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

Introduction

To understand IPO exit strategies, you need to understand how companies work. When a new company is formed, it uses private funding from venture capitalists, angel investors, and private equity investors. These investors invest in a company early and support the development of the product or service the venture is building. Once the company has found its footing and the product is launched, the IPO venture starts.

While the primary reason for launching an IPO is to raise capital from the public, it also serves as an exit point for private equity investors to cash in on their investments. A successful IPO allows private equity investors and all other early-stage investors to grow their investments significantly. For a successful startup, this whole process takes barely a few years. The risk is extraordinary for the investors who fund the startups, and as such, they are rewarded handsomely if all goes well.

So, what is an IPO exit strategy? And how does it work? Let’s understand the entire process in detail. But first, let’s familiarise ourselves with some IPO-related jargon to make understanding the concepts more accessible.

Glossary of Common IPO Terms

IPO: An Initial Public Offering (IPO) is issued by a company to become publicly listed for the first time and offer its new shares in the stock market. Investors and trading communities can freely buy and sell those shares. 

Primary And Secondary Markets: When an IPO is launched, the company directly sells its shares to the bidders. This is known as the primary market of shares. Once the IPO subscription and allotment phase is completed, general investors can then buy and sell the company shares among themselves, which is known as the secondary market of shares.

Issue Price: The issue price is also known as the launch price of a share. Once the IPO process is complete, the issue price serves as the price at which general public investors can buy the company shares. If the market price exceeds the issue price, investors earn a profit. If the market price goes lower than the issue price, investors may experience capital losses. 

Market Price: When the shares are listed in the stock market, the market price is based on the demand for the shares and the buzz the company has created over its shares.

Flipping: Flipping is a technique investors use to earn profits on their investments. It involves selling the IPO-allotted shares on the first day they become eligible for trading. Investors do this in cases where stocks have a very high demand and inflated share prices. This is a frowned-upon activity, and it can lead to the devaluation of company shares and its market reputation.

Lock-in Period/ Fixed Maturity: Various IPOs have a lock-in period to prevent the devaluation of company shares and their market reputation. This is done to avoid the flipping of shares partially or fully and to allow the company to stabilise its market position before giving investors the option to redeem their investments. In such cases, private equity investors have to wait till the end of the lock-in period to cash in on their investments.

What is An IPO Exit Strategy?

An IPO exit strategy refers to your plans as an investor to redeem your investment in a company for cash profits. This strategy applies whether you are an IPO investor or an early-stage private equity investor. Your financial goals, which can range from maximising profits on your investment to achieving specific investment objectives, determine the goal of this exit.

This is basically what an IPO exit strategy is. Based on your goals, this can be done on the first day when the lock-in period is complete or after a long-term allowing for long-term capital gains from your investment. Also, IPO exit strategies can apply even to company employees allotted shares in an IPO as an incentive.

Types of IPO Exit Strategies

There are several types of IPO exit strategies based on your financial goals. Here are some of the most common exit strategies used by investors.

1. Complete Exit: As the name suggests, a full exit is when investors sell all their holdings right after the IPO to liquidate their investment. As all the assets are sold, the investors do not get to experience or participate in the company’s future growth without reinvesting.

2. Partial Exit: A partial exit involves liquidating and earning a profit on some of your investments. It still allows you to contribute to the company’s future and reap the benefits of long-term gains. However, long-term gains can also become losses as the future is unpredictable, which puts your remaining stake in the company at risk. 

Apart from the two common exit strategies mentioned above, there are other strategic exit strategies as well, which are not as common but can prove to be highly profitable for investors.

1. Buyback: Based on the company's financial standing, it can offer to buy back shares from investors at market price for investors looking to redeem their investments. This is an excellent option for the company to boost their share prices in the near future.

2. Strategic Sale: This is a complex process, but investors can choose to sell their shares to anyone they please, including competing companies or strategic partners of the company. For the investor, this can mean great returns, but it can also damage the company's reputation and market performance.

How IPO Serves As An Exit Strategy

When planning your IPO investment strategy, having an exit in mind is crucial. As discussed, IPO offers early investors a way to redeem their investments. But how does it work exactly? There are two ways investors can redeem their investments after an IPO. They can either sell their stake to other private investors in the company or sell their holdings to various buyers in the secondary stock market.

Finding private equity buyers willing to invest significant capital upfront takes a lot of work. So, investors often choose to sell their holdings in the secondary markets. Whether you decide to sell all your holdings or just some of them depends on your financial goals. Holding on doesn’t guarantee returns, and selling doesn’t necessarily mean losing out. If you act based on your needs and goals instead of going on impulse, you can live with the results, no matter what.

IPO Exit Strategy Example

You are the owner of a company planning to launch an IPO. How do you go about the whole process and actually list your IPO? There are a lot of steps involved that will help you plan your exit strategy properly as an owner of the company.

1. Setting up an IPO: As per SEBI (Securities and Exchange Board of India), every company has to hire an underwriter and a registrar to start an IPO. They will help the company develop a formal prospectus or DRHP (Draft Red Herring Process). This document highlights the company's financial performance, management team, and other key details.

2. Setting an Issue Price: Once the DRHP and the RHP are developed, the company will need the services of an investment bank to determine the issue price. The issue price is determined by the market demand for the company’s share, market conditions, operational performance of the company, and its financial health.

3. IPO Launch: Once SEBI approves all the details, the IPO can launch to retail investors and institutional investors like mutual funds and insurance companies.

4. Post-IPO Share Trading: After the IPO subscription period is over, the shares of the company can freely be traded in the secondary stock market, subject to the fact that there are no lock-in periods associated with the IPO. If there is a lock-in period, the stocks will only be listed in stock exchanges after the IPO, but they can be traded only after the lock-in period is complete.

5. Exit: If there’s no lock-in period associated with your IPO, you and other investors in your company can choose to sell your stake in the company in the secondary market.