Chapter 6: Issue of Shares

Chapter 6: Issue of Shares

Introduction

• Exploration of how companies issue securities.
• Two primary types of transactions:
  • New Issues (Primary Market Transactions): Issuer, such as a company, raises funds by selling securities to lenders (e.g., pension funds, insurance companies).
  • Secondary Market Transactions: Involves the sale of securities from one investor to another investor.

Stock Exchange Quotations

• When a company is quoted on the stock exchange, the price of its securities appears on the official exchange list.
  • Listed Securities: Securities that are officially quoted.
• Requirements for obtaining a quotation include:
  • Must be a public limited company.
  • At least 25% of shares held in public hands.
  • Must have 3 years of trading records.
  • Annual audited financial reports required.

Reasons for Obtaining a Quotation on the Stock Exchange

1. Raise Capital:
   • Companies may require additional capital for expansion beyond what existing shareholders can provide.
   • A quotation enables sales of new shares to a broader market, facilitating large, inexpensive capital raises.
2. Future Capital Raising Facilitation:
   • Post-quotation, raising further capital becomes easier.
   • Debt providers view quoted companies as less risky due to adherence to ongoing Stock Exchange requirements.
3. Exit Route for Existing Shareholders:
   • Venture capitalists typically seek to realize investments over time; a stock exchange quotation allows them to liquidate investments.
4. Marketability and Valuation Facilitation:
   • Easier share valuation assists with inheritance and capital gains tax calculations.
   • Enhanced usability of shares for borrowing.
   • Quoted shares are preferable during takeover bids.
   • Employee share schemes are more appealing with quoted shares.

Disadvantages of Remaining a Private Company

• Restricted Access to Funding:
  • Cannot publicly sell shares; lenders may not rely on the company meeting Stock Exchange criteria.
• Limited Market and Exit Routes:
  • A confined market for shares equates to limited liquidity and high transaction costs.
  • Valuation of shares remains challenging.

Advantages of Remaining a Private Company

• Control Retention:
  • Shares are concentrated within a small shareholder base, enhancing control.
• Reduced Principal-Agent Problems:
  • Fewer owners lead to more effective management alignment with shareholder objectives.
• Lower Regulatory Costs:
  • Fewer disclosure and reporting obligations incur lesser costs.
• Family Control:
  • Family-owned businesses can maintain control over operations in accordance with tradition without outside influence.

Private Equity and Private Equity Funds

• Companies choosing not to offer shares publicly fall under the private equity sector.
• Insurance companies, banks, and pension funds can invest in private equity through:
  • Direct loans or equity purchases.
  • Tailored private equity funds requiring substantial investments.
• Some mutual funds and ETFs allow retail investments in private equity.

Methods of Obtaining a Stock Exchange Quotation

• Main methods include:
  1. Offer for sale at a fixed price.
  2. Offer for sale by tender.
  3. Offer for subscription.
  4. Placing.
  5. Introduction.

Method 1: Offer for Sale (Fixed Price)

• Predetermined shares offered to the public at a fixed price.
• Shares can be new or exist to facilitate existing shareholders' sales.
• Common method for companies obtaining initial quotation; quoted companies often choose rights issues thereafter.

The Issuing House and Underwriting

• Companies can sell to an issuing house rather than directly to public.
• Issuing House Responsibilities:
  • Sells shares to the public and provides underwriting (insurance against the risk of an unsuccessful issue).
  • If the public does not purchase all shares, the issuing house retains them, guaranteeing the targeted fundraising.
• Issuing houses generally belong to investment banks and provide advisory support throughout the process.
• Remuneration:
  • Fees can be explicit or derived from a discount on shares sold to the public.

Timetable of an Offer for Sale (Method 1)

1. One Year Prior:
   • Discuss plans with the issuing house; ensure positive press coverage.
   • Transition to public limited company, if not already a public entity.
2. Weeks Leading to the Issue:
   • Issuing house advises on pricing; cautious pricing tradition.
   • Final price set post-prospectus publication.
3. Prospectus Issuance - 'Impact Day':
   • Prospectus released, detailing company information and an application form.

Timetable of an Offer for Sale

• Applications:
  • Public can submit interest to purchase for about a week post-prospectus.
  • Oversubscription occurs; issuing house determines allocation basis (accept fully, reject, or scale down).
• Acceptance Letters:
  • Successful applicants receive acceptance letters, and refunds sent to those not meeting requirements.
  • Temporary usage of acceptance letters as share certificates possible until actual certificates are issued.

Method 2: Offer for Sale by Tender

• Public invited to submit tenders stating number of shares and desired price (minimum price established).
• A Single Strike Price is determined after offer closes based on the highest purchase price enabling allocation while ensuring shareholder diversity.
• Successful bidders pay the strike price despite higher bids; lower bids are rejected.

Method 3: Offer for Subscription

• Similar to offers for sale but not underwritten.
• Shares sold directly to public; issuing company faces part of the undersubscription risk.
• An issuing house is retained as an advisor.

Method 4: Placings

• Issuing house purchases securities initially and approaches institutional investors directly.
• No public applications; simpler and cheaper method.

Method 5: Introductions

• No new shares sold; existing shares become quoted on the Stock Exchange.
  • Applicable when an overseas company seeks UK listing alongside an existing USA listing or with de-mergers requiring new quotes.

The Role of Underwriting

• Underwriting process includes:
  1. The company sells all shares to the issuing house, mitigating risk of unsold shares.
  2. Issuing house may seek sub-underwriters to distribute risk.
  3. Pricing strategies aim to ensure high likelihood of success.
  4. Fully Subscribed Issue: All shares sold; profits equal to commission minus expenses.
  5. Partly Subscribed Issue: Not all shares sold; underwriters earn commission but must purchase unsold shares.

Issues from Quoted Companies

• Rights Issues:
  • Obligated to offer new shares to existing shareholders when raising further capital.
  • Rights issues provide new shares at discounted prices proportional to existing holdings.
  • Effects: Creation of new shares, additional capital, increased total company value, and potential decrease in share price based on discount extent.

Timetable of a Rights Issue

• Pre-rights issue discussions occur with advisors; ideally when stock market is high.
• Rights offer document circulated, explaining the rationale.
• Shareholders receive provisional allotment letters; shares traded as ex-rights (transferring rights to sellers).
• Shareholders have several weeks for acceptance or to sell nil-paid rights (rights yet unpaid).

Impact on Share Price

• Market Capitalisation Definition: Value of a company calculated as: $ext{Market Capitalisation} = ext{Current Price} imes ext{Number of Shares}$
  • Pre-rights issue price
    $P = \frac{ ext{Market Capitalisation}}{ ext{Number of Shares}}$
  • Post-rights issue price
    $P^* = \frac{ ext{Original Market Capitalisation} + ext{Extra Value}}{ ext{Total Number of New Shares}}$

Impact on Share Price - Factors Considered

• Incorporates:
  • Amount of new funds raised.
  • Issue expenses.
  • Market perception changes regarding the company and the funds' intended usage.
• For a company with share price P and N shares making a n-for-m rights issue at price Q:
  $P^* = \frac{(N imes P) + \frac{n}{m} imes N imes Q}{m + \frac{n}{m} imes N}$

Market Reaction

• Post-rights issue share price may dip below theoretical weighted average due to:
  • Shareholder reluctance to additional funding requests decreasing company favor.
  • Company distress perception evident from rights issues damaging market support.
  • Increased share supply (from rights sales) potentially pressures share price downward, at least initially.

Possible Shareholder Actions

• Shareholders may abstain from rights acceptance for various personal reasons (e.g., cash unavailability).
• Eligible to sell nil-paid rights, with theoretical market value determined by the difference between ex-rights sharprice and rights issue price.
  • Provides compensation for loss in original shareholding value.
• While rights issues may not require underwriting, most are underwritten to ensure desired fundraising.
• Underwriting relegates the risk, while low pricing can potentially eliminate the need for such support.

Issuing and Trading Shares

• Public Companies:
  • Post-issue, shareholders can freely trade shares on public exchanges.
• Private Companies:
  • Shares sold directly to chosen investors without public trading options, resulting in potential illiquidity as transactions occur infrequently and involve substantial shares.