India’s IPO market has witnessed a surge in listings, but a significant portion of proceeds often go to existing shareholders rather than funding business expansion. This trend raises important questions for investors about the actual capital available for company growth and future performance.

Understanding Offer for Sale (OFS) in Indian IPOs

In many Indian IPOs, a substantial share of the funds raised comes through the Offer for Sale (OFS) mechanism, where existing shareholders sell their stakes instead of the company issuing new shares. Over the past decade, 60-80% of IPO proceeds have stemmed from OFS transactions, meaning less fresh capital flows into the company for expansion.

The primary sellers in OFS-driven IPOs are company promoters and private equity or venture capital (PE/VC) firms looking to exit their investments. Promoters often use IPOs as an opportunity to cash out portions of their holdings while still retaining control. Meanwhile, PE/VC investors, who typically invested in the company during its early growth stages, sell their shares to realize returns on their investments.

For instance, the highly anticipated IPO of Zomato in 2021 raised ₹9,375 crore, of which ₹375 crore came from the OFS of Info Edge, an early investor in the company. Similarly, in the Paytm IPO, nearly 50% of the ₹18,300 crore raised was attributed to OFS, primarily benefiting pre-IPO investors like SoftBank and Alibaba. These cases illustrate how major IPOs often serve as exit routes for early backers.

Why Do Shareholders Opt to Cash Out?

Several factors drive large shareholder exits during IPOs, ranging from business strategy to market timing considerations. Promoters may dilute holdings to comply with regulatory norms while still maintaining overall control. SEBI mandates that post-IPO, promoters must hold less than 75% of total shares in listed companies, making partial sell-offs a strategic necessity.

For PE/VC investors, IPOs represent the culmination of their investment cycle. Early-stage investors enter companies during their growth phase and typically exit through IPOs or secondary market sales. Their withdrawal signals capital rotation, where funds are redeployed into new high-growth opportunities.

Market sentiment and macroeconomic factors also play a crucial role. Strong bull markets encourage higher OFS participation, as existing shareholders see favorable valuations and increased investor appetite. In contrast, during bearish phases, companies may reduce the OFS portion to attract investors with a greater allocation of fresh capital.

Understanding these dynamics helps investors gauge management intent and shareholder confidence. While OFS-heavy IPOs may indicate a strategic exit, they don’t necessarily imply weak future performance. Careful evaluation of financials, growth potential, and industry position remains essential for making informed investment decisions.

Does a High OFS IPO Impact Future Performance?

Investors often question whether a high Offer for Sale (OFS) component in an IPO signals potential risks. After all, if insiders and early investors are offloading large stakes, does it indicate a lack of confidence in the company’s future?

However, historical trends show that an IPO’s long-term success depends more on business fundamentals, industry outlook, and market conditions than just the proportion of OFS. While excessive insider exits can sometimes be a red flag, many companies with high OFS IPOs have performed exceptionally well in the long run.

For instance, Info Edge significantly reduced its stake in Zomato during its IPO, yet Zomato’s continued growth in India’s food tech space has rewarded long-term investors. Similarly, in the case of Nykaa, high early-stage investor exits didn’t hinder its post-IPO expansion, as strong brand positioning and industry tailwinds drove growth.

That said, investors should carefully assess a company’s financial health, competitive positioning, and reinvestment strategy. If an IPO primarily funds shareholder exits with limited fresh capital for growth, future scalability could be a concern. Conversely, if the company has robust revenue streams and a clear expansion plan, a high OFS should not be a deterrent.

Key Factors for Investors to Consider Before Investing in IPOs

Before investing in an IPO, scrutinizing key variables is essential to making informed decisions:

• Fresh Capital vs. OFS Ratio: Analyze how much of the IPO proceeds will be reinvested in the business rather than benefiting early investors.
• Business Fundamentals: A company with solid revenue growth, profitability, and a scalable model is more likely to generate sustainable returns.
• Industry Trends: Consider whether the company operates in a growth sector with favorable long-term demand drivers.
• Management & Governance: Strong leadership and a sound corporate governance framework enhance investor confidence.
• Valuation & Market Sentiment: Ensure the IPO is priced reasonably compared to peers and overall market conditions support investments.

Ultimately, not all high OFS IPOs are bad investments. The key lies in evaluating business viability beyond share sales.

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Disclaimer

Disclaimer: The numbers may not be exact. The information provided herein is solely for informational purposes. It should not be construed as investment advice, an offer to sell, or a solicitation of an offer to buy any securities or financial products. Mintbyte is not liable for any losses incurred from using this information. Investors are strongly advised to seek independent professional advice and carefully consider their investment objectives, risk tolerance, and financial situation before making investment decisions.