The IPO Markets 2

THE BANKER Three more years pass by and the company is phenomenally successful. The company decides to have a retail presence in at least 3 more cities. To back the retail presence across three cities, the company also plans to increase the production capacity and hire more resources. Whenever a company plans such expenditure to improve the overall business, the expenditure is called ‘Capital Expenditure’ or simply ‘CAPEX’. The management estimates 40Crs towards their Capex requirements. How does the company get this money or in other words, how can the company fund its Capex requirements? There are few options with the company to raise the required funds for their Capex… 1. The company has made some profits over the last few years; a part of the Capex requirement can be funded through the profits. This is also called funding through internal accruals 2. The company can approach another VC and raise another round of VC funding by allotting shares from the authorized capital – this is called Series B funding 3.The company can approach a bank and seek a loan. The bank would be happy to tender this loan as the company has been doing fairly well. The loan is also called ‘Debt’ The company decides to exercise all the three options at its disposal to raise the funds for Capex. It ploughs 15Crs from internal accruals, plans a series B - divests 5% equity for a consideration of 10Crs from another VC and raise 15Crs debt from the banker. Note, with 10Crs coming in for 5%, the valuation of the company now stands at 200 Crs. Of course, this may seem a bit exaggerated, but then the whole purpose of this story is drive across the concept! Note, the company still has 31% of shares not allotted to shareholders which are now being valued at 62 Crs. Also, I would encourage you to think about the wealth that has been created over the years. This is exactly what happens to entrepreneurs with great business ideas, and with a highly competent management team. Classic real world examples of such wealth creation stories would be Infosys, Page Industries, Eicher Motors, Titan industries and in the international space one could think of Google, Facebook, Twitter, Whats app etc. THE PRIVATE EQUITY Few years pass by and the company’s success continues to shine on. With the growing success of this 8 year old, 200 Cr Company, the ambitions are also growing. The company decides to raise the bar and branch out across the country. They also decide to diversify the company by manufacturing and retailing fashion accessories, designer cosmetics and perfumes. The capex requirement for the new ambition is now pegged at 60 Crs. The company does not want to raise money through debt because of the interest rate burden, also called the finance charges which would eat away the profits the company generates. They decide to allot shares from the authorized capital for a Series C funding. They cannot approach a typical VC because VC funding is usually small and runs into few crores. This is when a Private Equity (PE) investor comes into the picture. PE investors are quite savvy. They are highly qualified, and have an excellent professional background. They invest large amounts of money with the objective of not only providing the capital for constructive use but also place their own people on the board of the investee company to ensure the company steers in the required direction. Assuming they pick up 15% stake for a consideration of 60Crs, they are now valuing the company at 400Crs. Let’s have a quick look at the share holding and valuations.. Please note, the company has retained back 16% stake which has not been allotted to any shareholder. This portion is valued at 64 Crs Usually, when a PE invests, they invest with an objective to fund large capex requirements. Besides they do not invest in the early stage of a business instead they prefer to invest in companies that already has a revenue stream, and is in operation for a few years. The process of deploying the PE capital and utilizing the capital for the capex requirements takes up a few years. THE IPO 5 years after the PE investment, the company has progressed really well. They have successfully diversified their product portfolio plus they have a presence across all the major cities in the country. Revenues are good, profitability is stable and the investors are happy. The promoter however does not want settle in for just this. The promoter now aspires to go international! He wants his brand to be available across all the major international cities; he wants at least two outlets in each major city across the world. This means, the company needs to invest in market research to understand what people like in other countries, they need to invest in people, and also work towards increasing the manufacturing capacities. Besides they also need to invest into real estate space across the world. This time around the Capex requirement is huge and the management estimates this at 200 Crs. The company has few options to fund the Capex requirement. 1. Fund Capex from internal accruals 2.Raise Series D from another PE fund 3.Raise debt from bankers 4. Float a bond (this is another form of raising debt) 5. File for an Initial Public Offer (IPO) by allotting shares from authorized capital 6. A combination of all the above For sake of convenience, let us assume the company decides to fund the capex partly through internal accruals and also file for an IPO. When a company files for an IPO, they have to offer theirshares to the general public. The general public will subscribe to the shares (i.e if they want to) by paying a certain price. Now, because the company is offering the shares for the first time to the public, it is called the “Initial Public Offer’. We are now at a very crucial juncture, where a few questions needs to be answered.. 1. Why did the company decide to file for an IPO? In general why do companies go public? 2. Why did they not file for the IPO when they were in Series A, B and C situation? 3.What would happen to the existing share holders after the IPO? 4. What do the general public look for before they subscribe to the IPO? 5.How does the IPO process evolve? 6. Who are the financial intermediaries involved in the IPO markets? 7. What happens after the company goes public? In the following chapter we will address each of the above questions plus more, and we will also give you more insights to the IPO Market. For now, hopefully you should have developed a sense of how a successful company evolves before they come out to the public to offer their shares. The purpose of this chapter is to just give you a sense of completeness when one thinks about an IPO.