Study Notes: Business Finance & Accounting

New share issues via public flotations

Introduction

There are three main ways of raising equity finance:

- Retaining profits in the business (rather than distributing them to equity shareholders);

- Selling new shares to existing shareholders (a "rights issue")

- Selling new shares to the general public and investing institutions

This revision note outlines the process involved in the third method above.

How significant are new issues of shares in the UK?

Issues of new shares to the public account for around 10% of new equity finance in the UK.

Whilst not significant in the overall context of UK equity financing, when new issues do occur, they are often large in terms of the amount raised.

New issues are usually used at the time a business first obtains a listing on the Stock Exchange. This process is called an Initial Public Offering (“IPO”) or a “flotation”.

Methods

The process of a stock market flotation can apply both to private and nationalised share issues. There are also several methods that can be used. These methods are:

• An introduction

• Issue by tender

• Offer for sale

• Placing, and

• A public issue

In practice the “offer for sale” method is the most common method of flotation. There is no restriction on the amount of capital raised by this method.

The general procedures followed by the various methods of flotation are broadly the same. These include

- Advertising, e.g. in newspapers

- Following legal requirements, and Stock Exchange regulations in terms of the large volumes of information which must be provided. Great expense is incurred in providing this information, e.g. lawyers, accountants, other advisors.

Why issue new shares on a stock exchange?

The following are reasons why a company may seek a stock market listing:

(1) Access to a wider pool of finance

A stock market listing widens the number of potential investors. It may also improve the company's credit rating, making debt finance easier and cheaper to obtain.

(2) Improved marketability of shares

Shares that are traded on the stock market can be bought and sold in relatively small quantities at any time. Existing investors can easily realise a part of their holding.

(3) Transfer of capital to other uses

Founder owners may wish to liquidate the major part of their holding either for personal reasons or for investment in other new business opportunities.

(4) Enhancement of company image

Quoted companies are commonly believed to be more financially stable. A stock exchange listing may improve the image of the company with its customers and suppliers, allowing it to gain additional business and to improve its buying power.

(5) Facilitation of growth by acquisition

A listed company is in a better position to make a paper offer for a target company than an unlisted one.

However, the owners of a private company which becomes a listed plc (public company) must accept that the change is likely to involve a significant loss of control to a wider circle of investors. The risk of the company being taken over will also increase following listing.