Throughout a business’s evolution, there are several rounds of funding conducted. Funding is needed for a multitude of reasons ranging from operational growth to capital expenditure/asset expansion to debt repayments or even shareholder rewards. As a start-up, the company generally looks to tap venture capital and angel investors for their Series A, Series B etc. funding. What this means is that in exchange for a cash investment infusion from the VCs, the company gives them preferred shares i.e. a stake in the company. Each subsequent round of financing is conducted as the business grows and funds are needed to accommodate the growth plans of management. Eventually though, a company may want to become publicly listed on the stock market (commonly known as undergoing in IPO – Initial Public Offering). The investment banking name for this is a primary issuance – a term that is intended to emphasize that the proceeds from this financing go directly to the company. Once the shares have transferred hands to public shareholders however, any risk and reward from the fluctuations of the stock price is the responsibility and ownership of the shareholder i.e. the company does not make any more money off that.
The process for a primary issuance starts with company management calling an investment bank to discuss the potential and viability of an IPO. This stage is especially important as investment banks possess the expertise to advise on whether the company’s growth is at a point where an IPO would be optimal and whether the equity capital markets are active enough to ensure a successful issuance. Once they commence the listing process, the banks often underwrite the issuance wherein they buy the shares outright off the company and transfer the risk of selling the stock onto themselves. Leading up to and on the day of the issuance, the bank creates a book of investors who have subscribed to the stock. A good indicator of pricing and the success of an IPO is how heavily the stock has been subscribed to. The bank’s goal at this point is to capture as much of a profit margin as they can between the price they bought the stock off the company and the price they sell it at to these new investors.
For the company itself, the advantages of a primary issuance are significant. An IPO strengthens the company’s capital base as more equity is brought into the company to fund the operations and growth that management is interested in pursuing. There is also an element of prestige brought about by an IPO that management may want to feel self-actualized by. However, more importantly, M&A becomes significantly easier with a public company than a private one as regulatory approval is completed at a quicker pace. That said, there are some downsides to “going public” as well. After listing, companies have a duty to disclose and report earnings every quarter. While this is certainly an additional cost, there is now also pressure from shareholders of the company on management as they seek to align shareholder interests with the company’s interests. There is also new pressure on short term growth as shareholders investing with a shorter time horizon are likely to be less patient than previous financiers (e.g. VCs) regarding company growth and time taken for positive NPV projects to materialize.
In the USA, the dynamism of the primary issuance market is a key driver of the equity capital markets division being one of the most active in full-service investment banks. In 2016, the market capitalization of new primary issuances totalled a formidable $123.7 billion over 106 IPO transactions. Of these, 40 were in the healthcare sector, 22 were technology companies and 15 were financial services companies. Given the strength of the equity markets in recent times andgrowing corporate earnings, it seems likely that 2017 will end as a second consecutive strong year for ECM divisions in investment banks.
