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Financing Checklists

Raising Capital by Issuing Shares


Checklist Description

This checklist describes how companies can raise capital by issuing shares.

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Definition

A company that wants to raise capital by issuing shares has several options. If it is not yet listed on a stock exchange, the company can prepare for an initial public offering (IPO), in which it will be valued and an opening price will be set for its shares when they are released onto the market. How much finance can be raised through an IPO depends partly on the perceived value, and thus share price, of the company, and partly on how much interest there is in the shares when they are released on the market.

For a company that is already listed on an exchange, an alternative route is to launch an additional share issue (also known as a seasoned equity offering, or SEO) or a rights issue. A SEO is a new equity issue by a company following its IPO. A rights issue permits existing stockholders to purchase a designated number of new shares from a company at a specified price within a specified time. The offer may be rejected, or accepted in full or in part, by each stockholder. Rights are usually transferable, meaning that the holder can sell them on the open market. The additional shares in a rights issue are generally issued to stockholders on a pro rata basis—for example, in a two-for-five rights issue stockholders are offered two shares for every five they already hold.

Renounceable rights are rights offered by a company to existing stockholders to purchase further stock, usually at a discount. These rights have a value and can be traded. If rights are to be issued, the company has to set the price of the new shares, determine how many it will sell, and assess how the current share value will be affected as well as the effect on new and existing stockholders. Nonrenounceable rights are not transferable and cannot be bought or sold; these rights must be taken up or they will lapse.

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Advantages

  • For a company that has reached a certain size and has a strong reputation, an IPO can be a good route to raising a large sum of capital that will enable it to expand, or invest in assets that will enable it to grow in the future.

  • The company does not need to repay this share capital, but instead agrees to distribute future profits to stockholders in return for their investment.

  • Once listed, a company can periodically issue further shares via a rights issue, raising yet more capital for expansion without running up debt. Being in a position to raise capital from the stock markets, rather than privately from individual investors, is a major incentive for many companies to issue shares on an exchange.

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Disadvantages

  • The main disadvantage of issuing shares through an IPO is that a company’s owners no longer have full control of the business and become accountable to stockholders. Stockholders can block plans if they believe they pose too great a risk to their investment.

  • Any issuance of further shares dilutes the holdings of existing stockholders as a proportion of the company’s total shares. This can lead to dissatisfaction from minority stockholders, who have the most to lose. In some jurisdictions, such as the UK, stockholders have preemptive rights by law, which means they have the right to purchase new issuances first. In other jurisdictions, such as the US, preemptive rights must be enshrined in a company’s constitution. Stockholders who do not have preemptive rights are most at risk of seeing their investment diluted.

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Action Checklist

  • Consider whether options for raising capital other than a share issue might be more suited to your investment plans.

  • Consult your bank and other financial advisers on the time scale for an IPO or rights issues, and on the timing of the offer.

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Dos and Don’ts

Do

  • Issue a proper prospectus for your share offer.

  • Keep stockholders informed about how much dividend they can expect to receive each year.

Don’t

  • Don’t issue shares if you are not prepared to give up a certain amount of decision-making to stockholders.

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Further reading

Books:

  • Gregoriou, Greg N. Initial Public Offerings: An International Perspective. Amsterdam: Butterworth-Heinemann, 2006.
  • Temple, Peter. First Steps in Shares. Harlow, UK: Pearson Education, 2001.

Articles:

  • Goergen, Marc, Arif Khurshed, and Ram Mudambi. “The strategy of going public: How UK firms choose their listing contracts.” Journal of Business Finance and Accounting 33:1–2 (January/March 2006): 79–101. Online at: dx.doi.org/10.1111/j.1468-5957.2006.00657.x
  • Loughran, Tim, and Jay R. Ritter. “Why don’t issuers get upset about leaving money on the table in IPOs?” Review of Financial Studies 15:2 (Spring 2002): 413–444. Online at: dx.doi.org/10.1093/rfs/15.2.413

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