Companies often use IPO to sell their shares to the public to raise equity capital from public investors. The IPO process converts a privately-held company into a public one and offers savvy investors the chance to achieve substantial returns on their investments.

While the most common form of an IPO is an equity IPO, an alternative is the debt IPO.

What Are Debt IPOs?

Debt IPOs, or public issues of debt, are a method by which businesses raise capital by offering debt instruments to the public. This approach allows companies to secure funding through either private debt placements or public bond offerings, also known as bond IPOs. Typically, these private placements are more accessible to large institutional investors rather than individual investors, due to the specialised nature of these transactions and the timing and specifics of such issuances.

In India, the Securities and Exchange Board of India (SEBI) regulates the issuance of these debt instruments, imposing certain restrictions and requirements. These include limitations on the number of private placements a company can undertake in a given year and high minimum investment thresholds, which often restrict individual investors from participating directly.

For businesses seeking to borrow from the general public, they can issue non-convertible debentures (NCDs). NCDs are fixed-term debt instruments that offer a fixed rate of return and cannot be converted into equity shares.

NCDs offer investors fixed returns and are often considered a safer investment compared to equities, though they come with varying levels of risk depending on whether they are secured or unsecured. The interest rates on NCDs are typically higher than those offered by convertible debentures or fixed deposits, reflecting the risk and return profile of these debt instruments.

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Types of Debt IPOs

Secured NCDs: These are backed by the company’s assets, which act as collateral. In the event of default, the company's assets can be liquidated to repay the debt. This provides a level of security for investors, who are therefore typically offered lower interest rates compared to unsecured NCDs.

Unsecured NCDs: These are not backed by any collateral, making them riskier for investors. To compensate for this higher risk, unsecured NCDs generally offer higher interest rates. Investors in these instruments face a greater risk of loss if the company defaults, but the higher returns are intended to offset this risk.

Difference Between Debt IPO and Equity IPO

The primary distinction between a debt IPO and an equity IPO lies in the type of instruments used to raise capital. In a debt IPO, the company issues debt instruments like Non-Convertible Debentures (NCDs), while in an equity IPO, the company offers shares of stock.

Allocation Method: Funds raised through debt IPOs are typically allocated on a first-come, first-served basis. In an equity IPO, shares are allotted through a computerized system, especially if the IPO is oversubscribed.

Ownership Impact: There is no change in ownership with a debt IPO, as it establishes a borrower-lender relationship. In contrast, an equity IPO results in a change in ownership, with investors becoming part-owners of the company.

Return Structure: Investors in a debt IPO receive fixed returns at regular intervals. In an equity IPO, returns are not fixed and are subject to market fluctuations.

Risk and Return Profile: Debt IPOs carry moderate risk and provide moderate returns. Equity IPOs, on the other hand, come with higher risk but the potential for greater returns. Investors must evaluate their risk tolerance and expected returns before investing.

Investment Duration: Debt IPOs have a fixed maturity date, defining the timeframe for investment. In contrast, equity IPOs do not have a fixed timeframe; investors can choose when to sell their shares after the IPO.

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Disclaimer: This content was partially produced with the help of Benzinga Neuro and was reviewed and published by Benzinga editors.