Raising funds via the equity markets involves offering shares in a company to the public that will be tradable on a public market such as the London Stock Exchange or any of the smaller markets such as ISDX. If companies are seeking more than the equivalent of E5m they will be required to publish a prospectus, a legal document that complies with the EU Prospectus Directive.
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The Informed Funding two-minute guide: Stock Market Flotation
- What is a Stock Market Flotation?
When a company sells its shares to the public and arranges for them to be freely tradeable on a recognised stock market, this is usually known as a flotation. Companies that do this are said to ‘go public’. If the company is undertaking its first sale of shares on a stock exchange, the process is called an Initial Public Offering, or IPO. If the company subsequently issues more shares to raise further funds, this is called a Secondary Offer.
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- What conditions must a company meet to carry out a flotation?
Different stock markets have different rules. In general, a company will need a minimum of several years’ trading history so that investors can examine audited accounts for previous periods. It will also need to appoint a firm of brokers to organise the sale process, to generate interest among the financial institutions that buy the majority of shares offered to the public, and to ensure that the company meets all the rules of the exchange it plans to join. If the intention is to raise more than the equivalent of €5m via the share sale, the company and its advisers will be obliged to produce a prospectus, which is a detailed, legally binding document that sets out the relevant information on the company’s history and the important risk factors that buyers taking part in the offer need to know about. The prospectus will be drawn up by lawyers and will have to be approved by the UK Listing Authority before it can be issued.
- How does a company decide which market to choose?
There are several public stock markets in the UK, the most famous of which is the Main Market of the London Stock Exchange, which is used by the largest and most established businesses. Smaller companies usually seek to offer their shares via so called ‘junior’ stock markets such as the Alternative Investment Market (Aim) or ISDX. These have less demanding rules than the Main Market, for example allowing offers by companies with shorter trading histories, those that are not profitable and those that wish to float only a relatively small percentage of their shares. This is intended to encourage smaller and enable earlier-stage companies to gain access to the public share markets in order to raise funding.
- How much can a company raise via a flotation?
Companies that float their shares on a stock market are generally seeking to raise a minimum of several million pounds. There are significant costs associated with carrying out a flotation since the process requires a lot of professional advisers including lawyers, accountants, corporate financiers, brokers and underwriters, financial PR firms and so on. It is unlikely to make sense unless the proceeds are great enough to justify the expenses that will inevitably be incurred. As a guide, the cost of a flotation is likely to be several hundred thousand pounds, and there will also be an ongoing annual cost to maintain the company’s presence on the stock market, which can run to £100,000 or more on the Aim market.
- What are the advantages of floating your company?
A successful flotation represents a landmark for any business owner. Having its shares quoted on a public stock market and attracting large and well-known financial institutions on to its shareholder register are important signals of credibility for the company and should give it a much higher profile than it might enjoy as a private business. For many companies, these advantages are critical in their decision to go ahead, alongside the ability to raise additional funding and for founding shareholders to realise some of their paper wealth, of course. However, companies that go public can expect far closer scrutiny than those that stay private. Publicly quoted companies are subject to much greater disclosure obligations than their private rivals and must publish detailed six-monthly financial reports within set deadlines. They must also take great care not to allow any details about their performance or financial situation to leak out through unofficial channels. This could enable those who receive the information to profit from it before it becomes generally known, an illegal activity known as ‘insider trading’.
- Need to know:
- Companies that offer their shares on the Main Market are said to be ‘listed’. Those that use a junior stock market such as Aim are known as ‘quoted’ companies.
- It is not always necessary for a company to carry out an IPO in order to go public. Sometimes a private company will acquire a public company and in doing so will take over its target’s stock market quotation. This is known as a ‘reverse takeover’, meaning a takeover of a public company by a private one.
- Investors that take part in IPOs will expect to see the major shareholders retain a significant stake in the company after its flotation, as a signal of their long-term commitment to the business. Large existing shareholders are often subject to so-called ‘lock-ins’ under which they agree not to sell any more shares for a set period after the IPO. If the major shareholders attempt to sell the majority of their holding in the IPO, this will usually be regarded as a negative signal about the company’s prospects.
- Public companies must announce any major new information about their current trading or prospects to the market via the official news service at the earliest opportunity. This includes any unexpected improvement or deterioration in current trading that could affect the share price if it were made public. If the company is engaged in merger or acquisition talks and its share price starts to move as word of this leaks out, it must also make an official announcement. The key concern is to avoid a ‘false market’ in the shares due to important but undisclosed information.
- Preparing a company to go public on a stock market will take several months, during which the legal processes must be completed and the management must meet potential shareholders to pitch their business and answer questions.
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