IPO Exit Strategy – What is it and How Does it Work?

In 2021, a record-breaking 63 companies got publicly listed in the stock market. 2022, while paler in comparison, still witnessed an impressive 40 companies launching their IPOs and raising money from the public. While retail investors get an opportunity to buy new and promising stocks at launch rates, an IPO (Initial Public Offering) is also a way for existing investors and private equity holders to get a return on their investment. A common IPO exit strategy used by existing investors is to sell off their stake upon the IPO launch in return for cash profits. Another option is to hold on to their shares for the long term with the ambition of growing their corpus (or selling to cut losses) in direct correlation to the company’s performance.

To better comprehend the concept of an IPO, exit strategy, you should first know some of the commonly used jargon and industry terms.

Glossary of Common IPO Terms

• IPO

  – An ‘IPO’ or an initial public offering is the process through which a company becomes public-listed for the first time and puts its (new) shares in the stock market for the investor and trading communities to purchase.

• Issue Price

  – Also known as the launch price, the issue price is the amount at which the IPO shares are offered to the general public. Upon listing, if the current market price rises over the issue price, then the shareholders earn profits. On the other hand, a market price lower than the issue price will see a drop in the holding value of the investor.

• Market Price

  – This market price is determined based on the demand for the stock and the buzz it has been able to generate.

• Primary and Secondary Markets

  – When the IPO is launched, the initial sale of shares is directly between the company and the bidders intending to buy its shares. This is known as the primary market. Upon the completion of the IPO process and allotment of shares, the general public can buy or sell amongst each other in what is known as the secondary market.

• Flipping

  – Flipping is a frowned-upon activity that involves the sale of IPO-allotted shares on the first day of their trading eligibility. People do this to make quick profits due to high demand and (possibly) inflated prevalent share prices. As a consequence, the share’s value is likely to go down due to its oversupply, which can damage a company’s reputation in the market.

• Fixed Maturity or Lock-in Period

  – To keep the undesirable practice of flipping in check, many IPOs come with a maturity clause that prohibits private investors from selling their stake (portion or full) for a period of time after the company gets publicly listed. In such a case, the IPO exit strategy for private equity investors gets deferred till the end of the lock-in period.

[Read more: How to Apply for IPO]

How IPO serves as an exit strategy

In order to create a sustainable financial base or to expand operations, unlisted companies offer private equity firms to invest in them. In exchange, these private investors get a certain percentage of shareholding of the company, in proportion to their invested capital. Now, either to be able to invest in other more promising ventures, to cut their losses due to poor current performance, or as a pre-planned natural course, these investors may wish to encash their holdings and exit the investment.

The two standard ways of doing this are either selling their stake directly to another interested private investor or selling in the secondary market to different buyers. More often than not, it is difficult to find private investors willing to take a big stake in a company due to the large requirement of upfront capital, and also since it is more calculated to obtain accurate financial information of a privately listed company. Public listed companies, on the other hand, are obligated by rules and regulations to disclose their financial statements in detail, making it easier for the public to assess their performance and future potential before investing in them.

The IPO exit strategy, for most private investors, rests on the principle of the company going public and its stock price rising favourably in the share market. This opens up several possibilities for the investor. Offloading a large chunk of stocks in go, opting for a staggered or phase-wise sale of shares, or holding on in anticipation of a further price in the market price. Any of these strategies can be adopted based on the investors’ current financial situation and future goals.

IPO Exit strategy example

Suppose you own a startup company that has been operating in the IT sector for a while. Based on your year-on-year revenues, annual performance, and global clientele, you and your partners decide that the time is apt to make the company public-listed via an IPO. Your company's (and its pre-IPO investors’) IPO exit strategy is likely to involve the following steps:

• Groundwork

  – In accordance with SEBI’s rules, a formal prospectus will need to be prepared and other documents that describe the company's financial performance, management team, and other key details will have to be submitted.

• Establishing the Issue Price

  – Services of an investment bank are engaged to determine a reasonable offering price for the company’s shares based on a variety of factors, including the company's financial health, operational performance, prevailing market conditions, and investor demand.

• Launch of the IPO

  – Once approved by SEBI, the IPO can be launched and shares can be offered for sale to the public in the primary market, and also to institutional investors, such as mutual funds and pension funds.

• Trading

  – Once the IPO is launched and shares allotted, your company’s shares will be listed on a stock exchange, such as the BSE or the NSE. The company's owners and investors can then sell their shares on the open secondary market.

• Lock-in period

  – If there is a lock-in clause in your investor agreement, then the shares cannot be sold until the said period is over.

• Exit

  – If there is no lock-in applicable or after the lock-in period expires, you and your investors can begin selling your holdings in the company.

Do note, while an IPO can be an attractive exit strategy for private investors and company owners, it's important to carefully consider the risks and evaluate the benefits before deciding to go public.