieve scale and growth in many ways. Some re-invest the profits earned from their business. Some secure capital from strategic investors. There are many which after achieving a certain scale, look for other routes of raising funds. Two routes are largely favoured by companies to raise money. One is through an Initial Public Offering (IPO), and the other is a Follow on Public Offering (FPO). Let us understand the key differences between an IPO and an FPO
What is an IPO?
An unlisted company offers its shares to the public at large to fund its business needs or to offer an exit to its existing investors. This offer is termed as an initial public offer – IPO. It entails a process wherein its shares are sold to the general public through investment bankers. The company issues a red herring prospectus – a booklet in the prescribed format by markets regulator, the Securities Exchange Board of India (SEBI), which offers all business information to the investing public. The company also announces a price band within which it wants to offer its shares.
An IPO is announced when the company reaches a certain stage of growth in its business. Typically, companies are started by promoters with their own funds. Gradually, banks offer loans. Venture capitalists and private equity investors chip in with funds at various stages of growth. In some cases, governments also invest in shares of companies. If an existing investor wants to exit and is unable to sell it to a private investor or the promoter or wants an exit at a price determined by a larger public participation, then the company opts for an IPO. Such IPOs are not dilutive, meaning , the proportional ownership of the shareholder in the company does not change. The ownership structure however changes, as the ownership of stocks changes hands.
But, if an unlisted company is in need of funds for business expansion or to pay off loans, then too, the management could choose to issue fresh shares through an IPO. In that case, the IPO becomes dilutive in nature.
What is an FPO?
When an already listed company wants to raise more capital from the general public, then it could opt for an additional issuance of shares and offers through an FPO or Follow on Public Offering.
The process of FPO is similar to that of an IPO. But, in the case of an FPO, the process is generally dilutive. This means the equity base of the company expands and proportional ownership of shareholders reduces.
An FPO can also be done if an existing large shareholder of the company wants to offer his/her stock to the general public. In this case, the nature of the transaction is not dilutive as the equity base does not change.
Some key differences between IPO and FPO
Issuance- An IPO is the maiden or first-ever issuance of shares to the general public by a company, all future issuances to the general public are termed as an FPO.
Listing – When a company completes an IPO and its stock gets listed, then the company ceases to be an unlisted company. If a company goes for an FPO, the status of listing does not change.
Share capital –Depending on the nature of the transaction-dilutive or not- the share capital or the amount of money raised by the company through the sale of shares, changes after both the IPO and FPO.
Pricing – In most cases, IPOs are aggressively priced. FPOs, in contrast, are not as aggressively priced as an IPO.
Risk – IPOs are also considered riskier than FPOs. This is because in an IPO, the seller knows everything about the business but the buyers are completely dependent on what the seller tells them about the business through the Red Herring Prospectus. Additionally, the volume of information available about a business over a period of time after its listing is typically higher than what is available when it goes public for the first time.
Savvy investors track FPOs very carefully for a number of reasons, the primary one being the price factor.
An FPO typically exerts pressure on the stock price of a company as the supply of shares goes up overnight. A good instance is an offer for sale from the Government of India in a public sector enterprise. Prices of such stocks remain under the pressure with the government selling equity to meet the disinvestment targets.
In such a scenario, a company that manages to sell its shares at a higher price in FPO can be a good business commanding a premium, which is why smart investors track these closely.
IPO or FPO?
The answer: why not both?
Stock markets help create wealth for long-term investors. Buying stocks of good quality companies and holding on to them for the long term can be highly rewarding. This could be done via IPOs, in the retail market, or through FPOs.
FPOs provide vision and strong reasons to invest, while IPOs hold out the promise of long term gains by investing at an early stage of a business.
A disciplined investor decides based on the information or disclosures provided by a company, availability of funds and their own risk appetite. And, that, essentially, is how you too should choose to invest.