By Mr. Yash Gupta, Equity Research Analyst, Angel One Ltd
Initial Public Offering (IPO) is a process through which a company offers its shares to the general public for the first time. It is a common way to raise public companies’ finance by offering equity to the public. As an emerging economy, India witnesses many IPOs each year, depending upon the economic cycle and other market factors. In the previous year (2021), driven by the success of new-age tech companies and strong retail participation, the total funds raised through IPOs by domestic companies reached a record high of Rs. 1.19 lakh crores.
IPOs are often considered a way to seize decent returns on investment by traders and investors. As per the record, the average listing day returns were 31% during 2021. However, the averaging of returns does not write off investors’ concerns regarding IPOs and their performance on the day of listing and after that. A few examples include Paytm and Zomato, two of the new-age tech companies whose stocks have plummeted significantly post-listing.
This article primarily takes account of the greatest concerns regarding IPOs in India:
Allocation of a significant part to OFS (Offer for Sale)
Out of the total amount raised through IPOs in the previous year, a significant part (around 63% approx.) was towards an offer for sale. OFS refers to a method wherein the promoters of public companies can sell shares and reduce their holdings transparently, taking account of the stock exchange platform. Hence, rather than proceeds of fresh issues flowing in the company, an IPO including OFS results in a transfer of flow of money from the public to the company’s existing shareholders. It is crucial for an investor to assess how the money raised through a public offer would be put into use by the enterprise, before making an investment decision.
No significant impact on economic activity
The IPOs are meant to spur economic activities such as increasing a company’s production capabilities and generating employment opportunities. But such offers (OFS based) often result in increasing the net worth of the promoters and existing shareholders. For instance, in 2021, only 4 out of 63 issues did not have a component of OFS. Hence, from the perspective of economic development, there is no visibility of deployment and usage of the funds.
Exit route for PE and VCs
In addition to serving the promoters, IPOs have also worked as an exit route for Private Investors (PEs) and Venture Capitalists (VCs). The trend has been going on with the Indian companies for the past 6-7 years and is pretty common among the start-up enterprises going public. This means that the money raised through these offers provides an exit route for these investors. Further, there is a lack of visibility about whether such ploughed back investments are put back to any constructive usage. As per a report, around 50% of the total IPOs provided an exit route to these classes of investors. On the positive side, the capital market’s ability to provide an exit to PEs and VCs could further push the start-up revolution further which could be beneficial for the next generation of entrepreneurs.
Steps taken by SEBI
To address these issues, the regulator SEBI has taken a few steps, including increasing the lock-in period for QIBs and anchor investors to 90 days, introducing a cap of 35% on general corporate purposes quote in an IPO, and majority of stakeholders restricted to sell only up to 50% of the pre-offer shareholding in the IPO. In addition to this, the regulator has consistently worked to improve on a number of factors such as putting a cap of 25% on utilising funds for unidentified acquisitions. Besides all the restrictions, the regulator has also worked closely for creating awareness and educate investors.
The popularity of IPOs as the most prominent funding source for companies and as a way for retail investors to make substantial gains continues to increase in spite of listed concerns. Any investor should be aware of the objective of an IPO and the outlook of the majority shareholders for such an offer. The regulator must frequently step in (as it has done in this case) to address such concerns for ensuring the continuous participation of retail investors in future public offers.