What it means
In a public offering the company, usually with help from investment banks, invites anyone eligible to buy new securities. The banks market the deal to institutional investors and sometimes to individuals, and the sale ends with the securities trading on an exchange.
The banks usually take on part of the risk by agreeing to buy any unsold securities, a process called underwriting. The process is heavily regulated.
The company must file a registration document with the securities regulator, publish a prospectus describing the business, risks and use of the money, and have its accounts audited, so investors can make an informed decision. There are two broad types.
An initial public offering is the first sale of shares to the public, and a follow-on offering is a later sale by a company that is already listed, often to fund an acquisition or reduce debt. An offering may involve new shares, which raise money for the company, or existing shares sold by current owners, which put cash in their pockets instead.
A mix of the two is common, and the prospectus explains how much of each is on offer. The nuance is that raising money is not free.
Banks charge an underwriting fee, there are legal and audit costs, and issuing new shares reduces the percentage held by existing owners, which is called dilution. Existing owners accept dilution because they hope a larger company will be worth more in total.
A public offering also changes the company permanently. After the sale, it must report regularly, comply with listing rules and answer to a much wider group of shareholders.
Many managers say the discipline improves decision making, although others find the constant reporting a burden.
In practice
Real-world examples.
Example
A fast-growing medical device maker lists on a stock exchange and sells new shares to fund a second factory. The finance team uses part of the money to repay bank loans, which reduces interest costs and strengthens the balance sheet. Interest cover improves, and the company can borrow more cheaply in future.
Example
A listed retailer announces a follow-on offering to finance the purchase of a competitor. The share price dips slightly on the day because investors expect dilution, but recovers after management explains the expected savings. The deal raises $250,000,000 and the acquisition completes on schedule.
Example
A founder of a software business sells part of her own shares in the company's offering. She receives cash as a personal gain, and the company receives nothing from her portion, which the prospectus makes clear to buyers. Buyers read this as a sign that the founder is taking some money off the table, which can be a mixed signal.
Formula
Calculation
Net proceeds = (shares sold x offer price) - underwriting fees - other expenses
Suppose a company sells 5,000,000 new shares at $20 each. Gross proceeds = 5,000,000 x 20 = $100,000,000. The underwriting fee is 5% of that amount, which is 100,000,000 x 0.05 = $5,000,000. Legal, audit and filing costs add $1,500,000. Net proceeds = 100,000,000 - 5,000,000 - 1,500,000 = $93,500,000, or 93.5% of the gross amount raised.Case study
Seen in the real world.
Coastline Solar is an illustrative, fictional installer of rooftop solar systems with rapidly rising orders. Its bank facility could not support the working capital needed, so the board agreed to a public offering.
The chief financial officer modelled the net proceeds after fees and compared them with the planned spending on stock, vehicles and staff. She also showed how existing owners' percentage stakes would fall. The board compared that cost with the alternative of arranging a larger bank facility at a higher interest rate.
The deal raised enough to double capacity and repay the most expensive loans. The illustrative lesson is that a public offering suits a business with a clear use for the money, and the cost of raising it should be counted before the plan is approved. Coastline's board now reviews the fees line by line before any future issue is launched.
Watch out
Common mistakes.
- Treating gross proceeds as the amount the company keeps, when underwriting fees and other costs can take a meaningful share.
- Assuming all the money goes to the company, when part of an offering may be existing shareholders selling their own shares.
- Forgetting dilution, which reduces the ownership percentage of existing shareholders when new shares are issued.
Questions
People also ask.
Is a public offering the same as an IPO?
Not exactly, because an IPO is the first public offering, while a follow-on offering is made by a company that is already listed.
Why do companies choose a public offering?
They can raise large sums, create a market for their shares, gain public visibility and give early investors a way to sell. A listing also makes shares a useful currency for paying staff and buying other companies.
Who decides the offer price?
The company and its underwriters agree it, usually after gauging demand from institutional investors in a process called bookbuilding. Strong demand allows a higher price, and weak demand usually means a lower one.
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