Raising Capital
Summary of How Companies Raise Capital
The securities industry relies on the public’s resolute trust and confidence that the markets operate fairly with complete integrity to best perform its capital-raising function. When a company needs more money than is available through bank loans or private venture capital sources, it raises funds in the capital markets through the sale of stock, bonds, or other securities.
The first sale or distribution of shares by a company in the public markets is called an initial public offering. The company contacts an investment banker, who advises the corporation on the price, quantity, type, and timing of the security to issue.
The issuer can sell the securities outright at a set price in a firm commitment to the underwriter, who then resells them to the general public. Or, under a best-effort arrangement, an investment banker may act as a sales agent for issues on a commission basis. Often, new issues are so large that one underwriter cannot commit to the entire offering. The underwriter then invites other investment bankers to form a syndicate to spread the underwriting risk and carry out the security’s distribution. The underwriter helps the company prepare a prospectus.
The prospectus, which must be made available to the public, assesses the company’s risks.
The underwriter, primarily through the syndicate manager, is expected to exercise due diligence (reasonable effort and care) in obtaining and verifying the information it uses to value the company and rate its prospects.
After the company registers the offering with the U.S. Securities and Exchange Commission (SEC), the underwriter can begin soliciting indications of interest from its customers. During this so-called “quiet period,” the underwriter registers the security in states where it will be sold. Many securities are exempt from individual state registration if they are listed on a regional or national stock market. Sometimes, the underwriter organizes meetings between the company’s management and potential investors, such as managers of pension or mutual funds.
IImmediately prior to the actual sale, the underwriter establishes the price at which each share will be sold to the public. Once the SEC declares the offering effective, indications of interest previously received from customers can be confirmed as binding orders, and the underwriter may sell them the new securities. On the first day the stock trades, its price can rise or fall depending on whether investors agree with the underwriter’s valuation of the new company.
Some companies choose to sell their securities privately to investors in a private placement, which, because it does not involve sales to the general public, entails fewer regulatory requirements. Since the transaction sizes are quite large in the private placement market, the buyers are institutions.
Securities firms raise additional funds for public companies by redistributing a block of stock sometime after it has been sold by the issuing company in a secondary offering or private placement. Usually a company issues new stock only if its stock price is high, since the larger the supply of stock outstanding, the less valuable each share is because profit-sharing is diluted.