Companies have diverse financial needs, ranging from sustaining day-to-day operations and settling debts to fueling growth initiatives. To fulfill these needs, companies have two primary avenues: borrowing funds from financial institutions or turning to the public for capital.
For businesses not listed on stock exchanges, known as unlisted companies, Initial Public Offerings (IPOs) serve as a common mechanism to secure funds necessary for their operational requirements.
When it comes to raising capital, companies have two fundamental choices: equity and debt. In the equity market, businesses invite investors to become shareholders, providing them with ownership stakes in exchange for investment. Conversely, they acquire debt by borrowing money from investors and promising to repay with a fixed rate of return.
This dual approach allows companies to tailor their financial strategies to meet their specific needs and objectives, striking a balance between ownership and debt obligations.
Equity IPOs
Equity IPOs are financial instruments employed by private limited or unlisted companies as a means to raise capital through the issuance of equity. These offerings invite investors to inject funds into the company in exchange for ownership shares, effectively making them shareholders in the company. Following a successful IPO, the company becomes listed on an exchange, enabling its stocks to be traded openly.
Types of Equity IPOs
- Fixed Price Issue: In this type of IPO, the company predetermines the price per share before the issuance. Investors acquire shares at the fixed price set by the company.
- Book Building Issue: Contrarily, a book building IPO provides a price range to potential investors. Investors then submit bids within this range. Based on the response to the issue and the bids received, the company determines the final share price after the bidding process concludes. Shares are subsequently allocated to investors accordingly.
NCD IPOs
NCDs (Non-Convertible Debentures) represent fixed-term financial instruments utilized by companies to raise capital through debt. In NCD IPOs, companies seek to borrow money from investors for a specified duration to fulfill their financial requirements. In return, investors receive a predetermined rate of return on their investments.
Types of NCD IPOs
- Secured NCDs: These NCDs are backed by the assets of the issuing company. In the event that the company defaults on its repayments, the assets can be liquidated, and the proceeds are used to reimburse the investors.
- Unsecured NCDs: Unsecured NCDs, in contrast, lack backing by any company assets. As a result, they carry a higher level of risk. However, to compensate for this increased risk, unsecured NCDs typically offer a higher rate of return to investors.
In essence, Equity IPOs allow companies to raise capital by offering ownership stakes, while NCD IPOs enable companies to secure funds through debt offerings. These financial mechanisms provide companies with versatile options to meet their specific capital-raising needs.
Difference between Debt IPO and Equity IPO
| Aspect | Debt IPO | Equity IPO |
|---|---|---|
| Definition | Capital is raised by borrowing from the public | Capital is raised by selling company shares |
| Allotment | Funds raised on a first-come, first-serve basis; In oversubscribed cases, allotment is computerized | Allotment often computerized, especially in oversubscribed cases |
| Change in Ownership | No change in ownership; More like a borrower-lender relationship | IPO investors become part owners of the company, leading to a change in ownership |
| Returns | Fixed rate of returns at regular intervals | Returns not fixed, dependent on market performance |
| Cost | Lower cost compared to equity IPOs | Can be costlier due to multiple steps and associated fees |
| Risk | Moderate risk, resulting in moderate returns | Higher risk but with potential for higher returns |
| Timeframe | Fixed timeframe with maturity date for debt papers | Tenure not fixed; Investors can decide when to sell shares |
In summary, the primary distinction between debt IPOs and equity IPOs lies in the financial instruments used to raise capital and the consequent impact on ownership, returns, cost, risk, and timeframe. Debt IPOs involve borrowing from the public through debt instruments, leading to a borrower-lender relationship, fixed returns, and a fixed timeframe. In contrast, equity IPOs involve selling shares, resulting in a change in ownership, returns tied to market performance, potentially higher costs, higher risk, and a flexible timeframe for investors
Naren is a finance graduate who is passionate about cryptocurrency and blockchain technology. He demonstrates his expertise in these subjects by writing for cryptoetf.in. Thanks to his finance background, he is able to write effectively about cryptocurrency.