25556 Chap.15 IPOs and Raising Additional Equity
IPOs and Raising Additional Equity
The last part of Topic 7 follows a company onto the share market and beyond. An initial public offering, or float, is the first sale of a company's shares to the public for a stock exchange listing, and it can raise growth capital, let founders sell down, or both.
Going public brings liquidity and financial strength, but it is expensive, dilutes the continuing owners and separates ownership from management.
This chapter sets out the float process from appointing a manager and preparing the prospectus to due diligence, audited accounts, the three marketing phases and the setting of the issue price.
It explains why small and large floats are priced differently, why issue prices tend to sit below the first-day close, and the competing explanations for that underpricing. It then compares the ways a listed company raises more equity: retained earnings, rights issues, placements and dividend reinvestment plans, with the dilution arithmetic each implies.
What this chapter covers
- 01
Purposes of an initial public offering
- 02
Advantages and drawbacks of going public
- 03
The float process and the prospectus
- 04
Bookbuilds, best efforts and IPO pricing
- 05
Underpricing and money left on the table
- 06
Rights issues, placements and dividend reinvestment plans
Worked example · free
Put the stages of an initial public offering in order for a software float
- 1Preparation comes first: choose the manager, prepare the prospectus, carry out due diligence checks and audit the accounts.
- 1Marketing follows in three phases: pre-marketing, then the roadshow and bookbuild that gather orders, then pricing and allocation, ending on listing day.
- 1Investor protection: the prospectus, required under ASIC and ASX rules, discloses the company, its directors and its prospects, while due diligence and the audit verify what the prospectus claims.
- 1A small float usually lacks comparable issues and is mostly sold on a best-efforts basis, which gives the manager an incentive to set a low price; a large float sets its price through the bookbuild and tries to time the issue for a rising market.
Key terms
- Prospectus
- The disclosure document required for a float, describing the company, its directors, the issue and the shares as an investment.
- Bookbuild
- The process of collecting investors' orders during a float's marketing so that the issue price can be set from demand.
- Underpricing
- Setting an issue price below the first-day closing price, so the company raises less than it could have.
- Rights issue
- An offer of new shares to existing holders in proportion to their holdings, at a price below the market.
- Private placement
- A sale of new shares to selected investors, typically institutions, without a pro rata offer to every holder.
- Dividend reinvestment plan
- An arrangement that gives holders new shares in place of a cash dividend, without transaction fees.
IPOs and Raising Additional Equity FAQ
Why do companies go public?
A float can raise new equity to fund growth, let existing owners sell some or all of their holdings, or do both. Listing also strengthens the balance sheet, gives investors a liquid holding and widens the ways the company can reward staff, though it is costly and dilutes the continuing owners.
What does a prospectus do in an IPO?
It is required under ASIC and ASX rules and has two purposes: to give potential investors accurate and complete information about the company, its directors, the issue and the investment case for the shares, and to help market them. Due diligence verifies the claims it makes before it is issued.
What is money left on the table?
It is the amount a company gives up when its issue price is below the first-day closing price, equal to that price gap multiplied by the shares sold. The company raises less than it could have, and investors who bought at the issue price make an immediate gain.
How is a rights issue different from a placement?
A rights issue offers new shares to every existing holder in proportion to their holding, usually at a discount, so holders who take up their rights keep their percentage. A placement sells to chosen investors; it is quicker and cheaper and often achieves a better price, but it dilutes everyone else and ASX rules limit its size.
Are rights issues risky for the company?
Yes. If the market price drops under the subscription price before the closing date, holders will not take up their rights and the raising can fail, although it can be underwritten. Rights issues also require a prospectus, which makes them expensive compared with a placement.
Exam move
Draw the float process from memory as two rows, preparation and marketing, and check the order against the chapter. Then write one sentence for each explanation of underpricing and invent a short case where it is the best fit, because explanations are easier to recall when attached to facts.
Practise the dilution arithmetic with your own share counts, working out a holder's stake after a placement, after taking up rights and after letting them lapse. Finish with a three-column comparison of rights issues, placements and dividend reinvestment plans covering cost, speed and who ends up owning the new shares. Test yourself by explaining each method's main risk to a classmate who has not studied the topic.
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