Secondary public offerings, also called follow-on offerings, differ from IPOs in some key respects. Learn the types of secondary offerings in this guide.
Rising stock prices are one reason public firms may
do a secondary public offering.
Why it’s important to understand the relationship
between IPOs and secondary offerings in any market environment.
Learn as much as you can about the motivation
behind a secondary offering before you invest.
By fall 2021, companies and existing shareholders made 556 secondary public market offerings, the most since 1996, according to The Wall Street Journal and Dealogic data. In all, these sales raised $133 billion.
Secondary public offerings represent a second bite at the apple for investors who might’ve potentially missed or wanted to buy more shares in promising companies at their initial public offering (IPO) stage. As stock prices rose at that time, secondary public offerings moved hand-in-hand with IPO growth that continued through most of Q1 2022—just before aggressive Federal Reserve rate hikes poured water on that deal volume.
So why discuss this topic even when relatively few companies are going public? Because down markets eventually turn. Here’s how secondary public offerings work.
Anyone thinking about buying shares of a secondary offering should begin by understanding that there are big differences between a secondary public offering and an IPO.
The IPO process tends to take a lot of time, relatively speaking, because not much is initially known in the investment community about a private company that wants to go public. Companies seeking an IPO need to file a prospectus with securities regulators and supply investors with financial information before listing. But without any trading history on public markets, or quarterly financial results, determining an IPO’s prospects is more art than science.
Retail investors rarely have the chance to participate in an IPO because about 90% of the shares are generally allotted to institutional clients. The other 10% are divided up and sold to retail investors through brokerages.
On the other hand, secondary public offerings occur much more quickly. It can happen in a matter of days because secondary offerings are made after a company’s shares are available for purchase.
From a purchasing and availability standpoint, secondary public offerings mean little change to average investors buying that particular stock. More shares have simply entered the market for purchase, and we’ll get into more detail about that below.
So, what’s really important for investors to know about secondary public offerings? It’s important to know how they work, but it’s almost as important to know why they happen.
There are two types of secondary public offerings. The first is called a non-dilutive secondary offering. These shares usually come onto the market after what’s known as a “lockup period,” when insiders are allowed to sell their holdings. So, in this case, no new shares are created, but the public now has access to these newly available shares.
It’s called non-dilutive because the number of outstanding shares hasn’t changed, and any existing holders retain the same amount of ownership in the company.
A dilutive secondary public offering, sometimes called a follow-on offering, looks more like an IPO because the company wants to raise new capital, just as it did with the IPO.
There are many reasons a firm may want to issue new stock.
It could choose to do it do it to enable a new growth opportunity or complete
an acquisition or finance debt, for example. If companies have an opportunity
to grow faster and/or extinguish higher-rate debt in the process, that’s
generally a good thing.
However, secondary public offerings can depress the
price of a stock—at least in the short term—simply because there are more
shares out there to buy. However, this is when investors should take a closer
look at the ‘why.’ If company executives are making their own shares available
for purchase as part of a secondary offering—which often happens—it’s important
to know their reason for the sale and how many of their shares will be
available for purchase.
If the company’s fundamentals are solid, it likely
won’t pose a problem for long-term investors. But it’s important to become a
student of every investment you buy for that purpose—so you understand the
motivation behind the action.
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