There are two ways of raising equity capital for any company - private equity funding or public offering of shares (IPO). Both have different implications, advantages & disadvantages and may be suitable for SMEs at different stages.
Let’s discuss both of these funding methods and how they affect SMEs' business;
What is Private Equity Financing for SMEs?
Private Equity (PE) funding is a way to raise the capital required from a small group of investors such as angel investors, venture capitalists (VC), or private equity firms/ institutional investors. Thus, when an SME offers its shares to a selected group of investors, it is called a private offering.
These investors inject capital into the company to pursue expansion and growth strategies, and in return for the money invested, they get a stake in the company.
SMEs in their early growth phase need more than just capital, including strategic insights and operational and managerial guidance for business growth; PE funding is the best for them.
What is a Public Offering of Shares or SME IPO?
In public issues, an SME offers its shares to the general public. Thus, it is the first time a company sells shares to the general public in the primary market and gets listed on the stock exchange. BSE SME and NSE Emerge (NSE SME) are the two platforms for listing SME shares.
Unlike private placement, in the IPO, an SME aims to raise capital from a wider pool of investors, including institutional investors, wealthy individuals, and retail investors.
Once the company is listed, it becomes a publicly traded company.
Private Placement Vs SME IPO Public Offering: 10 Key Differences
Let's point out the important difference between fundraising through private placement and via SME IPO .
| Private placement of shares | SME IPO | |
| Meaning | A private placement is a process of offering shares to a targeted group of investors for fundraising. | SME makes a share sell offer to the general public to raise the required capital. In a public offering, an SME not only raises funds but also gets listing benefits on the SME Exchange. |
| Company status | The SME remains a privately held company. | In the event of an IPO, the company status quo changes from private to publicly traded company. Post-listing, its shares will be bought and sold on the respective exchange. Thus, listing provides a credible trading platform to all investors. |
| Investor Group | Private Equity funding targets restricted investor groups, more particularly, large institutions i.e., pension fund houses, insurance companies, etc. These investors can provide significant access to capital for SMEs to grow and expand. |
In a public offering, as the company sells securities to the public thus, funds are raised from a larger group of investors' qualified institutional investors, high net-worth individuals, and retail investors. |
| Access to Capital | The company sells shares to a limited number of accredited investors to raise targeted funding for expansion. | IPO is the best way to raise a substantial amount of capital from the general public. Thus, SME IPO provides larger access to capital than private offering. |
| Controlling Power and Impact on business decision making | PE firms acquire a considerable stake in the company and may seek a board seat and also participate in business decisions. The best thing here is institutional investors bring in industry expertise, diversified experience, and strategic guidance to help in SME's growth. Also, their valuable network and connections in the industry help you get the required resources you need for expansion. |
Though selling shares means transferring control in the company, but majority of stake and controlling power remain in the hands of SME promoters. |
| Regulatory requirements | Raising funds from a targeted pool of investors does not have strict regulatory requirements. | SMEs going public are subject to various regulatory compliance i.e., satisfy exchange eligibility criteria, due diligence assessment, legal and regulatory compliance, audited financial statements, disclosure of risks, underwriting, and much more. Once an SME gets listed, it is required to submit half-yearly and annual reports, shareholding structure, and various ongoing compliances. |
| Exit Pressure | Institutional investors may put exit pressure via IPO acquisition or OFS to realize return by offloading their investment. | After SME listing, all the shares buy and sell transactions are held on the exchange, which means no question of exit pressure. Any investors - be it institutional or retail can place a share sell order anytime on the exchange. |
| Intermediaries involved | No mediators are involved while raising funds from private investors. SMEs seeking funding pitch institutional investors and convince them to invest showing their growth and scalability potential. | Various intermediaries are involved in the SME IPO issue process, like merchant bankers/lead managers, financial advisors, auditors, underwriters, legal counsel, and more. |
| Valuation | Private companies do not have comparable peers so market-approach cannot be used. So, valuation typically is based on analysis of SME's customer base, revenue, profitability, and growth prospectus. | SMEs ready to go public are mature and have a good track record, so it's quite easy to find listed peers for comparison. Discounted Cash Flow (DCF) is the most commonly used method for valuation. |
| Negotiation | Negotiation makes a big difference in funds required and actual funds raised. Private equity investors usually negotiate on valuation and equity stake to finalize the deal. | Once the SME IPO issuer company with the merchant banker, decides the IPO price, there is no room for negotiation. All investors, including institutional and retail investors, must apply for the IPO at the offered price. |
SME IPO Vs Private Placement: Which Is The Best Funding Solution for You?
SMEs looking to raise funds but struggling to find the right funding solution? Both Private and public offering are the ideal ways to raise capital for different types of companies.
- IPO is the best for matured SMEs seeking a large influx of capital for growth. Though there are many benefits of SME IPO, including higher brand visibility and prestige, high credibility, and public awareness, but before IPO, one must analyze the cost of going public, market scrutiny, and compliance with regulatory norms.
- Private Equity funding is the best fundraising method for early-stage SMEs, who need capital access alongwith strategic guidance, networking access, and managerial assistance. Obtaining funds from targeted investors is a fast and cost-effective process and maintains confidentiality.
