In the ever-changing business world, companies are constantly seeking new methods of raising capital. Capital is the very lifeblood that fuels innovation and expansion and keeps operations going on. Be it launching new product lines, entering into a new market, or stabilization of the operations, for any business, raising capital is of great importance. Companies raise capital through various methods, and three common methods that come into play are Initial Public Offerings (IPOs), Follow-on Public Offerings (FPOs), and Offer for Sale (OFS). Understanding the differences between these methods can provide valuable insights into how companies raise capital.
Understanding How Companies Raise Capital
Before we start off discussing the differences, we first have to understand the general context of this section. Companies raise capital to finance their business and investments. Capital for such financing could be done either through equity, debt, or a mix of the two. Equity typically involves a method of raising capital that often requires a company issuing its shares to the public or selected investors. Let us proceed with some of the most common ways of doing that, describing their principal differences.
What is an IPO?
IPO is referred to as Initial Public Offering. An Initial Public Offering (IPO) is the first time a private company offers its shares to the public on a stock exchange. It is a gateway of a company into the world of public trading. Companies can raise capital by selling a part of their ownership to investors in return for capital through an IPO.
Key Features of IPO
- New Issue of Shares: When a company goes public through an IPO, it issues new shares and offers them to the public for the first time.
- Access to Large Capital: IPOs are usually undertaken by companies that want to raise a large amount of capital to finance their expansion plans or pay off existing debts.
- Increased Visibility and Credibility: Companies gain increased visibility and credibility by going public, which may help attract further investments and business opportunities.
- Ownership Dilution: Shares are being offered to the public, which means the ownership of the company’s
- founders and existing investors get diluted.
What is an FPO (Follow-on Public Offering)?
A FPO is a public offering made by a company that is already listed in the stock market. FPOs are utilized for raising further equity funds by companies once they are already listed, and it takes place after the IPO.
Key Features of FPO
- Secondary Share Issue: Unlike the IPO, which comprises the issue of shares for the first time, FPO comprises either shares issued afresh by the issuing company or shares sold by existing shareholders.
- Lesser Risk Involved than IPOs: On the whole, FPOs are riskier propositions than IPOs in that a company is listed and thus has a public history that is available for potential investors to assess.
- Capital for Different Purposes: FPOs are used by companies to finance expansion, debt reduction, or other strategic purposes. It is an opportunity for investors to acquire more shares in a listed company.
- Dilution of Equity: Similar to the IPO, an FPO leads to dilution of equity for existing shareholders if the company issues new shares.
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What is an OFS (Offer for Sale)?
An Offer for Sale (OFS) is a way in which existing shareholders, such as promoters, sell a part of their shares to the public through the stock exchange. Unlike IPOs and FPOs, there is no new issuance of shares. OFS is often seen as a way for existing investors to monetize their holdings.
Key Features of OFS
- No New Shares: In an OFS, no new shares are issued. Instead, the existing shareholders, usually promoters or big investors, sell their shares to the public.
- Generally Applied by Large Shareholders: OFS is generally applied by institutional investors or company promoters to sell out their holding without affecting the capital structure of the company.
- Liquidity for Existing Shareholders: Existing shareholders can cash out without having to sell their shares privately or on the open market.
- Minimal Impact on Control: Since there is no issuance of new shares, the control and ownership structure of the company remains largely unaffected. However, if a large number of shares are sold, it can dilute the control of the promoters or large shareholders.
Key Differences Between IPO, FPO, and OFS
Now that we have a general idea of what each of these means, let’s drill down to some key differences between how companies access capital through IPOs, FPOs, and OFSs.
1. Source of Shares:
IPO: Issues new shares to the public.
FPO: Could be an issue of fresh shares (if it’s a new issue) or an offer for sale of existing shares by promoters or major stakeholders.
OFS: This involves the sale of outstanding shares by promoters or other big investors.
2. Amount Raised:
IPO: A company generally raises a huge amount of money in an IPO as they are issuing new shares to the market for the first time.
FPO: FPOs are issued for raising additional capital after an IPO but the amount raised is normally less than that raised through the IPO.
OFS: As no fresh issue of shares is involved, there is no issue of raising fresh capital for the company. It is essentially an issue of shares from the existing shareholders to the new investors.
3. Ownership Dilution:
IPO: The ownership is significantly diluted since the shares are issued to the public.
FPO: The case is almost similar to the IPO scenario; in the event of a fresh issue of shares, the ownership gets diluted.
OFS: There is no dilution of ownership for the company because no new shares are issued.
4. Purpose:
IPO: Primarily for raising funds to grow the business, pay off debts, or for general corporate purposes. It also offers an opportunity for the company to gain visibility and credibility.
FPO: Raised by the already listed companies to expand their business or to pay off the debts. It also gives existing investors an opportunity to liquidate their shares.
OFS: The objective is to enable existing shareholders to liquidate their stake, generally for reasons such as to increase liquidity or reduce ownership in the company.
5. Risk Factor:
IPO: The risk for investors is higher since it’s the first time the company is going public, and there is no track record.
FPO: There is less risk involved since the company has an established market presence, and investors have historical performance data.
OFS: The risk is relatively low for investors since they are buying shares that already exist, and the company’s performance is known.
Conclusion
Conclusively, how companies raise capital, whether it is by an IPO, FPO, or OFS, will depend on their needs, growth stages, and objectives. IPOs are usually sought by companies that want to go public and raise substantial funds. FPOs are sought by companies already listed and require raising more funds while OFS allows existing shareholders to sell their stake without affecting the capital structure of the company.
Each method has its pros and cons, and a company needs to assess the financial goals and strategy before settling on the best approach for raising capital. This understanding will help investors make more informed decisions, and companies can use these avenues to strengthen their position in the market.
It can help businesses and investors master how companies raise capital through IPOs, FPOs, and OFSs, and walk confidently through the complex world of capital raising.