By: Christopher Dier-Scalise
One of the main reasons for a company to go public is it enables them to raise money whenever they need it via the capital markets.
We see this all the time. Companies raise money to fund new research (most commonly seen in biotechs looking to fund drug development), give themselves added balance sheet flexibility, finance an acquisition, or simply take advantage of a high stock price.
We saw the latter happen last week with Viacom (VIAC), which announced it would raise $3 billion by issuing new shares after the stock had more than doubled in the first three months of 2021.
In the case of Viacom, the mechanics of the offering triggered a margin call and subsequent crash in the stock. But most secondary stock offerings are not nearly as eventful.
Dilutive Secondary Offering
This is the main type of secondary offering. In a dilutive secondary, the company will create new shares out of thin air and sell them into the market via investment banks (underwriters).
The selling of these shares into the market will subsequently raise new money for the company, however, it will also increase the float, or total shares available for trade, thereby slightly diluting the value of current shares.
A stock might drop slightly on news of a secondary offering, though very often the price that the underwriters sell new shares at can act as a temporary floor for the stock, as the market may interpret it to mean there is a large supply of buyers at that level.
For example, if Company A prices a 4 million share secondary offering at $20, that’s a signal to the rest of the market that the underwriters were able to find willing buyers for the stock at that price.
Offering prices and size are usually set by the underwriter a day or two after the company files for the offering with the SEC.
Non-Dilutive Secondary Offering
In a non-dilutive secondary, a selling shareholder (such as a company insider or institutional investor) will offer a large block of shares to the market. In these instances, the company is not receiving any proceeds from the sale, as no new shares were created.
Instead, all proceeds from the sale go to the selling shareholder. The shares outstanding count will remain the same, though the float may increase if the shares being sold were previously restricted.
For shareholders, shelf offerings have the same effect as dilutive secondaries. The main difference is the flexibility provided to the company.
In a shelf offering, a company registers to sell shares as they would in a dilutive secondary, but they do not have to sell those shares right away. Companies are allowed to register for a shelf offering up to three years in advance, essentially giving themselves the option to sell those shares “off the shelf” should they need it.
This window allows companies more time to assess how much capital they’d like to raise, wait for better market conditions, or do the offering in phases over time without having to file additional paperwork with the SEC.
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The author holds no positions in any of the stocks or indices mentioned.
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