Secondary offerings are those shares that an investor sells, and the buyer is the general public. The investor sells his holdings, and the proceeds of the sale are paid to stockholders, transferring the ownership from one investor to another.
Working knowledge of Secondary Offerings
Generally, when an IPO is floated, a company that wants to raise money chooses to sell its shares to the public through an initial public offering (IPO). The name suggests that it is the first time that the company is publicly trading its shares. These new shares are sold to investors on the primary market. The company may use the capital raised for its everyday operations, mergers, acquisitions, or any other activity it deems fit.
Once the IPO is done, investors can then make a secondary offering on the shares to other investors on the stock market or secondary market. When sold from one investor to another on the stock market, these shares constitute a secondary offering. The proceeds of this sale go directly to the investor who sold the shares and not to the company of which the shares are sold.
Sometimes, a company may go ahead with a follow-on offering. A Follow-on offering is an issuance of stock shares following a company’s IPO, commonly known as FPO.
Types of Secondary Offerings
Secondary Offerings are categorized into two types. These types are distinct from each other and fall into one of these each time they are disbursed.
Non-dilutive Secondary Offerings
Non-dilutive shares are those which are held by shareholders and whose value does not change because no new shares are created. The issuing company may not benefit from this offering since the shares are offered for sale by private shareholders, such as directors, CXOs, venture capitalists, etc., who may want to alter their portfolios or change their current holdings.
Non-dilutive secondary offerings often result in a drop in the issuing company’s stock price but recover quickly if the market sentiments are optimistic and if investors believe in the company’s future.
Dilutive Secondary Offerings
A dilutive secondary offering is usually issued after an IPO and is commonly known as a follow-on public offering or FPO. This type of offering occurs when a company creates new shares and offers them to the market, thereby diluting the value of existing shares. Dilutive offerings happen when the Board of Directors agrees to raise more capital for the company and sell more equity.
In this case, the number of outstanding shares increases and causes the earnings per share (EPS) to decrease. This difference in the share price causes the company to receive a cash flow that it may use to achieve its goals, expand to newer markets or pay off debtors.
Dilutive secondary offerings are usually not in the best interest of current shareholders as it decreases the value of existing shares.
Market sentiments towards Secondary Offerings
The pandemic has changed the way investors and companies look at secondary offerings. Though there are pros and cons, secondary offerings broadly impact investor sentiments and a company’s share price.
While it’s difficult to gauge how a company will perform after a secondary offering, companies usually suffer a slump initially but bounce back to give decent returns. Sometimes, the general public responds positively to the offering if it’s believed that the capital raised from the sale may help the company. This, of course, depends from case to case. Investors should therefore be picky about which companies to back and which companies to avoid when it comes to this.
Investors should also be cautious about when to invest in a secondary offering. Short-term and medium-term investors can usually anticipate when a company usually offers one. The usual time for this is at the end of the lock-in period, which used to be 1 year after the IPO, but SEBI reduced this to 6 months in April 2022. The best way to invest in secondary offerings is to check the company’s behavior and understand the conditions of why a company is offering one. Market sentiments are not always reliable, and a thorough analysis is recommended before investors opt for a secondary offering. Also, current investors should check if it is feasible enough to hold onto the company’s shares before it goes for a secondary offering.
Conclusion
Secondary offerings offer companies and major stakeholders a chance to make money by issuing their shares to the public. Non-dilutive offerings may not affect the stock price per se, but they have the ability to cause the market to doubt the company. Dilutive offerings, on the other hand, bring down the stock price because of the decrease in the value of the stock. Individual investors should be aware of these offerings before investing and gauge the risks they pose.
Disclaimer
- This blog is exclusively for educational purposes
- Investments in the securities market are subject to market risks, read all the related documents carefully before investing.
