Ways to offer a pizza slice
Did you think it’s a food blog??
Here pizza is referred to as a company and slice mean its shares. In this article, we will see what are the different ways a company can offer its shares to prospective investors.
There are four ways to offer shares to the public:-
- Initial public offer
- Dutch auction.
- Direct public offer (Also, known as direct listing).
- Special purpose acquisition company (SPAC).
Let's get started!!
This method is not in trend these days. But it gained a lot of traction during the dot-com bubble financial crisis.
Here it is the buyers, not investment banks, who decide what a stock is worth. The company decides how many shares to offer, and sets a minimum bid price. Buyers submit a bid with the number of shares they would like to purchase at a specified bid price, and the winning bidders pay the same price per item also known as clearing price.
Google went public via Dutch Auction
Direct public offer —
Unlike IPO, here the company doesn’t hire underwriters or any other intermediaries to sell the shares. Instead, the company directly offers its shares to the public to raise capital. The company itself sets all the rules and conditions related to the offering i.e. the offer price, minimum deal size, a limit on the number of securities one investor can buy, and the offer period. So, unlike a traditional IPO, the company is not selling shares to anyone; rather, existing shareholders are instead selling some portion of the shares they own, to a new set of institutional investors.
Before August 2020, the Securities and Exchange Commission didn’t allow companies to raise fresh issues through a direct listing. But in August, SEC gave a green signal to New York Stock Exchange to let companies list directly and issue new shares at the same time.
It is best suited for companies that have a lot of brand recognition. If the majority of the public is familiar with your brand, you don’t have to put lots of effort and money into marketing.
- It is a faster and cheaper process than going public via an IPO. There are no underwriting fees paid to investment banks.
- When a company goes public via an IPO, the underwriters distribute shares among select brokerages who then impose restrictions on who is allowed to participate in the IPO. This can make it hard for all investors to gain access to IPOs. With a direct listing, stocks being listed on the market for everyone to access and trade.
- Insiders can sell the shares immediately unlike 180 days restriction insiders have on IPO.
- Most of the time, underwriters buy the shares from the company at a fixed price, and on the day of opening, share price surges which leaves less money on the table of the company’s investors and more on underwriters. That’s where direct listing helps.
- There is no real price discovery as the company evaluates the share price using its own internal methodology or with the help of financial advisers. It lacks interaction with investors which doesn’t help the company to understand the demand perspective.
- All the shares are being offered by existing shareholders, not the company, in order to cash out their position. Hence all the money received from the offer will go to investors’ accounts instead of the company account. So, it is not good for those companies who want to raise capital from the public.
- There’s no guarantee that available shares will be sold completely in the market.
Spotify and Slack followed this way to offer the shares to public.
Special purpose acquisition company
Consider SPAC as a moon. Like moon doesn’t have its own light, same way SPAC doesn’t have a value of its own. SPAC management also known as sponsors, raises capital through IPO and looks to acquire or merge with an operating company. You can think like this: An IPO is basically a company looking for money, while a SPAC is a money looking for a company.
SPACs have no commercial operations at the time of listing and receive investment from public investors as well as from institutional investors.
Generally, a SPAC is formed by an experienced management team or a sponsor with nominal invested capital, typically translating into a ~20% interest in the SPAC (commonly known as founder shares). The remaining ~80% interest is held by public shareholders through “units” offered in an IPO of the SPAC’s shares.
Sometimes SPAC is referred to as a reverse merger as the private company gets acquired or merged with a SPAC, which is already a public company. The acquisition must be completed within 24 months of the IPO — or, as is more typical, not later than 36 months, if the SPAC is listed on NASDAQ. If they can’t get it done in the designated time frame then money goes back to shareholders. Also, if investors don’t like the target company, they have an option to sell their shares but to keep warrants. Each unit consists of a share of common stock and a fraction of a warrant.
In order to protect investors, SPAC has to keep a certain percentage of the raised funds in an escrow account until an acquisition is agreed to and requiring shareholder approval of any identified acquisition.
Bill Ackman — the founder of Pershing Square Capital Management — recently sponsored a SPAC called Pershing Square Tontine Holdings. This is the largest SPAC ever created and has thus raised $4 billion for its IPO for one or more target companies by July 22, 2020.
- SPACs broadens the investment option and provide easy accessibility to retail investors to participate in private markets.
- SPACs can be attractive fundraising opportunities for young companies in particular, especially since smaller companies are usually private equity funds.
- SPACs are a quicker way to list your shares on an exchange.
- As most of the SPACs are run by experienced business investors, young companies can benefit from that investment expertise.
- SPAC acquisition sometimes causes company owners to lose control over their company. It can also lead to conflict between the management and SPAC.
- While the SPAC merger process does require transparency regarding the target company, so the due diligence of the SPAC process is not as rigorous as a traditional IPO.
A private company that went public following the SPAC route this year is electric truck maker, Nikola and the Virgin Galactic.
- Traditional IPO is expensive and a lengthy procedure.
- Direct Listing is a good option in case a company has a famous brand in the market. But, here uncertainty hovers on capital raise amount.
- SPACs take the least time among them, which reduces the time-risk. SPACs with excellent management teams can add visibility and generate interest among investors. It also gives an opportunity to retail investors to invest in public companies. With a SPAC the company has much, much more control. With a SPAC you could be public in two-months from when you start the process.
There isn’t a one-size-fits-all solution for public offering. For young companies, SPAC would be a better option. For mature companies, the direct listing would be better and but in case a company is looking out for fundraising then definitely IPO is a better option.