Have you ever wondered how early investors in companies manage to cash out their investments? While investing in a company might seem like a long-term commitment, there are strategies in place that allow investors to exit profitably.
One such popular method is through an Initial Public Offering (IPO). An IPO marks a company's transition from private to public, providing early and direct investors with an opportunity to sell their shares and potentially profit.
This article will guide you through the intricacies of IPO exit strategies, helping you understand how they function and what benefits they offer to investors.
Glossary of common IPO terms
Before going into the exit strategies, let us look at the glossary used when discussing initial public offerings.
Primary market
The primary market constitutes a company's initial interaction with the public. It is a marketplace where companies and organisations issue securities for the first time.
Secondary market
Once the securities enter the secondary market, they are listed on the stock exchanges and available for other investors to trade. People bid on the shares, and the IPO allotment status is updated. At the IPO listing time, the shares enter the secondary market, where new investors can buy and sell them easily through their demat accounts.
Float
Float refers to the total amount of shares that are in circulation. This is the maximum number of shares investors can trade on the stock exchanges.
Market price and market valuation
Once the shares are listed on the stock exchanges, they reach a certain price, known as the share price. The market price also determines the market valuation of the company, depicting how much it is worth based on the share price and the share float.
Issue price
The issue price is the initial price at which the company's shares are offered during the IPO phase. If the shares are listed at a premium (listing price higher than the issue price), the investors who received the shares during the IPO process earn profits.
Flipping
Some shareholders sell the shares acquired during an IPO as soon as the shares list on the stock exchanges at the IPO listing time. This practice is called flipping and is often discouraged. This is because the share value goes down due to a sudden increase in supply.
Lock-in period
The company sometimes signs an agreement to prevent the share price from dropping. The agreement states the lock-in period, usually 3 to 12 months, during which the shareholders cannot sell the shares.
How IPO serves as an exit strategy
Private investors might want to exit because they want to invest in other opportunities or because they need to liquidate the funds.
There are two IPO exit routes in this case. The first option is to sell the shares to another private investor, and the second is to sell them to the public. Private investors mostly opt for the second option because selling the shares to other private investors might be difficult.
This is because, at this stage, it is not possible to know at what valuation the company will be priced or know the market price of the share. Additionally, other investors might want to profit from this offer and be willing to pay less than what the shares are worth.
Most people reach out to private investors since the market demand at the time is high, and the private investor can make a good deal.
IPO exit strategy example
Now, let us understand the steps of an SME IPO exit strategy in detail with an example. Let us say Company ‘A’ had multiple private investors. They now chose to launch an IPO, which will give the private investors an opportunity to exit. As soon as the company grows enough to meet the minimum requirements of offering an IPO, it can begin preparing for the launch.
Let us say one of the private investors had 100 shares in total worth Rs. 10 each. They can now sell either a part of their shares or all the shares to the public and exit from the company.
Conclusion
An IPO is the exit route for all private investors, where they can sell their shares to the public. They only have to wait for the lock-in period if the company has signed an agreement prohibiting insiders from selling their shares before a specified period.
When done prudently, selling the shares can help investors earn huge profits on the initial amount they spent buying them. Private investors can still keep some shares to hold on to a part of their stake in the company.
When done the right way, these shares can be sold in batches. It helps both the investors and the company. Because of this strategy, the price of the share does not fall, and the private investor’s motive is fulfilled.
