Investing in stock markets offers immense opportunities to grow your capital and accumulate wealth. Two popular methods of participating in the equity markets are Initial Public Offerings (IPOs) and Offer for Sale (OFS). Both provide opportunities for investors to purchase shares of companies, but they differ significantly. In this article, we will find out what is the difference between IPO and OFS and also explore how they work and benefit the investors.
- What is Initial Public Offering (IPO)?
- What is OFS?
- How Does IPO Work?
- How Does OFS Work?
- Benefits of OFS and IPO
- Benefits of OFS
- Key Takeaway
Topics Covered :
What is Initial Public Offering (IPO)?
An IPO is a pivotal event in the life of a company. It marks a transition of a privately owned company to a publicly traded entity. With an IPO, the company offers its shares to the general public on a stock exchange for the first time. It allows the company to raise capital by selling a portion of its ownership (i.e. equity) to external investors.
During an IPO , the company issues new shares to the public. The pricing is determined through a process called book-building, where potential investors submit bids within a price range specified by the company. The final price is typically set based on the highest price at which the total demand matches the number of shares available. Once the pricing is finalized, the shares are allotted to the investors and the company becomes publicly listed on the exchange.
An IPO involves thorough regulatory scrutiny and requires the company to disclose detailed financial and operational information in a draft red herring prospectus (DRHP). The IPO is issued only after the prospectus is accepted by the SEBI. The document helps potential investors assess the company's financial health, growth prospects, risks and overall investment potential.
SEBI takes around 2 months to approve a DRHP and after a few weeks an IPO can be announced. There are no fixed timelines. Thus, Investors get access to the upcoming IPO list in advance. Many investors make strategies for investing in the latest IPO listings.
What is OFS?
An OFS is a distinctive method of selling shares in the stock market, primarily employed by existing shareholders of a publicly-listed company. Unlike an IPO, where the company issues new shares to raise capital, an OFS involves the sale of existing shares by large stakeholders, such as promoters, venture capitalists or institutional investors. The funds generated from the sale in an OFS go directly to the selling shareholders rather than the company itself.
In an OFS, the selling shareholders collaborate with stock exchanges and the market regulator to announce the offering. They specify the number of shares they intend to sell and set a floor price, which is the minimum price at which the shares can be bid for. Interested investors then place bids at or above the floor price, indicating the quantity of shares they wish to purchase and the price they are willing to pay.
Once the bidding period concludes, the shares are allocated to the highest bidders, and the selling shareholders receive the proceeds from the sale. OFS is a mechanism that allows existing shareholders to exit their investments, realize gains or adjust their ownership without the company being needed to issue new shares.
Differentiate between IPO and OFS
Both IPO & OFS cater to different objectives for companies and shareholders. Let’s explore Initial public offering & offer for sale.
1. Purpose:
An IPO is primarily aimed at raising fresh capital. New shares are issued, increasing the total number of outstanding shares and diluting existing shareholders' ownership to some extent.
OFS, on the other hand, serves as a route for existing shareholders, such as promoters or early investors, to monetize their holdings and exit partially or completely. Existing shares are sold, and no new shares are issued. This does not impact the company's equity structure or dilute ownership.
2. Beneficiary:
The company is the primary beneficiary of the funds raised through an IPO. The capital raised can be used for various purposes like expansion, debt reduction, research and development. In an OFS, the selling shareholders receive the proceeds from the sale. The company itself does not receive any funds.
3. Regulatory Framework:
IPOs are subject to rigorous regulatory requirements. Companies are required to provide comprehensive information about their financials, operations, risks and growth prospects. While there are regulatory requirements for OFS, they are generally less stringent compared to IPOs.
4. Price Determination:
The price of shares in an IPO is usually determined through a book-building process. Investors submit bids within a specified price range, and the final price is set based on demand and supply dynamics. The price in an OFS is often set by the selling shareholders based on market conditions and their desired valuation.
Additionally Read: What is Demat Account?
How Does IPO Work?
Here are the steps involved in issuing IPOs:
1. Decision to Go Public:
The management and stakeholders decide to raise capital and go public to support growth and expansion.
2. Hiring Underwriters:
The company hires investment banks or underwriters to manage the IPO process for pricing and regulatory compliance.
3. Financial Preparation:
The company compiles financial statements and disclosures into a DRHP, which offers insights into its financial health and growth prospects.
4. Regulatory Approval:
The SEBI reviews the document to ensure compliance with securities laws and accurate information.
5. Pricing and Roadshow:
Underwriters and the company determine the IPO price through a book-building process, while the company conducts a roadshow to attract investors.
6. Subscription Period:
Investors place orders to purchase shares at the IPO price during the subscription period.
7. Allotment of Shares:
Underwriters allocate shares to investors based on order size, category and demand.
8. Listing on Stock Exchange:
The company's shares are officially listed and traded on the chosen stock exchange. The stocks are now accessible in the secondary market for sale & purchase.
How Does OFS Work?
1. Seller Decision:
Existing shareholders such as promoters, venture capitalists, or institutional investors decide to sell their shares to the public.
2. Announcement:
The selling shareholders collaborate with the stock exchange and market regulator to announce the OFS, specifying the number of shares they intend to sell and set a floor price.
3. Bidding Period:
The stock exchange opens a bidding period during which interested investors can place bids for the shares. Investors indicate the quantity they wish to purchase and the price they are willing to pay per share, which should be equal to or higher than the floor price.
4. Allocation:
After the bidding period concludes, the shares are allocated to the highest bidders based on their bid price and order size.
5. Settlement:
Once the allocation is complete the buyers' accounts are debited with the purchase amount and the sellers' accounts are credited with the sale proceeds.
6.Ownership Change:
The ownership of the shares transfers from the selling shareholders to the new buyers. This change in ownership occurs without affecting the company's equity structure, as no new shares are issued.
Benefits of OFS and IPO
Benefits of participating in the latest IPO
1. Capital Infusion:
IPOs provide companies with a significant influx of capital, which can be used for expansion, research and development, debt reduction and other corporate initiatives.
2. Enhanced valuation:
Going public increases a company's visibility and credibility in the market. Being listed on a stock exchange attracts attention of investors, customers, business partners and the media.
3. Employee Incentives:
IPOs often include special equity participation provisions for employees.
4. Liquidity for Founders and Early Investors:
Founders and early investors who hold shares can monetize their investments and diversify their portfolios by selling their stakes in the secondary market.
5. Mergers and Acquisitions:
A public company with readily tradable shares can use its shares as a currency for mergers, acquisitions and strategic partnerships.
Benefits of OFS
1. Quick Monetization:
OFS allows existing shareholders (promoters or early investors) to quickly sell shares and realize gains without waiting for the company's decisions.
2. No Dilution:
Companies can help their existing shareholders reduce their stake without issuing new shares, maintaining the same ownership structure.
3. Market Discovery of Share Price:
OFS enables the market to determine the fair price for the shares being sold, reflecting investor demand and supply dynamics.
4. Flexibility:
Existing shareholders can decide the timing and quantity of shares they want to sell.
5. Unlocking Value:
For large institutional investors or private equity firms, OFS can help them exit from investments and generate returns.
Key Takeaway
While both IPOs and OFS offer a legitimate route to participate in the equity market, they differ significantly in their purpose. IPOs involve the issuance of new shares to raise capital for the company, while OFS involves the sale of existing shares by shareholders. Knowing the difference between IPO & OFS, you can make a more informed investment decision. Ready to seize opportunities in the equity market? Open demat account today to participate in IPOs and OFS seamlessly and capitalize on potential investment opportunities.
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