When a company begins selling shares of stocks, bonds, or other securities to the public, it’s called an offering.
If a company that has already made an initial public offering, any later offerings it makes are called secondary offerings, secondary distributions, or follow-on public offerings. Companies may make secondary offerings if they need cash, are looking to expand their business, or want to acquire another company.
Secondary offerings can have a significant impact on stock prices, so it’s beneficial for investors to understand how they work.
Let’s dive into the details.
What Is a Secondary Offering?
Any public sale of securities by a company after it has made an initial public offering is called a secondary offering.
When companies first issue stock or securities, they hold on to a certain amount, so during the secondary offering they put up some of their holdings for sale. Sometimes in a secondary offering, shareholders such as the CEO and founders sell a portion of their shares instead.
If the shares come from the company, the money raised from the sale goes to the company. If the shares are sold by individuals, the money goes to those sellers.
A secondary offering might also involve a combination of securities from the company and individual shareholders.
There are two types of secondary offerings: dilutive and non-dilutive. It’s important for investors to know the type of secondary offering because it can affect the value of the shares. More on that later.
Dilutive Secondary Offerings
A dilutive offering involves the creation of additional shares by the company, which in turn reduces the amount of ownership that preexisting shareholders have. As the name implies, the offering has a dilutive effect. Investors often have a negative sentiment toward dilutive offerings.
The company’s board of directors must approve of the increase in floating stock shares. The float of a stock is the number of shares available for trade.
Non-Dilutive Secondary Offerings
With non-dilutive offerings, no additional shares are created during the sale. A non-dilutive offering is often made by major shareholders selling their existing shares. This doesn’t have any effect on the company itself, except perhaps investor’s perception about why the shareholders are selling.
This type of offering can also be beneficial because it allows more individuals and institutions to invest, which can increase the stock’s liquidity since there are more people buying and selling.
Examples of Secondary Offerings
Google did an offering in 2005 after its IPO in 2004. During the IPO, the company had a share price of $85 and raised $2 billion. During the secondary offering, the share price was $295 and the company raised $4 billion.
Then there’s Rocket Fuel, a company that made a secondary offering of 5 million shares in 2013. Existing shareholders sold 3 million shares and the company sold 2 million, all at a price of $34 per share. Just one month after the secondary offering, the value of the shares had gone up 30%, to $44.
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Why Make a Secondary Offering?
Similar to an IPO, a secondary offering helps companies raise money so they can expand their operations. Individual shareholders, such as CEOs, might choose to sell shares of stock to raise money for other purposes. This is a great way for companies to raise significant funds fairly quickly.
Companies may also hold a second offering between their IPO and the end of their stock’s lock-up period, which is a time when large shareholders are not allowed to sell shares. After the lock-up period, a stock’s price often falls when these shareholders sell off some of their shares. By holding a secondary offering before the end of the lock-up period, additional investors can benefit from the success of an IPO.
It’s important for investors to look into why a company is making a secondary offering before deciding whether to invest, as this can affect the price of the stock in both the short and long term.
Scouting Secondary Offerings
Most companies that file secondary offerings choose to do so soon after the end of the lock-up period after their IPO.
When a company wants to make a secondary offering, they file it for approval with the SEC.
Investors can find out about the latest secondary offerings in a few ways. The SEC has a database of secondary offerings called the EDGAR database, where investors can find out about them. Investors can also look to the NASDAQ list of secondary offerings made by companies listed on the NASDAQ stock exchange. Companies filing secondary offerings tend to get covered in the media and also put out press releases with details about the offering.
How Do Stock Prices React to a Secondary Offering?
The basic concept of supply and demand dictates that if there is more of something available, its price will decrease. This is sometimes what occurs during a secondary offering, but not always. If more shares are created, the price of the shares may fall.
Even when a secondary offering is announced, it can cause the price of a stock to fall. This is especially true with dilutive offerings, because they decrease the earnings per share of the stock.
The price of stocks can also decrease during a secondary offering because the company issues the offered shares at a discounted price to incentivize investors to buy. This results in the price of the stock lowering to the discount price. The decrease in value can last a while, because any investors who buy in at the discounted price can sell at a slight increase and make a profit.
If a company creates new shares and sells them at market value with a discount to account for the amount of dilution, this generally results in the least amount of price volatility.
Although a secondary offering often results in a decline in stock price, that isn’t always the case. Non-dilutive offerings are viewed more positively, as they don’t affect the stock’s earnings per share or shareholders’ amount of ownership. Also, it can be seen as a good sign for the long-term value of a stock if a company is investing in growth and acquisitions.
Many secondary offerings don’t have any restrictions, but some may require a lock-up period similar to an IPO, during which investors aren’t allowed to sell their shares.
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