An IPO exit strategy is a plan for investors to sell their shares in a company after the IPO to realise profits. This strategy is guided by the investor's financial goals, whether it's maximising profits immediately after the lock-in period or holding shares for long-term capital gains. Employees who receive shares as part of an IPO can also use exit strategies. Timing plays a crucial role, and investors can choose to exit based on short-term gains or a long-term approach, depending on market conditions and personal investment goals.
Types of IPO exit strategies
When investing in an IPO, it's essential to have a well-defined exit strategy. Here are common approaches:
- Complete exit: Sell all your shares immediately after the IPO to liquidate your investment. This locks in profits or losses but forfeits potential future gains.
- Partial exit: Sell a portion of your holdings to realise profits while retaining ownership. This balances gains with potential future growth, but also exposes your remaining shares to market risks.
Additional strategies:
- Buyback: The company may offer to repurchase shares from investors at a specific price, providing an exit opportunity and potentially boosting share prices.
- Strategic Sale: Sell your shares to a third party, such as a competing company or strategic partner. This can yield significant returns but may impact the company's reputation and market performance.
Remember, each exit strategy has its own advantages and risks. Carefully consider your financial goals and risk tolerance before making a decision.
Glossary of common IPO terms
Before going into the exit strategies, let us look at the glossary used when discussing initial public offerings.
1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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
Launching an IPO involves several key steps:
- Setting up the IPO: Engage an underwriter and registrar to guide the IPO process and prepare the Draft Red Herring Prospectus (DRHP).
- Determining issue price: An investment bank helps set the IPO price based on factors like market demand, company performance, and financial health.
- SEBI approval: Obtain approval from the Securities and Exchange Board of India (SEBI) to proceed with the IPO.
- Public offering: Launch the IPO to retail and institutional investors.
- Post-IPO trading: Once the subscription period ends, shares can be traded on the secondary market, subject to any lock-in periods.
- Exiting your investment: If no lock-in period exists, you and other investors can sell your shares in the secondary market.
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.
