Let’s talk about companies!
What is a company? A company is a legal entity that is capable of carrying out transactions, owning assets, and having liabilities. Interestingly, the owner of a company and a company are two distinct entities according to the Companies Act, of 2013, which contains the laws all companies are required to fulfill.
There are several kinds of companies explained in the Act, but the most prominent ones are Public Companies and Private Companies. One can differentiate between the two by their ending initials: Private companies end with “Pvt. Ltd. in India” (for example- Google India Pvt. Ltd., the Indian subsidiary of Google LLC) while Public companies end only with “Ltd.” (for example- Reliance Industries Ltd.) where ‘Ltd.’ stands for ‘Limited’.
By definition, a public company is a company where the general public is an investor. Private companies, on the other hand, are those which are privately owned or do not have any public investment.
Having a Private company is beneficial since the number of laws and regulations to be complied with are lower than that of a Public company. So why would anyone incorporate a public company? One needs to incorporate a public company to raise funds from the public i.e. list its shares on stock exchanges.
Companies who raise funds from the public are accountable for it, so to safeguard the money of the general population, this rule was put in place. Now we steer our discussion to a company’s fundraising methods.
These days we hear a lot about startups. Recently, a Tata Group company called ‘Tata 1mg’ turned unicorn i.e. a privately held startup company with a valuation of $1 billion or more. As a matter of fact, India currently has over 100 such startups! A startup is a company in its early stages of operations, sometimes to the extent that it isn’t even earning anything.
So how will such a company raise funds? Taking a loan from a bank is always an option for all companies, but how does a startup avail of bank loans? They do not have collateral to offer or sufficient revenues to pay the principal, let alone the piling interest.
So, startups who can present a commercially viable idea (product or service) raise funds from entities like Angel investors, venture capitalists, private equity funds, etc. by giving them shares.
A great example of an Angel investor is Mr. Anupam Mittal, founder of the People’s Group (which manages shaadi.com and several other sites) and one of the sharks from Shark Tank India.
In April 2011, Mr. Mittal had invested somewhere around Rs 50-60 lakhs in Ola, which was in its infancy at the time, for 2% ownership in the company. The same investment grew to Rs 25 crores in three years!!
All the entities mentioned above invest in companies that are unlisted. These companies are generally in their growth phase and end up creating great value for their investors. They receive funding in the following series of rounds:
- Pre-Seed Funding= Pre-seed is the earliest round of funding for a company. At this point, the startup is just an idea that hasn’t been implemented. A blueprint detailing the business is on paper, but funds are needed to bring them into reality. In this round, the founders or family/friends are the investors.
- Seed Funding= This is a company’s first official stage of funding where it presents its idea to institutional and angel investors to raise funds, significantly higher than the money invested in the pre-seed round. This round allows the company to undertake greater expenses to get the company going toward its vision.
- Series-A= The first round after the seed funding and the first in the series of funding rounds is the ‘Series-A’ round. From this round onwards, investors aren’t just looking for a company with a good idea. They are also looking for companies with plans to monetize these ideas effectively. The quantum of funds raised is fairly higher than those raised in the seed funding round.
- Series-B= The number of rounds proceeds alphabetically from the ‘Series-A’ round and the series progresses as the company grows. The companies that head in to raise funds in ‘Series-B’ are more established and have higher valuations. Typically, investors from the ‘Series-A’ round infuse additional capital into the company while a few other investors join in to invest in the company.
- Series-C= By this point, the company has already raised a lot of funds and is quite successful at its business. They may not be profitable, but have grown well, earn fairly high revenues, have clear expansion plans, and are on the path to profitability (if not profitable already). The pool of investors grows fairly large by this round as companies are raising funds to fund greater expansion plans, normally global in nature.
There is no set limit of rounds that every startup goes through, they could stop at C or go up to J or K! Funds are raised when necessary and equity is diluted on every fundraiser. Normally, the founders dilute their holding, but some investors may also offload their stake i.e. sell their stake to other interested investors if they decide to book a profit.
How long do these investors hold on to these holdings? As stated above, investors may get off early when they have realized their desired amount of profit, or until the company goes public, referred to as an IPO.
An Initial Public Offering (IPO) refers to the offer where a company lists its shares on stock exchanges for the first time. These companies are required to file a Prospectus [Draft Red Herring Prospectus in India (DRHP)] with the regulator of the stock exchanges (SEBI in India).
The company hires investment banks to act as managers for the issue and these IBs take care of all the regulatory requirements of the issue as well as the pricing, in order to maintain a fair valuation which is mentioned in the prospectus. This prospectus contains all relevant details of the IPO (also called public issue) such as the size of the issue, the basics of the company, the reasons for the issue, etc.
After approval by the regulator, the company floats the issue which is divided into the following 3 categories: Institutional investors, High Net worth Individuals & Retail investors. As normal middle-class investors, we fall under the category of Retail investors. An IPO is ‘subscribed’ by all three categories by bidding for ‘lots’ of a company’s shares (not higher than Rs 15,000 per lot).
After applying for the IPO, which can be done by your broker, funds are not deducted from your bank account. A ‘hold’ is maintained on the funds until the day of allotment. If your bid is eligible to be allotted the shares, the amount is deducted from your bank account and the shares are credited to your Demat account. After allotment, comes listing. Listing is the date on which the shares of the company are listed on the stock exchange, ready to be traded by the public. After this date, members of the public who did not receive allotment or did not apply in the IPO can buy these shares from investors who did, making the company’s stock a publicly traded stock.
Fun Fact: World’s largest IPO was the IPO of Saudi Aramco, Saudi Arabia’s state-owned oil company. The company offered 3 billion shares for sale in the IPO with an issue size of a staggering $29.4 billion, which valued the company at $1.7 trillion!