Public issues

There are three main sources of equity finance:

• internally-generated funds - retained earnings
• rights issues
• new external share issues - placings, offers for sale, etc.

Public issues

A public offer is an invitation to apply for shares in a company based upon information contained in a prospectus, either at a fixed price or by tender.

Fixed price offer

Shares are offered at a fixed price to the general public (including institutions).

Details of the offer document are published in a prospectus for the issue. The prospectus contains information about the company's past performance and future prospects, as specified by the rules for stock exchange companies. The rule book for UK companies whose shares are listed on the main London Stock Exchange is the UK Listing Rules. These are overseen by the UK Listing Authority, a department of the Financial Services Authority (FSA).

One of the most difficult problems in making a new issue to the public is setting the price correctly. If it is too high, the issue will not be fully taken up and will be left with the underwriters, and if it is underpriced some of the benefits of the project for which the finance is being raised will accrue to the new shareholders and not to the old.

Offer for sale by tender

Shares are offered to the general public (including institutions) but no fixed price is specified.

Potential investors bid for shares at a price of their choosing. The 'striking price' at which the shares are sold is determined by the demand for shares.

The price will be either:

(a)the highest price at which the entire issue is sold, all tenders at or above this being allotted in full, or

(b)a price lower than in (a), but with tenders at or above this lower price receiving only a proportion o the shares tendered for, so as to avoid the concentration of ownership in the hands of a few.

Institutional advisers on new share issues

As well as requiring the assistance of accountants in preparing the prospectus, new share issues may require the services of an issuing house. An issuing house is an investment bank specialising in new issue of shares.

Issuing houses

A company wishing to raise capital by offer for sale would first get in touch with one of the issuing houses which specialise in this kind of business.

In some cases, the issuing house earns a fee by organising public issues. In others, it purchases outright a block of shares from a company and then makes them an 'offer for sale' to the public on terms designed to bring in a profit to the issuing house.

There are between 50 and 60 members of the Issuing House Association, including all the important merchant banks. The fact that an issue is launched by one of these banks or other houses of high reputation is, in itself, a factor contributing to the chance of success of such a venture.

Investment banks

Investment banks also perform the functions of underwriting, marketing and pricing new issues.

• Underwriting: large share issues are usually underwritten which adds to the cost of raising finance but reduces the risk. An underwriter is someone (usually an investment institution) who is prepared to purchase shares in a share issue that other investors do not buy. For example, suppose that XYZ Co is issuing 50 million new shares at $2.50 each. If the issue is underwritten, the investment bank assisting the company with the issue will find one or more institutions that are prepared to buy up to a given quantity of the shares, if no one else wants them. In return for underwriting a portion of the new issue, an underwriter is paid a commission. If there are just one or two underwriters for an issue, the underwriters might offload some of their risk by getting other institutions to sub-underwrite the issue. Sub-underwriters are also paid a commission.

• Marketing: the marketing and selling of a new issue is a business activity in its own right. The investment bank provides the expertise.
• Pricing: one of the most difficult decisions in making a new issue is that it should be priced correctly. If the price is too low, the issue will be over-subscribed, and existing shareholders will have had their holdings diluted more than is necessary. If the price is too high and the issue fails, the underwriters are left to subscribe to the shares. This will adversely affect the reputation of the issuing house and the company. Correct pricing is important, and the investment bank will be able to offer advice based on experience and expertise. One way round the issue price problem is an issue by tender.

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