Initial Public Offer (IPO) allows investing in any offered business to participate in their respective business growth and take advantage of holding an equity share like dividends, bonus, stock split rights issue, etc. Here you can understand what is Initial Public Offer (IPO) and why the company goes for Initial Public Offer (IPO). Below given points let us understand how any business starts and goes for IPO.
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1. Origin of a Business Idea before IPO:
- Entrepreneur’s Challenge: A budding entrepreneur with a great business idea (e.g., organic cotton t-shirts) needs money to kickstart the business. But to start a business, they need initial funds to start working on their idea. For that, Initially, they often turn to family and friends or use their own savings to start their business.
- Seed Funding: The entrepreneur raises capital, often from angel investors (family/friends), known as “seed funding.” This initial investment helps to start the business.
2. Valuation and Shares:
- Company Valuation: The business is valued at the amount of seed capital raised. For example, if INR 5 crores is raised, the business is valued at INR 5 crores.
- Shares and Ownership: The company issues shares based on the valuation. For example, with a face value of INR 10 per share, 50 lakh shares are issued to investors, reflecting their ownership stake.
3. Angel Investors and Early Stages:
- Angel investors take the highest risks because they invest in the early stage of business.
- Shareholding Pattern: At this stage, a business shareholding pattern can be defined. The early investors (entrepreneur + angels) holdings. How much entrepreneurs hold on company’s shares and how much angel investors hold on company’s shares.
4. Expansion and Venture Capital (VC):
- Once the business proves successful, it needs more funds to expand. The entrepreneur now turns to Venture Capital (VC) for large investments.
- Venture Capital Investment: The VC invests at a higher valuation (e.g., INR 50 crores) and takes a smaller percentage of the company (e.g., 14%). This increases the company’s overall value, rewarding earlier investors with higher valuation on their shares.
5. Private Equity (PE) Investment:
- When the business grows, it may need even more capital for things like expansion, new products, or entering new markets. This is when Private Equity (PE) investors come in.
- Private Equity Funding: PE firms invest large sums, usually at a later stage in the business. They often take a more hands-on approach, sometimes placing their own people on the company board to guide strategic decisions.
6. Bank Funding :
- In addition to VC and PE funding, businesses often approach banks to finance their operations and expansion, especially for capital expenditures (CAPEX).
- Bank Loans: As the company grows and demonstrates steady revenue, banks are more willing to provide loans at favorable rates. This debt financing allows the company to access funds without diluting ownership by issuing more shares.
- But the main issue arising here is when we prefer bank funding, the bank charges some interest for funding. It raises liability for the company and they need to refund the main capital along with interest which can reduce the profit margin of the business. To overcome this issue our next point is here to resolve it.
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7. IPO – Going Public:
- After achieving growth and success, the company may need even more capital to expand its business without making any liability. At this point, the company decides to go public through an IPO where the company does not need to refund the main capital and does not need to give interest to get this funding.
- Why Go Public?: By offering shares to the public, the company raises funds for expansion while avoiding additional debt. It also gives an exit opportunity to early investors (like angel investors, VCs, etc.).
- The company hires merchant bankers, prepares documents like the Draft Red Herring Prospectus (DRHP), and sets a price band for the shares.
- After a successful IPO, the company’s shares are listed on the stock exchange, and its valuation increases, enabling global expansion.
How a Business Becomes a Big Company and Goes for IPO
- Start with an idea and seed funding from angel investors, family, or friends.
- Grow and attract venture capital (VC) for expansion.
- Private Equity funds help scale the business even further.
- Use bank loans to finance capital expenditures (CAPEX) and operational growth.
- Finally, the company raises capital through an IPO, offering shares to the public and enabling global expansion.
By following this growth trajectory, many successful companies like Google, Facebook, and Infosys evolved from small ideas into major global businesses, eventually offering shares to the public through an IPO to fund further expansion.
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