In order for a business to grow, capital is needed. There are two ways in which money can be raised–equity or debt. Equity is the capital that the entrepreneur or the promoter or group of promoters bring in a proprietary partnership or a private limited company. Debt is the component that lenders loan to the business, which is to be repaid over a fixed tenure.
When a private limited company intends to raise more capital through the primary market, it has to go through the IPO route or the Initial Public Offering route. Here, the company seeks funds through a process where the general public can invest in the company.
By investing in the company, the public is essentially becoming a partner in it. In order to seek such partners, a company has offered a price at which it is willing to take them. This offer price at the time of an IPO has two components–Face Value and premium.
In order to understand these terms, let’s first dive deep into understanding the IPO process.
It is the merchant banker, who through their experience and market study, informs the issuer on the pricing that the company can charge. Looking at the mood of the market, the company’s fundamentals and the relative valuation of its peers, the merchant banker suggests the issue price.
A company can have a face value of as low as Re 1 and any number above that. Most companies in India have a face value between Re 1 and Rs 100. The most common numbers apart from these two are Rs 2, Rs 5, and Rs 10.
Face value is also the minimum price at which a company can raise money. If a company having a face value of Rs 10 decides to raise funds at the face value or at Rs 10, it is said that the company is raising money at par.
Most companies have raised money at a face value of Rs 10 and a premium above it. If the share price of the company increases in higher four digits or five digits, it is observed that the trading volume in the company reduces in the secondary market. In order to attract more investors to the company and have a wider investor base, face value is reduced.
A change in face value impacts the earning per share (EPS) of the company, which in turn impacts the price to earnings or PE ratio, one that is among the most important valuation ratio monitored.
The dividend announced by the company is also based on the face value. If a company has a face value of Rs 10 and announces a dividend of 30 percent, it means that the dividend payout will be Rs 10 * 30% = Rs 3 per share.
Conclusion
Understanding of face value is very important both at the time of IPO when the company is raising funds and also at the time when it is being actively traded in the secondary market. A number of corporate actions like dividends, rights, and splits of shares are announced on the basis of face value. Important ratios and valuation parameters use face value as an important component.
When a private limited company intends to raise more capital through the primary market, it has to go through the IPO route or the Initial Public Offering route. Here, the company seeks funds through a process where the general public can invest in the company.
The price that a company asks from investors to subscribe to its issue is the IPO price. There are two components of an IPO price, the face value and the premium.
A Face Value is the par value or the nominal value of one share. The face value is fixed by the company.
If the share price of the company increases in higher four digits or five digits, it is observed that the trading volume in the company reduces in the secondary market. In order to attract more investors to the company and have a wider investor base, face value is reduced.
The premium is the money over and above the face value that a company demands from the investors during the IPO. Looking at the mood of the market, the company's fundamentals and the relative valuation of its peers, the merchant banker suggests the issue price.
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