What is a Secondary Offering
2022-06-22 | Simpler Trading Team
There are a variety of stock offerings that traders need to have a grasp on as company announcements often see reactive price action. In the case of secondary offerings, the stock price tends to move downward. However, the stock price can remain flat – or even go higher.
Once a company’s initial public offering (IPO), shares have already been sold, and the initial stock offering has closed. A company may sell more shares to the public, known as the secondary offering. The company uses a secondary offering to raise additional needed capital. Traders must be aware of these events that have investment ramifications concerning public and private stock offerings.
Secondary Offering Explained
A finite number of shares are available for each company – referred to as the float. Current shareholders won’t be thrilled when a secondary offering occurs as a company’s share prices are negatively affected. A secondary offering of stock to the public dilutes or makes that particular stock less valuable. The secondary offering to the public is viewed as a good thing for the company as it raises more capital. Still, the shareholders who bought into the IPO will generally lose value in their holdings.
Should a company make a profit, it can distribute this back to shareholders as a dividend. Your dividend payment is also reduced with a smaller piece of the pie. The pain could be lessened, however, the company can use the capital from the secondary offering to increase company profits.
Another factor traders and investors should watch is if the share price drops below $1. The stock could become delisted and move to the over-the-counter market (OTC) with penny stocks and other less-regulated shares.
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What Are Initial Offerings: Public and Private
Before going into too much detail about secondary offering, it’s fair first to pause to understand the initial public offering. An initial public offering (IPO) is the issuance of new stock shares from a private company to the public. This event must meet the Securities and Exchange Commission (SEC) requirements.
Generally, the issuance of stock is done to allow an established company to raise capital from public investors. The transition from a private to a publicly-traded company typically includes a share premium for current private investors.
IPOs allow companies to raise capital by offering company shares through the primary market. An IPO can be viewed as an exit strategy for the company’s founders and early investors to realize the potential of their private investment.
How an Initial Public Offering (IPO) Works
Before a company became publicly traded, it was privately owned. Before the IPO, businesses attain capital through a relatively small number of shareholders and early investors – founders, family, friends, or even venture capitalists.
An IPO allows the company to raise capital for reinvestment and growth. Typically, a company goes public when it has reached a private valuation of approximately $1 billion – also known as unicorn status. Private, small companies with solid fundamentals and proven potential can also qualify for an IPO depending upon the market competition and their ability to meet listing requirements.
When a company goes public, the previously owned private shares convert to public shares. The formerly private shareholders’ shares have the same value as the public trading price.
The transition from private to public is an opportune time for private investors to cash in and earn the expected returns. Private shareholders may hold or sell their shares in the public market. The company’s number of shares and the price for which shares sell are the factors for the company’s new shareholders’ equity value.
What does the closing of the public offering of common stock mean?
Following the close of the IPO, the execution of the business strategies the company committed to goes underway. Companies that frequently beat earnings estimates are rewarded for their efforts. However, they have to constantly prove to the market that they are strong performers in the long run.
Types of Secondary Offering of Publicly Purchased Stocks
Secondary offerings can be either dilutive, which increases shares, or non-dilutive, where new shares are not created. There are two types of secondary offerings – also known as follow-on public offerings (FPO). The first is a non-dilutive offering, and the other is a dilutive secondary offering.
Non-Dilutive Secondary Offerings
The term secondary offering, in this case, refers to the sale of shares on the secondary market that an investor to the general public owns. The company offered no new shares in this case. These are the shares the company already sold in an initial public offering (IPO).
- Corporations have the ability to sell shares through secondary offerings to raise capital.
- The stockholders are paid from the shares they sell when a secondary offer has been formed.
Dilutive Secondary Offerings
A dilutive secondary offering – also known as a subsequent offering or follow-on public offering (FPO) – occurs when the company itself creates and places new shares onto the market. This, dilutes the existing shares.
When the company’s number of outstanding shares increases, this will cause the dilution of earnings per share (EPS). The resulting cash allows the company to pay off debts or finance an expansion for future growth. This may serve as an indicator to shareholders regarding the company’s financial stability. The offering happens when a company’s board of directors agrees to increase the share float to sell more equity.
How do I buy a secondary stock offering?
Stockholders and corporations sell secondary offerings on the New York Stock Exchange (NYSE) and the NASDAQ. It’s a secondary offering because the transaction exchanges the shares after the company’s first public distribution.
However, not every secondary offering dilutes the value of existing shareholders’ shares. For example, a company’s major shareholder could sell all its shares on the exchange. This transaction is solely between investors. Corporations do not make any money on these trades. Only the trader selling shares can make a profit or sell for a loss. The shares merely change hands. Investors can purchase shares of a secondary offering in the form of bonds, mutual funds, stocks, or other types of securities.
A Secondary Market of Privately Purchased Stocks
Privately purchased shares can be sold on public secondary markets. Private investors with stock in a private company, such as SpaceX, could choose to sell it to other investors in the private secondary markets. These are a few examples of these markets:
Investors who purchase shares on the secondary markets aren’t able to research companies as quickly as those that are listed on the stock exchanges. Those companies must openly provide information to traders and investors each quarter.
Investors looking to sell private shares on the secondary market can contact any private secondary marketplace to gather information to assess a fair share price and whether there is a demand for the stock.
Does a Direct Offering Affect Stock Price?
A direct public offering (DPO) is when a certain company offers its securities directly to the public to raise capital. The issuing company using a DPO eliminates the intermediaries, such as investment banks, broker-dealers, and underwriters. Cutting out the intermediaries from a public offering lowers a DPO’s capital cost.
A direct offering may dilute shares when a corporation sells its shares to the public in an initial public offering (IPO; dilution can occur if the shares are newly created.
Existing shares that company employees or investors privately owned are not considered new and would be undiluted. When a public offering raises money, earnings must be divided up across a more significant number of shares.
What is a common stock offering?
When a business offers common stock and warrants through an IPO, it must operate according to its strategy. Offering common stock not only means an increase of capital to the company. It also means that the company must abide by a strict set of rules. However, the money acquired helps leaders spend on benefiting the company, such as acquiring other companies, marketing, expanding into new markets, or developing new products. In addition, a company can also issue bonds to raise capital.
Comparatively, investors sometimes purchase preferred stock. Preferred stock presumes less risk than common stock as it receives higher and more regular dividends. Unlike common stockholders, preferred stockholders receive fixed dividends on a predetermined schedule that are not subject to the volatility in the broader market. Should a company declare bankruptcy, preferred stockholders receive payouts before common stockholders.
Though preferred stock may be less volatile, it also has lower profit potential. Preferred stock may be “callable,” which means the company can repurchase the stock at any time, for any reason. Like buying common stock, purchasing preferred stock can be executed through a broker or online brokerage firm.
Secondary Offering Wrap Up
A public offering is when an issuer, such as a firm, offers securities such as bonds or equity shares to investors in the open market. Initial public offerings (IPOs) occur when a company sells shares on listed exchanges for the first time. Secondary offerings allow firms to raise additional capital later after the IPO has been completed, which could dilute existing shareholders.
Once traders grasp the concept of the initial public offering, the rest will fall into place. This is critical to understand as the market’s response to these events regularly occurs. Trading is risky; there is no hiding that, but it can also be stressful, and that’s why Simpler Trading has opened the Simpler Free Trading Room. We know the importance of guidance and mentorship and know you can learn the importance of it for FREE! Sign up today and never trade alone.
FAQs on Secondary Offering
Q: Do public offerings lower stock prices?
A: The effect of a public offering on a stock price depends on whether the additional shares are newly created or are existing shares that were held privately. The effect of a public offering on stock price is generally that of a share price that moves lower, but that is ultimately determined by the type of shares offered – diluted or undiluted – and the market’s response.
Q: How is a Direct Public Offering traded?
A: Although an issuing company can raise funds from the company through a DPO, investors will find that a trading exchange platform is not available. While the shares of an Initial Public Offering (IPO) trades on the NYSE or Nasdaq, a DPO will not have such a trading platform. These shares are traded in the over-the-counter markets (OTC).
A public offering is a corporation’s sale of stock shares to the public. The effect of a public offering on a stock price depends on whether the additional shares are newly created or are existing, privately-owned shares held by company insiders. Newly created shares typically hurt stock prices, but it’s not always a sure thing.
Q: What Is a Secondary Offering?
A: A secondary offering can be the offering for sale to the public shares by an investor; or the creation by the company of new shares and then the offering of those newly created shares for sale to the public.
Companies use secondary offerings for various reasons, to fund new projects, complete acquisitions, or meet operating expenses. Other types of assets can also undergo a secondary offering. The securities in such a secondary offering may be bonds, mutual funds, stocks, or different types of securities.
Q: How does a secondary offering work?
A: A non-diluted secondary offering occurs when an investor sells their shares to the public on the secondary market after an initial public offering (IPO). Proceeds from an investor’s secondary offering go directly into an investor’s pocket rather than the company. Follow-on offerings can be either dilutive, increasing shares, or non-dilutive, where new shares are not created.
Q: Is a public offering good or bad?
A: An initial public offering opens the door for current investors to either hold their shares after they become public or sell them. Once these securities are converted into public shares, they are much easier to sell in the open market.