A guide to equity raisings
Your ultimate guide to understanding how and why companies look to raise equity.
What is equity?
Equity represents the ownership of the value in a business. Equity is calculated by deducting the company’s liabilities from its assets, and the resulting net assets are owned by shareholders. This equity is owned by shareholders in the form of shares.
Owning equity, or shares, means you have a stake in the business and are entitled to certain things. This includes a proportion of the net assets, earnings and also any dividends that are paid.
Shares also come with voting rights, which can be used to vote on matters like re-electing directors in annual general meetings (AGMs) or on major proposals at extraordinary general meetings (EGMs) when companies ask shareholders for permission to make a major decision for the business, such as pursuing a major acquisition of a rival.
Most of the time, every share in the business carries equal rights and voting powers. For example, one share will typically give an investor one vote at meetings and entitle them to one dividend. But some companies, albeit quite rarely, do issue different classes of shares with different rights, which can see some shares carry more voting rights or be entitled to more dividends than other shares in issue.
One way that companies can raise capital is by selling new shares, or equity, in the business.
Equity financing: why do companies raise equity?
Virtually all businesses will need to raise money at different stages of their development, either to grow the company or simply to sustain it. Ideally, a company would finance itself solely off the profits it generates by reinvesting them into the business.
However, many companies do not make the money they need to fund their growth ambitions and need to access larger sums of capital.
When a company needs to raise cash there are only two primary options. The first is debt, which can be accessed in various forms from overdraft and revolving credit facilities to corporate bonds and asset financing. The second is to raise equity by selling new shares in the business.
Most companies will utilise both debt and equity in their fundraising plans, and each of these bring benefits and drawbacks. The main difference between the two is that debt must be repaid and comes with interest payments whilst any money that is raised through equity does not need to be repaid. However, utilising debt does not dilute existing shareholders whilst raising new equity often does.
Raising equity can be an offensive or defensive move. Some raise cash from investors to repay debt and strengthen the balance sheet, while others do it to fund ambitious growth or an acquisition. This can define the mood and appetite among investors for an equity raise, which means some are welcomed by shareholders while others are not.
How do companies raise equity?
There are several ways that a publicly traded business can raise equity. Usually, the first time a company raises equity as a public company is when they launch their initial public offering (IPO) to raise cash to fuel expansion. After that, companies can choose to raise further equity from existing investors through a rights issue or an open offer, or look to attract new investors by conducting a placing or subscription.
We have a look at each of these methods of raising equity and outline how they work.
Virtually all companies start out life in private hands, owned by founders, staff and early investors that specifically look to inject funding in small but fast-growing businesses. The problem is, however, that selling any shares you own in a private business can be extremely difficult, not only because there is no mechanism to find potential buyers but also because it is harder to value an unquoted business compared to a publicly-traded one.
This is one reason why companies choose to launch an IPO to go public and be quoted on a public stock exchange. It allows early investors to cash-in on some or all of their stake in the business by offloading them to other investors. However, these shares only generate cash for the owners and not the business itself, which is why most of them decide to create and sell new shares in the business alongside the shares being sold on behalf of existing investors.
These new shares are sold to investors under the IPO to generate funds to help grow the business, and the IPO also provides a valuation (for the entire business and on a per share basis) that is otherwise hard to gauge as a private company.
There are different ways of conducting an IPO, which can be pivotal in deciding the value of the business and its shares. Getting the IPO valuation right is key for both the business and its shareholders.
For example, if it is too low then a company could sell itself short and end up selling a large chunk of the business for a below-optimal price, but investors will be pleased at being able to buy shares on the cheap and benefit from any subsequent rise in the share price once the IPO is completed.
On the other hand, if it overprices itself in the IPO then it may not be able to drum-up the same level of interest in the market and investors will be left disappointed that the value of their shares suffer a drop in value after the IPO, but early investors will be pleased as it gives them a higher value for the shares that they sell in addition to the new shares created by the business.
There are various forms of IPO. Some see the board of directors set a pre-determined price which is then fixed and offered to investors. Some decide to set a minimum price and then offer the shares by tender, whereby investors make bids for shares at whatever valuation they believe is right. The bids are then collected to form what is known as a strike price – which is the price they will be sold at. Those that make bids equal to or above the strike price will be sold shares, while those that bid below it would fail to receive any shares.
Alternatively, some companies conduct an IPO but don’t raise any new equity. This means the company does not raise any money for itself or create any new shares in the business and only sells existing shares on behalf of its investors. One example of this would be luxury carmaker Aston Martin, which chose not to raise any fresh equity in its 2018 IPO.
Most companies only get one shot at an IPO (unless they delist and relist later, or are taken private before going public again later down the line). However, most of them will need to raise more equity in the future, which is where other types of fundraising come into play.
IPO example: Calisen
Calisen launched its IPO in February 2020, when the smart energy meter company decided to raise cash and capitalise on its growth and strong outlook, and allow early investors to monetise some of their investment in the company.
Calisen conducted a bookbuild process to determine how it would price its IPO, meaning institutional investors effectively bid for the shares to give the company an idea of what sort of value the big potential shareholders attribute to the company. This ended up at 240 pence per share and gave Calisen a market cap of £1.32 billion upon listing.
Calisen sold 125 million new shares in the business at 240p to raise £300 million in new equity, while existing investors sold an additional 12 million shares to raise just under £29 million for themselves. The shareholders also made another 20.5 million shares available to the public in an over-allotment option, which would kick-in if there was sufficient demand from investors wanting to take part in the IPO (which it did, but there was only demand for 3.6 million of the shares). Upon listing, it had an issued share capital of 548 million shares, each of which represented an equal slice of the business, with 25.7% of its shares in the hands of the public.
The IPO opened up Calisen’s stock to more investors, raised cash for the business, provided a firm valuation for the publicly-listed company, and allowed early investors to cash-in on part of their investment.
A rights issue is when a company offers to sell new shares in the business to existing investors. Existing investors can buy a certain amount of shares depending on how many they already hold. For example, a ‘2-for-1’ rights issue would mean each shareholder could buy one new share for every two shares they already own, while a ‘5-for-1’ would mean they could buy one new share for every five shares held.
This ratio keeps everything in proportion. Assuming all existing investors take up their rights, a rights issue will not dilute their stakes as everyone is purchasing a proportional number of shares based on their existing stake. This means everyone’s slice of the company grows at the same rate and that all investors would own the same stake as before the rights issue.
However, any investors that decide not to take up their rights – either because they can’t afford to or because they don’t believe putting more money into the business is worth it – will be diluted. Investors can choose to either let their rights lapse, or they can sell their rights on to other investors who can use them to buy even more shares, potentially allowing them to increase their stake in the business.
The price of shares issued under a rights issue is usually offered at a discount to the prevailing share price on the open market. This encourages existing investors to take up their rights as they can buy more shares in the company at cut-price. Existing investors prefer rights issues to other forms of equity raises because it doesn’t dilute their stake by selling shares to new investors.
In any rights issue, one of the key things to look for is the ‘theoretical ex-rights price’, sometimes referred to as TERP. As more shares are being issued, the value of each share is reduced, and the TERP tells you how much each share will be worth once the new ones have been issued, allowing you to gauge the true value of what’s on offer.
The reason for a rights issue goes a long way in dictating the appetite among investors. Many regard a rights issue as a warning that the business could be in trouble and is being forced to tap shareholders for more cash, especially if the funds are to be used to repay debt or provide ‘general working capital’.
However, rights issues that are launched to fund expansion or mergers and acquisitions (M&A) generally receive a warmer welcome among investors as it is regarded as a way of funding further growth without dilution.
Rights issue example: M&S
The company said existing investors could buy one new share in the business for every five they already owned at the price of 185p per share. That meant it was enlarging its issued share capital by one-fifth but without diluting existing investors. In total, it issued 325 million new shares at 185p to raise just over £570 million. M&S shareholders were enticed by the fact the 185p price was a 30% discount to the share price at the time.
Only 85% of the new shares on offer were taken up by investors, suggesting that whilst most investors were happy to take up their rights that there was a significant number that either couldn’t or didn’t want to buy more shares in the business. However, M&S sold the shares that were not taken up in what is known as a rump placing to new investors.
If a company conducts a placing (also known as a placement of shares) then it is aiming to raise equity by issuing new shares in the business to new investors, rather than existing shareholders like it does under a rights issue. The new shares are usually sold to a small band of high-profile investors, usually to institutions such as banks and pension funds rather than individuals.
From a company perspective, a placing can be one of the fastest and cheapest ways of raising new equity, partly because they sell a substantial amount of new shares to a handful of major investors rather than many smaller lots of shares to thousands of individuals. It can also be useful if it knows it would struggle to gain the same level of interest from many individual investors.
From the view of existing investors, a placing can cause dilution and transfer value in the company from existing investors to new ones that join the register through the placing. If the placing is priced at a discount, then new investors get the chance to buy stock in the company at a discounted rate while existing investors are diluted and not offered any new shares at the discounted price.
The dilution of any placing will undoubtedly impact the company’s share price over the short-term, as the company’s value must be stretched over more shares. A £1 billion business with 100 million shares in issue will undoubtedly be worth less per share if it conducts a placing and then has 150 million shares in issue, for example.
Again, the reasoning behind a placing goes a long way in deciding the mood among both new and existing investors. If the funds raised from a placing can help the business prosper then it can be beneficial for both sets of investors over the long term, but if it is a more defensive move to strengthen finances and avoid financial trouble then it could prompt concern among existing investors that the business is in trouble.
Placing example: Ryanair
The airline industry was one of the hardest hit by the coronavirus outbreak and Ryanair, believing this would see its competitors fail, wanted to raise cash so it was able to capitalise on any opportunities that arose. It also provided some strength to the balance sheet, which had understandably been hit hard by the lack of travel during the crisis.
The low-cost airline decided to launch a placing to bring new institutional investors on board, although it also made it available to its existing institutional investors too. Interestingly, Ryanair made it clear it wanted to raise €400 million before setting the price of the placing, which was determined through a bookbuild process.
This means Ryanair was always going to raise the cash it wanted and that the variable was actually how many shares it would have to issue to get it. In the end, it issued 35.2 million new shares at €11.35 each. It was a relatively small placing, only accounting for around 3% of its issued share capital, and priced at a minor discount of just 2.6% to the share price at the time.
The discount implies investors saw this as an aggressive move to fuel expansion rather than a defensive one to prop up a struggling business. Plus, the small discount would have helped allay any concerns among existing investors that were diluted as a result of the placing.
An open offer is when new shares in the business are offered to existing shareholders, much like a rights issue. However, an open offer is always conducted alongside another form of equity raise, most commonly a placing, whereas a rights issue can be conducted on its own.
The idea of an open offer is that it can minimise dilution for existing shareholders that comes from selling new shares to new investors through a placing. Selling shares under a placing will dilute existing shareholders, but an open offer gives them the opportunity to minimise this.
The open offer will always be priced the same as the placing that is run in tandem, meaning new and existing investors pay the same price for the new shares being issued.
Open offers are therefore used to try and satisfy existing shareholders while being able to attract new ones. Existing investors will still be diluted if new shareholders are joining the register through the placing, but at least they have an opportunity to buy more shares and minimise dilution to their stake by taking part in the open offer.
Open offers give existing shareholders the right, but not the obligation, to buy additional shares in the business. However, unlike in a rights issue, those that decide not to cannot sell the rights to the new shares to other investors.
Open offer example: Ted Baker
Fashion house Ted Baker launched a placing and open offer in June 2020 as part of a wider financing package to help turnaround the struggling company. It decided to set its own price rather than gauge appetite in the market, and said it would look to raise £95 million by selling 126.7 million new shares at 75p each. The huge 51% discount to the placing price was enough to attract investors.
The vast majority of the new shares were issued under the placing. The problem was that this meant the new investors would own over half of the company once the shares were issued, which is why it also launched an open offer to try and give existing investors the chance to minimise it. It allowed existing investors to buy four new shares for every seven they already owned at the same price of 75p. Around 18 million shares were issued under the open offer, meaning existing investor’s stakes were still significantly diluted as part of the fundraising.
The holder of a stock or share warrant has the right, but not the obligation, to convert it into shares in the company at a pre-determined price before a set deadline. They are often issued to investors as part of other equity raises to provide added incentive for investors to take part.
Warrants will usually be attached to ordinary shares. A company may, for example, offer one warrant that can be converted into one ordinary share for every five shares purchased under a placing. The investor would then be able to purchase more shares in the company before a pre-determined deadline, either at the investor’s discretion or only on set dates.
The conversion price of exercising a warrant is usually set higher than the market price of shares at the time, and investors often have years to decide whether to exercise them or not.
The idea is that the company will grow, and the share price will rise above the exercise price, giving investors a way of building their stake in the business at a discounted rate in the future.
However, if the share price fails to exceed the exercise price then the warrants become less attractive as you could purchase shares at a cheaper rate on the open market compared to exercising the warrants.
If the warrant is exercised, then it is converted into shares and the investor pays the exercise price to the company, which can then use the proceeds.
Warrant example: Integumen
Healthcare and research technology company Integumen launched a placing in late 2019, selling 91.3 million new shares in the business for 1.5p each to raise a total of £1.4 million. This was to raise funds to expand and achieve its growth targets over the following year.
It conducted the placing through its broker, Turner Pope. As part of the placing, Integumen awarded warrants to Turner Pope over 5.3 million new shares in the company at the same price as the placing at 1.5p, exercisable anytime for three years after the placing was complete. This was to help pay for some of the costs owed to its broker for conducting the placing.
The Integumen share price initially fell after the placing but began to find higher ground in 2020. Shares hit an all-time high of 4.7p in August 2020, which will please Turner Pope considering it could exercise its warrants at just 1.5p. It could then retain these shares or sell them on the market to book an immediate profit.
Convertible debt and bonds
Convertible debt involves a company borrowing funds from investors in the form of debt, but with a view of converting it into equity in the company at a later date. This can sometimes take the form of a convertible bond or another similar instrument like a loan note, and the details of how it will be converted (and at what price) are usually pre-determined at the time the debt is issued.
Issuing convertible debt gives a company immediate access to funds but delays the dilution to existing shareholders. The idea is that the equity of the business will grow before the debt is converted, which will result in less dilution for existing shareholders compared to issuing equity in the first place. For the owners of the debt, they may be attracted by any warrants attached or by the price the debt will convert at. Plus, creditors to the company – as in those that it owes debt to – are higher priority than shareholders when a business falls into financial difficulty.
Read more: How to trade bonds
Convertible debt example: Salt Lake Potash
Mining company Salt Lake Potash decided to raise AU$15 million by issuing convertible loan notes to new and existing institutional investors in July 2020. This allowed it to raise the cash it needed to continue construction on its mine.
The stipulation that came with the loan notes is that they would be automatically converted into shares if the company launched another equity raise of over AU$10 million within a year. They would be converted at 45 cents per share or at a 5% discount to the issue price of the new equity raise – whichever was lowest.
If Salt Lake Potash doesn’t conduct another equity raise before the deadline, then the notes will automatically convert into shares at 90% of the average of the five lowest daily volume-weighted average prices during the 20 days before the maturity date of the loan notes. Holders of the loan notes can convert them before the deadline, but they would not receive such a big discount.
Salt Lake Potash did not have to pay any interest on the loan notes because the notes are guaranteed to convert into equity into the future, but companies often have to pay interest on the loan notes so long as they are not converted into shares.
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