How does a company raise money post-IPO? What you need to know in 3 minutes
A friend recently asked me about Tesla stock. I said that the company makes cool cars, which look like they are fun to drive. I also said that there are lots of smart people who have run a ton of numbers and assert that Tesla isn't profitable and question its accounting.
I summed it up by saying, “Look dude any company can keep going if the market keeps funding it.” After a moment, he asked, “What’s the market? I mean don’t companies only have one IPO? What can they do to raise money after that?”
This brief piece covers how a company can raise money post-IPO. It assumes little to no financial knowledge.
TL;DR - There are a bunch of ways companies can raise money after an IPO, and they do so all the time. Most equity raises are dilutive.
Let’s say you have a company, and it went IPO a few years ago. Now you need money to grow your business, develop a new product, or pay off some debt. How can you raise money? You have a few options to raise equity or debt capital. Just a heads up that most ways of raising equity are dilutive to shareholders.
Whoa, hold on, what’s dilution?
A company issues new shares. Subsequently, shareholders end up owning a smaller percentage of the company. Let’s say that you own 100 shares in your company and are the only shareholder (ie. you own the entire company). You decide to raise money by issuing an additional 100 shares to an investor. Well, your company hasn’t changed much, but after issue, there will be 200 shares outstanding. Now you only own half the company. That’s dilution.
Ok, fine. I still want to raise equity post-IPO. How can I do that?
Private Placement - Usually, large amounts of equity are raised through a “Private Placement.” This is when you sell equity to big investors like mutual/hedge funds, pensions, insurance companies and sovereign wealth funds. To entice these investors, you sell the stock at a discount to the current market price. The good thing is that you kind of know how much money you are raising once these investors commit to buying your shares. On the other hand, you are selling stock for below market price, and that kind of sucks because who wants to sell something for less than what the market thinks its worth?
At the Market Equity Program - Another way to raise money (usually smaller amounts) is via an “At the Market Equity Program.” This is when you sell shares on the open market. Maybe your stock price went through the roof because some people on Reddit made a bunch of hilarious memes and wanted to stick it to some hedge funds or something. This is exactly what AMC did a few weeks ago during the Gamestop saga. The benefit is that you get to sell your stock directly to the market at market prices. If your stock is going up, you can raise more money than you thought you would, which is pretty sweet. The downside is that you don’t know how much money you’ll raise because the pricing isn’t fixed.
Secondary Offering – This can go two ways. One way is that your company has shares of its stock in reserve that it releases (ie. sells) to the market. This is dilutive. The other way is that you or other insiders are selling your stock to the public. This is not dilutive since the shares are just exchanging hands. Insiders like you are selling existing shares to non-insiders (other investors who don’t have inside information on the company). This is usually for insiders to generate some cash from their investment and maybe buy a house, yacht/Lambo or pay for their kids’ college.
Secondary Listing – This is when a company lists on another stock exchange (a foreign one), often by issuing new shares. Maybe your company is popular in Brazil, and you want to expand there. You want to raise some Brazilian Reals and you want access to investors in Brazil because they know and like your product and will pay a lot for the stock. Oh, and you might win some points with the Brazilian Government by showing your commitment to the country. Your company does a listing (like in an IPO) on the Brazil stock market. This is great because you get access to a whole new group of investors and win points in Brazil. The issue is that you probably have to do a lot of work/hire people in order to adhere to potentially confusing local laws and regulations. Recent (non-Brazil) examples include Alibaba and JD.com, which are Chinese companies that had IPOs in New York, but recently did secondary listings in Hong Kong.
Rights Issue – This is when you go to your existing shareholders and offer them the right to buy more shares of stock that they already own. For example, you might say “Yo, shareholder, I need/want some money, and I will sell you 1 share for every 2 shares that you already own. And to sweeten the deal, I’ll sell you that 1 new share at a discount to the current market price.” The benefit is that investors can get more shares of a company at a discount. Investors can also trade the right to buy the stock and make money that way. Shareholders who participate don’t get diluted while others do. Companies that do rights issues usually really need the money because things probably aren’t going too well and because there is little interest in the market for the company’s equity. Otherwise, you’d just go raise money in one of the previous ways above rather than begging your existing investors and giving them a discount, right? An example is HSBC, which raised nearly $20bn in 2009 during the financial crisis by doing a rights issue.
Never mind. Dilution is lame and interest rates are low. How can I borrow money?
Loan - Bank loans are old school and popular, especially outside of the US. These are often custom negotiated deals. The bank will probably place financial conditions (called “covenants”) in order to reduce the risk that the bank loses money. For example, covenants may limit how much debt you can take on, how you can use the money, and/or specify minimum financial metrics that your company must maintain. If it’s a big enough loan, the bank may divide your loan and let in other banks on the deal. This is called “syndication.” But you only have to negotiate with one counterparty, and that means less work and more time for you to focus on your business.
Bonds - You can also issue bonds which are more standardized than loans. But your company has to hire investment bankers to hustle and find big investors who will buy your bonds. Of course, before they sign up to buy your bonds, investors will try to negotiate terms. They may demand covenants too, but they are usually fewer/less stringent, since, well, there are a lot more investors than banks and bonds are traded. If the investor wants to sell your bond in the market, it can. That’s much tougher to do for loans. And if investors really like your company/industry, they might not demand much and might even fight over the privilege of lending you money. Advantage: you.