12.3.1 Method Of Offering

The Method Of Offering

In corporate financing, a key aspect is determining how an issue will be distributed or sold. This chapter explores the different methods of offering, including private placements, primary offerings (such as initial public offerings, or IPOs), and secondary offerings.

Private Placement

A private placement involves selling the entire issue to one or several large institutional investors. Here, the issuer targets major financial entities such as banks, mutual funds, insurance companies, or pension funds. Private placements are generally aimed at sophisticated investors and institutional clients; therefore, the requirements for detailed disclosure and public notice are typically waived, negating the need for a formal prospectus. This waiver significantly reduces the cost for the issuing company. Private placements are often declared only after completion, usually through advertisements in the financial press.

Public Offerings

Public offerings involve preliminary agreements between the corporation and the dealer to decide whether the dealer will act as an agent or as a principal.

Types of Underwriting Agreements

• Best Efforts Underwriting Agreement: Here, the dealer acts as an agent and makes its best efforts to sell the securities to the public. If the securities do not sell, the issuer does not receive the proceeds, and the unsold securities return to the issuer. The issuer faces the risk of not raising the intended capital.

• Firm Commitment Underwriting Agreement: Also known as a bought deal, the underwriter acts as a principal, commits to buying a specified number of securities at a set price, and then resells them to the public. The issuer receives the full proceeds of the sale regardless of whether all securities are sold. The underwriter assumes the risk of selling the security and thereby advantages from a presumed lower risk after due diligence.

Primary Offering

A primary offering of securities requires significant expertise and finesse, particularly in terms of the pricing and marketing of the issue. The process details, such as the dealer’s commission, offering price, and volume of issued securities, depend on market conditions.

Secondary Offering

A secondary offering involves the resale of previously issued stock by shareholders, often those in control positions. Investment dealers or syndicates usually manage these offerings.

Repurchasing Shares

Companies may repurchase outstanding shares, known as treasury shares, which do not have voting rights or dividend entitlements but can be resold back to the market with restored rights.

Bond Issuance

Bond issuance usually involves multiple groups. The issuing company initially sells bonds to a financing group or lead underwriter, which then offers them for public resale.

Groups Involved in Bond Issuance

1. Financing Group: This group led by the managing underwriter arranges the prospectus preparation, securities commission clearance, and selling documents. The group members have direct liability for the issue on behalf of the entire syndicate.

2. Banking Group: These additional dealers agree to participate on pre-set terms, accepting a certain degree of liability.

3. Selling Group: Other dealers who are not part of the central banking group but assist with sales.

4. Casual Dealers: Non-members who may include broker-dealers and foreign banks.

5. Special Group Orders: Considerations for specific dealers or bankers, sometimes dictated by the issuer.

6. Exempt List: Primarily large financial institutions exempt from prospectus requirements.

Debt and Equity Financing

Differences Between Debt Financing and Equity Financing

In debt financing, companies raise funds by borrowing money, typically through issuing bonds, which must be repaid over time with interest. Equity financing, on the other hand, involves raising funds by issuing shares of the company’s stock, giving shareholders ownership stakes without guaranteed repayment.

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Key Takeaways

1. Private Placements: Target institutional investors with minimal disclosure requirements for lower costs
2. Public Offerings: Can involve best efforts or firm commitments, each with its own risks and benefits
3. Primary vs. Secondary Offering: Primary involves new stock issuance; secondary involves resale of existing shares
4. Bond Issuance: Involves multiple groups, from financing to casual dealers
5. Debt vs. Equity Financing: Debt demands repayment with interest, while equity shares company ownership risks and rewards.

FAQs

Q1. What is a private placement? A private placement refers to selling securities directly to large institutional investors, largely bypassing extensive disclosure requirements and reducing issuing costs.

Q2. What is the difference between a best efforts underwriting agreement and a firm commitment underwriting agreement? In a best efforts agreement, the dealer acts as an agent with no sale guarantee, while a firm commitment agreement sees the underwriter buy securities outright, assuming resale risk.

Q3. What is a primary offering? A primary offering refers to the sale of new securities, often as IPOs, to raise fresh capital for the issuing company.

Glossary

• Underwriter: A financial specialist who administers and ensures the proper conduct of issuing securities, assuming various levels of risk.
• Prospectus: A legal document offering comprehensive details about an investment offer to potential buyers.
• Treasury Shares: Shares repurchased by the issuing company, holding no vote or dividend rights, but can be resold later.
• Bond: A fixed-income instrument representing a loan made by an investor to a borrower (typically corporate).