The recent IPO frenzy in Dalal Street saw dozens of companies raising capital through IPOs. The raised capital from these IPOs was 57,000 Crore rupees but did you know that only 20% of this raised amount actually went to the company and the other 80% went to the exiting investor. That is where the concept of Fresh Issue and Offer for sale of shares in an IPO come into play.
Lets look at an example and understand:
You own a company called ABC. This company sells soaps. Let’s say this company was started by you and your friend. This company’s share capital is composed of 1,00,000 shares worth 100 rupees each. Both you and your friend own 50,000 shares each of 100₹. Therefore the total value of company is 1,00,00,000₹ (1,00,000 shares * 100₹).
Suppose your company earns 1,00,000₹ in year 2007. Since you and your friend own 50% each of the company, you and your friend are entitled to 50,000₹ each.
We can depict this profit sharing in another way which is how it is done in a publicly traded company. Since there are 1,00,000 total shares of company , and earnings are 1,00,000₹ , hence Earnings per share is 1₹ (1,00,000 divided by total number of shares which are 1,00,000). Since you and your friend own 50,000 shares each, the respective earnings for each person is 50,000 into 1₹ = 50,000₹
Now let’s say the company has earned a profit of 10,00,00,000₹ in 2017(Naturally their respective share of profits is 50,00,000₹ and earnings per share is 1000₹). The company wants to raise capital, and they consider doing an IPO. They can do it through an Offer for Sale or an Fresh issuance of shares.
Fresh Issue: This refers to the issuance of new equity shares in the company and selling those newly issued shares to the investors. For example let’s say a company has 20 shares, and a profit of 30 rupees. Naturally earnings per share is 1.5 rupee (30 rupees/20 shares). Now company wants to raise capital , so it issues fresh shares (let’s say 10 shares at 2 rupees each) , and company raises 20 rupees. But because of new shares, the earnings of 30 rupees will be divided into 30 shares instead of earlier 20 shares (EPS falls to 1 rupee per share from 1.5 rupee per share). Also earlier the company was owned 100% by a single person, now it’s just owned 75% (this is what is called Equity Dilution). The money raised by the fresh issue of shares and its subsequent sale in an IPO is received by the company and utilized as per the objects of the issue which is mentioned during its IPO.
Offer for Sale: Offer for sale means selling of shares by an existing promoter/investor of the company. Let us understand with an example. We have a company called ABC , which is owned 70% by A and 30% by B. Now B wants to decrease his stake to 15% and hence he sells his 15% of his total shares via an offer for sale. Here the money raised will all be received by B as he is selling his own shares and not issuing fresh ones. The main advantage of OFS is that it does not lead to equity dilution but the main disadvantage is that the company does not receive any money which will be raised.