Through an Initial Public Offering (IPO), a private company gets listed on stock exchanges and offers its shares to the public for the first time. It enables companies to raise large funds for their growth and development. While investors spend a great deal of time thinking about their market entry, it is also essential to formulate an exit strategy to maximise profits.
In this blog, we will look at some of the IPO exit strategies that you can consider along with other important details.
What Are the Different IPO Exit Strategies?
Detailed below are some of the IPO exit strategies that you can consider for maximising profits:
When an investor acquires shares in an IPO and then sells them on the listing date, it is known as flipping. Stock prices can change significantly on the listing date, which is the first day shares are traded on stock exchanges. Depending on investors’ demand and market outlook, prices may either rise or fall.
Many times, shares of an IPO are in high demand on the listing date which leads to a price increase. Investors who did not get the IPO allotment try to buy shares on the listing day. During this time listing gains can be booked by those investors who got IPO allocation and earn decent profits. Brokers discourage people from practising flipping as company’s need long-term investors..
- Selling and Reinvesting
Often, investors sell off their shares at a loss when stock prices fall on the listing date and later reinvest in the same company at a much lower price in the secondary market. Then, they hold the shares till it generates the desired returns and profits.
It is an effective strategy to offset capital gains with booked losses and reduce tax liability. Financial experts use the term tax loss harvesting to refer to this strategy.
- Long-Term Investing
You can choose IPOs as a long-term mode of investing because good businesses generate wealth over a longer period of time. It has been observed in the past that people who have invested at a time when the IPO price has been the lowest, have earned good returns and profits over the years.
The upward curve of large caps over the past 10 – 20 years demonstrates that this process works. This is referred to as a long-term exit strategy and is also called the buy-and-hold strategy.
After conducting thorough research, if you see that a company holds massive potential for growth in the upcoming years, its IPO can be a good entry point. You can buy the stocks and hold them until it generates the returns you desired. This strategy is commonly employed by passive investors.
Why Do Investors Need an IPO Exit Strategy?
Detailed below are the reasons why investors need an IPO exit strategy in the first place:
- Early investors, promoters, and other insiders have a lock-in period, which prevents them from selling off their stakes immediately after listing. Once this time frame is over, insider selling may have a negative impact on stock prices.
- Moreover, these days, anchor investors have a lock-in period from the date of allotment. Retail investors may not have the ability to handle the price volatility which comes with massive sell-offs by large institutions. That is why they need to have an IPO exit strategy to avoid massive losses.
- Business situations may undergo rapid changes especially because it doesn’t take much time for false moats to disappear. Regulatory changes and disruptions caused by technology may turn an asset into a liability. So, if you have an exit strategy, it will be easier for you to handle changes in different market situations.
- IPO pricing almost always goes in favour of the issuer because company insiders have more knowledge about operations than outsiders. Sometimes, private companies and their auditors may provide incorrect financial figures to turn the entire system in their favour. Misinformation and incorrect figures can result in massive losses for investors which is why a strong IPO exit strategy is so necessary.
- Often, companies might be caught in multi-year down cycles due to sectoral headwinds and various macroeconomic events. Financial experts have observed that some market disruptions are strong enough to reduce profit margins. An investor may not be able to exit with profits in bear markets.
- Investors often find it difficult to identify which stocks will deliver good returns in the future as such traits might simply not be there. Moreover, it has been observed that promising companies that launched much-awaited IPOs plummeted after the listing. In such situations having an IPO exit strategy is quite helpful.
Things to Consider Before Creating an IPO Exit Strategy
Given below are some factors you must consider before devising an IPO exit strategy:
- Before formulating an IPO exit strategy, conduct thorough research on the company, its future potential, and the state of the economy.
- Align your IPO exit strategy with your financial goals.
- Do not forget that the ideal exit strategy may vary from one IPO to another.
- Furthermore, you can consider consulting your financial advisors for helping you with IPO exit strategies.
- Don’t forget to check the lock-in period for the anchor investors. Higher supply can lower the price after lock-in ends.
While it is beneficial, if you look at an IPO from a long-term investment perspective, having an IPO exit strategy will prove to be immensely beneficial in unforeseen circumstances. You can implement some of the above-mentioned exit strategies to book maximum profits and minimise losses. Make sure to do enough due diligence to align the strategy with your financial goals.
Frequently Asked Questions
In which category should an investor bid for the shares in an IPO?
An individual must apply under the ‘retail’ segment if they wish to bid for less than ₹2 lakh. But, if they want to place a bid above ₹2 lakh, the investor has to apply under HNI (High Net-Worth Individual) category.
Does an IPO offer the ideal exit option for start-ups and early investors?
Yes. The underlying concept of start-ups viewing IPOs as an exit strategy is the creation of the right value. Before making an investment, early investors focus on profitability, sound balance sheet, and growth prospects. Although IPOs are a much more complicated process than raising money through private investors, new ventures are increasingly viewing it as a good exit strategy.
What are the formalities I need to complete before participating in an IPO?
You need to make sure that your Demat account is active. The broker needs to make sure that all formalities related to KYC are complete. Before subscribing, the IPO application must be filled out properly.
Can I send more than one application for an IPO?
No, there can be only one application under one PAN. You cannot submit multiple applications or duplicate applications under one PAN. But, suppose you have 4 members in a family. So, putting in 4 applications under 4 different PAN is allowed.
Krishna is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.E. (Hons) in Computer Science Engineering from BITS Pilani and MBA (Finance) from JBIMS, Mumbai. He is currently working as Investments Principal at Wint Wealth. Previously he worked at Kotak Mahindra Bank at their DCM desk and Northern Arc Capital at their Structured Finance desk.