In the introduction of this series, I touched on the definition of an IPO and that has generated some comments. Most interestingly, comments that says an IPO is a way for the investors to exit from the company. It is true, but there is more to it.
IPO as an exit
Imagine you are an owner of a private company that does a profitable business. You have invested say, 100,000 ringgit into the business and the money has become other assets like machines, stocks etc. Your only income at this point would be the profits of the business, less any reinvestment (you cannot take out those cash that you need to reinvest in the company for whatever reason). The value of your initial investment has also increased by the amount of cash you have generated from the profits and all your accumulated assets (the machines and such) less your liabilities.
Let us say that now the assets of your business has grown to RM200,000. Wow..it looked like you have doubled your wealth!
Or is it?
Let's say you had an accident and badly needs RM200,000 cash in a week. Or a business opportunity arise and you need cash of RM200,000 to grab that opportunity. And your only asset is the business that is worth RM200,000.
Now you need to turn that investment into cash. You cannot pay the car repair workshop with the shares of your company (most of the time at least). You need to realize your investment, turning it into instrument of payment and trade - cash.
What are your options? Yes, you can sell your shares in the company to someone. You scout around and tell people, "Hey, I need cash and I am willing to give this company to you - all its assets and all the future income you can get from it". Then someone (might) come along and pay you for the company or a portion of the company.
So an IPO is like that and in that sense it is technically an exit for a portion of your investments if not all. But instead of finding a private person to buy your shares, an IPO is a systematic way to offer your shares /investments to the public at large. Bankers call this the stock market, a part of the capital market.
Price is not the value
And remember the price that 'someone' paid for your RM200,000 company. It might not (most likely will not) be RM200,000. Regardless of how much it means to you, it will transact at how much it means to the buyer. If he is willing to pay only RM150,000 then that is what you get. That is the price. It is definitely not the value to you but that is the price.
Coming up next
1. An IPO lets you do wonderful things which sometimes defy common logic. You can sell a loss making company. Twitter never made a profit and valued at USD12 billion at least.
2. The price might be wrong at the start. Facebook IPO went underwater but now has shoot up way above.
3. The price might be wrong. period.
I will elaborate more about the above in the next posting.
---note---
Yazdi occasionally holds and runs corporate finance workshops, where you could gather the financial sense required to succeed in business or at your workplace. His past participants included senior managements (including a CEO or two) and executives of financial industry (including fund managers, analysts) as well as business practitioners.
If you would like to know more about his upcoming workshop of corporate finance in general, please free to drop your email at this link, here. We will not spam your mailbox - let's keep that personal between us. We appreciate your support and if you could share this with whoever you think might benefit from this (like friends or colleagues), we thank you a gazillion times.
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