As an entrepreneur, it is common to seek private funding when you want to start a business. These calls for meetings with angel investors and venture capital firms where you will get to present your idea and if they like it, they will fund you in exchange for a percentage in your company. Once you have the equity, you can implement your ideas and strategies.
Within a year or so, your new company will be a fast growing business and you will have the need to expand. This calls for a new strategy – going public. An Initial Public Offering is done which allows your company to start trading on a stock exchange.
A few months or years, your shareholders will want to reduce their position in your company and the only way to do so is through a second offering.
What is a secondary offering?
This refers to the provision of new stock by a public company for trading after an initial public offering. The reason why public companies seek a secondary offering as a solution is because they are looking to refinance.
The proceeds generated from the offering do not go to the issuing company but to the shareholders themselves. This is because the new shares offered for sale dilute the ownership position of the shareholders holding shares bought during the IPO.
The public company issues the new offering via an investment bank which underwrites it.
Types of secondary offering
1. Dilutive Secondary offering
There is no single moment when a business will attest to the fact that they have reached their limit for growth. Growth is not easy and it requires immense capital.
Public companies have to invest in new infrastructure, offices, human capital and others. Conducting a secondary offering after the IPO helps to spread market capitalization.
2. Non dilutive Secondary offering
As said earlier, majority of entrepreneurs start their business by seeking capital from VC’s, angel investors and lenders. This is done in exchange of equity or a share of the company.
There will come a time when the founders or backers of your business would like to decrease their positions in your company.
This secondary offering happens after the termination of the lock up period. These shares are often sold gradually with the purpose of maintaining the share price.
Furthermore, the sale does not increase the number of shares in the market because it’s only done when the company is thinly traded.
How secondary offering works
Privately owned companies and publicly traded companies looking to expand to international markets as well as seek acquisitions need to finance their operations. In an IPO, the companies would be required to seek the assistance of an underwriting firm.
The underwriting firm helps to determine the type of security to be issued, the amount of shares to be issued, the best price and time to sell.
In a secondary offering, an investment bank underwrites the offering. Here is an example to explain both scenarios – dilutive and non-dilutive.
Let’s assume Mike is a venture capitalist. He bankrolled a young business which means he expects a certain share of the company. The young business starts to grow fast and within no time, they need to expand.
To seek new capital, the young business will resort to an IPO. Mike will take this chance to sell off some or all his shares depending with the offer and market conditions. John, a businessman decides to buy into the company during the IPO.
The proceeds from John will go to the company because it sold its shares in the IPO. After a few months, the company decided to acquire another smaller business that is crucial to its growth.
Furthermore, they want to go global. To raise capital, the company will seek the help of an investment bank to issue the secondary offering. The company may decide to issue new shares thus resulting in a dilutive offering.
When John, Mike and other share holders decide to sell, no new shares will be issued. The money gained from the sale will go to the shareholders and not the company. Furthermore, the share price of the company will remain the same.
Final Thoughts
It is important to distinguish between an IPO and secondary offering. While an IPO seeks to raise capital for expansion, secondary offering transfers ownership among investors. This simply means that the benefit of the offering lies towards shareholders as well as the public company in terms of spreading market capitalization.