What really is the best method of issue when initially floating of the stock market?

Nowadays, two of the most common ways of raising finance for a firm are through debt finance and raising equity capital. Debt finance in most instances is essentially taking out a loan, whether that be in the form of bonds, bank loans or debentures for example, however the other option a firm has is to sell shares in the company, essentially selling a portion of ownership within that company in order to raise capital. Unlike debt financing, there is no obligation to repay these funds, with the shareholders’ main aim is likely to be ‘wealth maximisation’, therefore essentially raising the long term flow of dividends and in turn the value of their holding. If this is the route a firm wishes to pursue in order to raise capital, then they have to list their shares on a stock exchange. In this case, there are a number of different methods a firm has to choose from, with the aim of this blog to explore which is really the best method for companies.

To make this blog slightly more interesting than reading a textbook, we will consider the example of a football club and therefore consider the alternative methods of issue available if Ipswich Town Football Club (ITFC) chose to raise capital though listing on an equity exchange. In reality this is not too much of a fictitious example as there are a number of professional football teams in the UK listed mainly on the London Stock Exchange main market and Alternative Investment Market (AIM). The AIM market tends to attract firms slightly smaller in size to those listing on the LSE main market due to its lower cost and regulatory requirements, however either exchange is arguably suitable for an ambitious club possessing the history and stature such as that of ITFC.

When it comes to listing on the stock market, a firm is likely to have a sponsor (or nominated advisor for the AIM) in the form of an investment bank or stockbroker for example, who essentially is an expert in the field and therefore guides or advises the company through this process. However we will assume that we do not have this luxury to provide us with their expert opinion on which is the most suitable method of floatation and therefore assess each option individually. So what are the main options available?

·         Offer for Sale

·         Offer for Sale (by tender)
·         Offer for Subscription
·         Placing
·         Intermediaries Offer

The offer for sale method of flotation on the stock market is arguably the most simple of them all. Essentially the shares are offered at a fixed price determined by the company directors. Therefore the directors of ITFC along with the sponsor or nominated advisor would decide on a price and offer the shares at this set price. A variation of this method is the method of offer for sale by tender. With this method, investors are encouraged to ‘bid’ based around a target price at the price they wish to pay for the shares. The bids are then gathered to determine a strike price which would sell all of the shares for the maximum value. Investors who have bid below the strike price receive no shares and those optimistic investors who have bid above the strike price receive the shares receive the shares at the determined strike price.  If ITFC decide to issue shares through the tender method an element of risk is incurred, as although it may result in a larger sum overall being raised, investors may be put off by the task of valuing the company themselves along with ITFC incurring greater costs administering the bidding process.

Similarly to the offer for sale method of floatation is the offer for subscription method. With the offer for sale method, underwriters will usually be in place to purchase shares if they are not purchased on the market by investors. However with the offer for subscription method, underwriters are not used and instead if the share issue does not raise a set minimum, the offer is aborted and the whole issue is abandoned. For example ITFC could choose to offer shares at a price of £100 per share, however if the market deemed this too high, thus resulting in only 50% of offered shares being purchased by investors, then with this method they would have the option to abandon the whole idea altogether. This method tends to be more focused around the initial issuing of larger ‘funds’ such as pooled unit trusts for example where a set amount needs to be raised to make it worthwhile to pursue the idea. In the case of ITFC floating, I feel an offer for sale would be suffice with the underwriter purchasing the remaining shares in such a situation.

The next potential method of issue I feel would be appropriate to discuss is placing. Placing is where the sponsor or advisor dealing with the floatation sells the shares to institutions it regularly deals with. For example the sponsor, who is likely to have a wide range of contacts in the industry, may contact different pension funds to sell the shares in this way. This method is likely to be much cheaper than the alternatives as it incurred much lower publicity, marketing and legal costs. However this method of issue severely limited the spread of shareholders by only offering the shares to set institutions, which could lead to issues such as an illiquid secondary market for example. This method tends to be used for small offerings where the costs of an offer for sale are too high. However I feel that a company the size of ITFC would be able to manage these costs and therefore placing should not be used as the sole method. Another common method, often used alongside placing is that of an intermediaries offer. Like placing, the sponsor/advisors contact base is utilised by offering shares for sale with set stockbrokers who in turn offer the shares to their clients. This offer allows a large number of clients to be targeted, however relies heavily on individual stockbrokers carrying out their role, limiting the control of both ITFC and the sponsor in this situation.

So we have analysed each of the alternatives in terms of the potential methods of issue, should Ipswich Town Football Club choose to raise equity capital. Which is the best method is open to interpretation however in most cases I would suggest the best method would be that which is likely to raise the most from the issue of shares. In this case I would suggest the best option would be the offer for sale by tender. This method, which allows investors to bid at the price they wish to pay, will ensure that all shares are sold and at the strike value which maximises the sum being raised. Whilst this method carries high administrative costs, along with there being an element of risk as investors may be put off due to it being up to them to value the company themselves, I feel that investing in a exciting venture like a football club, should provide sufficient interest to encourage investors to bid in sufficient quantities in an offer for sale by tender issuing. In my opinion, this theory is also true across the board when it comes to methods of issue, as I personally believe the additional cost and slight risk involved in offering shares for sale by tender is worth encountering due to the potential for raising larger sums from the floatation offering.