An IPO, also called an initial public offering, refers to a private company going public and listing itself on the stock exchanges by issuing shares to the public for the first time. Put together, 2021 and 2022 saw at least more than 100 mainline IPO launches, which is quite a lot to begin with. However, it should not be a surprise since India today is one of the fastest-growing major economies in the world. But why is that the case; what has economic growth got to do with IPO launches? To know that, we will have to take a closer look at the role of IPOs in the stock market.
The Function Of Ipos
As defined at the very beginning, an IPO is the process through which a private company becomes a publicly traded company by offering shares to the general public for the first time. So, first, let's understand why companies choose to launch their IPO and become publicly traded. After that, we will understand the broader function of IPOs in the economy.
Why Do Companies Go Public?
The primary role of an IPO is to raise capital for the company. By coming out with an IPO, the company offers its shares to the public at a certain price. The company may then use the funds it raised through the IPO for various business-related purposes. The most common use case is to use the funds to expand business operations and undertake capital expansion projects through organic or inorganic means. A company can organically upscale its operations by setting up new factories/offices, purchasing new equipment, and investing in research and development to improve its product portfolio. On the other hand, inorganic expansion can be carried out by making strategic acquisitions and mergers to expand and diversify its product portfolio.
Besides capital expansion, the company may also use the IPO funds to repay existing debt and improve its balance sheet. It also allows private equity funds to book profits and sell their stake in the company. In short, the funds go into areas that can help grow sales and improve the long-term profitability and cash flows of the company.
What's more, going public also improves the credibility and reputation of the company in the eyes of the public, as well as from an industry perspective. A publicly traded company is subjected to higher disclosure and compliance requirements. Hence, they are more transparent and attract more institutional investors.
What IPOs Mean to Investors?
So, we now know the function of an IPO from the company's perspective is to raise capital. But why should an investor invest in an IPO? Assume there exists a private company that delivers industry-leading services. Since its services are top-notch, the company decided to come out with an IPO so that it could expand operations and satisfy the growing demand for its services. As an investor, you would want to invest in the company since you believe than once it upscales its operations, it will increase its sales and grow its profits. You firmly believe the company's value will increase tomorrow.
In short, you may invest in an IPO because you believe it will help grow your wealth by virtue of being worth more in the future. The cash-rich balance sheet in the future may also reward you as a shareholder with dividends.
Role of IPOs in The Economy
When an economy is booming, there is an increase in the production of goods and services due to strong demand. These goods and services are produced and delivered by businesses in the economy. So, for an economy to do well, the majority of the businesses in the economy must perform well. However, without capital, a business will be able to produce enough goods and services to keep up with demand. That's where IPOs come in.
By coming out with an IPO, the company is able to raise capital to produce goods and deliver services in steady volumes to keep up with the growing demand. Moreover, since public companies are more transparent, more investors, not only domestic but even foreign investors, may start looking to invest in the company. That leads to increased inflows of funds in the economy in the form of foreign investments.
Hence, you will see many companies launching their IPOs when the economy is displaying strong growth. On the other hand, fewer companies issue initial public offerings (IPOs) during recessions and bad economic times because there is a drop in consumption of goods and services due to a drop in demand.
To summarize , IPOs benefit the company, the investor, and the economy as a whole. It helps the company raise funds, while investors see it as a vehicle to grow their wealth. The economy benefits as more goods and services are produced due to the foreign inflow of cash. All of this will reflect itself in the stock market. Every new publicly traded company offers itself as a new vessel to grow investors' wealth, and every new opportunity will attract more investors to the stock market. That will contribute to the inflow of cash from all kinds of investors in the Indian stock market, which reflects in bull markets. In addition to traditional IPOs, the SME IPO segment provides smaller companies with an avenue to raise capital and grow, further diversifying investment opportunities in the market.