Traders and investors in the stock market derive a significant portion of their profits from the reaction of stock prices to news related to the issuer. Key events in this context include stock offerings — initial (IPO), secondary (SPO), or follow-on public offerings (FPO). Each of these has its own characteristics for both the company and market participants.
From this article you will learn:
- Initial Public Offerings (IPO) allow private companies to go public, attracting capital while increasing transparency and recognition.
- Secondary Public Offerings (SPO) increase the free-float of shares, enhance liquidity, and attract large investors but do not guarantee profits.
- Follow-on Public Offerings (FPO) can dilute shareholders’ equity and carry potential risks due to the uncertainty of projects funded by the additional capital raised.
What is an IPO?
IPO stands for Initial Public Offering, which translates from English as primary public offering. The term fully reflects the essence of the event:
- “Initial” means that the company’s shares are being offered on the stock market for the first time.
- “Public” means they become available to an unlimited number of market participants.
Effectively, after an IPO, a private company, whose capital was previously solely comprised of contributions from founders/owners, becomes public. Both newly formed companies and long-established, well-known firms can conduct an IPO. The only common requirement for conducting an IPO is that the issuer’s shares have never been offered publicly before.
An IPO does not mean that the company is issuing shares for the first time. Prior to the offering, it may operate as a closed joint-stock company (CJSC), which involves issuing shares and distributing them exclusively among founders and co-owners. Some of these shares may be owned by venture funds.
Primary offerings generally have several objectives:
- Raising funds on favorable terms. Equity capital is non-repayable and can be used by the company for any purposes (in some cases, these purposes are specified in the issuance documents). Additionally, turning a company public typically simplifies access to credit resources and makes them cheaper.
- Fair valuation and maximization of capitalization. The market price of shares generally aims to reflect the fair value, which mirrors the issuer’s efficiency, financial, and operational performance. Naturally, as the share price rises, so does the total value of the company and the absolute value of each shareholder’s stake.
- Increasing transparency, recognition, and rating metrics. As demand for the company’s securities grows among investors, the company’s popularity rises. Moreover, going public involves regular audits with published results and the disclosure of information.
Going public through an IPO involves a series of mandatory steps:
- Decision-making. At this stage, a comprehensive analysis of the company’s activities and structure is conducted, and the potential benefits and risks of going public are calculated.
- Selecting participants (underwriters, bookrunners), choosing a stock exchange, drafting and publishing a memorandum, and conducting a marketing campaign for investors (roadshow).
- Setting the initial stock price, based on the collection of bids from investors.
- Starting the trading.
- Typically, the preparatory activities take about a year.
For investors, buying during the IPO stage is considered a promising investment with potentially maximum profit. However, for both the issuer and the new shareholders, an IPO is not a guarantee of success. There are numerous examples where even well-known companies’ shares have significantly dropped or traded around the offering price for a long time after the start of sales. One of the most notable cases is the more than 25% drop below the offering price in Facebook’s IPO in 2012.
SPO and Its Key Differences
A Secondary Public Offering (SPO) significantly differs from an initial public offering (IPO) in several ways:
- Conducted by a public company: An SPO is carried out by a company whose shares are already traded publicly (free-float).
- Does not change the total number of issued securities: It only increases the proportion of free-float shares.
- Involves the sale of shares previously owned by majority shareholders: Either part or the entirety of their stake is offered to the public.
Reasons for conducting an SPO may include:
- Owners and founders wanting to realize profits.
- Changes in the composition of majority shareholders.
- The need to raise additional funds for company growth or new projects without altering the charter capital.
Generally, investors view an SPO as an event with profit potential due to:
- Increased liquidity of the asset post-SPO.
- Heightened interest from large investors.
- Reduced price volatility and improved price predictability.
- Opportunity to purchase shares at a good discount to market price.
- Improved ratings and index weights due to increased free-float percentage.
However, buying assets during an SPO does not guarantee profits. For example the company might have exhausted its growth potential, prompting majority shareholders to lock in profits and exit.
A significant difference between the offering price and the market price could lead to selling pressure from existing shareholders, causing a drop in stock prices.
FPO and Its Characteristics
A Follow-on Public Offering (FPO) is the process of a company issuing an additional batch of securities. These can be placed on a stock exchange for public sale or distributed to investors through a private placement.
Typically, an issuer conducts an FPO to:
- Raise additional equity capital as non-repayable funds for development.
- Consolidate share packages and, consequently, management rights. For example, if the free-float was 25% (a blocking stake) before the FPO, issuing more shares to majority shareholders, making their stake 50%, would reduce the free-float to just over 14%.
- Increase charter capital to meet minimum requirements for a certain type of activity or due to changes in legislation.
In practice, an FPO follows the same rules as an IPO, falling under the purview of regulators and requiring certain (sometimes significant) expenditures.
From an investor’s perspective, an FPO is generally seen as undesirable or even unprofitable:
- Dilution of shareholders’ stakes due to the issuance of additional securities.
- Projects funded by additional investments may have uncertain prospects.
- Even if the funds raised are used to improve the issuer’s financial condition (e.g., paying off debts), future increased debt burden or further dilution of stakes in assets cannot be ruled out.
In any case, a company’s offering of securities on trading platforms attracts investors’ attention. Making an informed decision to invest in such moments requires a thorough analysis of the issuer, project prospects, and the overall market condition.