What is a Secondary Offering IPO? Definition, Example, and Features

Understanding Secondary Offerings

The secondary market transfer of shares for a company from one investor to another is known as Secondary offering. The firm has already sold these shares as a part of its IPO. The company won't issue new shares or accept cash. Rather, the exchange of shares takes place between investors directly.

Businesses may decide to sell investors their shares through an IPO to raise funds. In an Initial Public Offering (IPO), a business offers its shares to the public for the first time. These are basically fresh securities sold to the investors. The firm could finance acquisitions, working capital needs, and other business needs with the funds from the sale.

Investors may sell these shares on the secondary market after closing of an IPO. The firm whose shares are traded does not get any proceeds from the secondary sale. Instead, they go directly to the seller. A business may occasionally do a follow-on offering. It is also sometimes referred to as a secondary offering.

In certain situations, shareholders may request to sell their investments. So, some businesses might make follow-on offers to allow shareholders to refinance their debt at discounted interest rates.

Example of a Secondary Offering

Let’s now take an example to understand what is secondary offering of shares. Assume that throughout the IPO process, Aziz purchases about 40% of the outstanding shares from Company A. Then he sells 30% of the shares after the company's listing on the Stock Exchange. Aziz's initial subscription during the IPO process is an example of a primary market transaction. However, it is a secondary market transaction or secondary offering when he later sells 30% of his subscription in the secondary market.

How Secondary Offering Works

Let's take a closer look at how a secondary offering works.

Suppose the client firm chooses to go public and launches an IPO. It will issue the shares in the primary market. Investors shall purchase the company's shares for the first time. The company receives the funds from the selling of shares.

The stock exchange lists its shares. Investors will now sell these shares on the secondary market. Trading, or the buying and selling of shares, takes place in this market. Instead of the company, investors will now get the money from the sale of shares. This is because they are the ones who currently hold the shares.

Businesses may also sell fresh shares as part of a secondary offering. It is referred to as a follow-on offering. This is frequently carried out to fund research programs, settle debt, etc.

So, a secondary offering in an IPO refers to the sale of shares to potential buyers on the secondary market. The sellers may be existing investors or the company themselves.

Types of Secondary Offerings

There are two kinds of secondary offerings. These include the following.

Non-dilutive Secondary Offerings

They are shares held by existing shareholders whose value remain unchanged. This is because new shares are not created. Private shareholders, including directors or venture capitalists, sell these shares. They may choose to modify their present holdings or portfolios. So, the issuing firm might not profit from this offering.

The stock price of the company typically declines due to non-dilutive secondary offerings. However, this usually happens only for a short period. If investors have faith in the company's future performance, the prices may soon increase again.

Dilutive Secondary Offerings

A follow-on public offering, or FPO, is a dilutive secondary offering. Here, a business issues new shares in the market and dilutes the value of its existing shares. The companies give dilutive offerings when they decide to sell more shares and generate additional funds for the firm.

In this instance, there are more outstanding shares, which lowers earnings per share (EPS). The firm receives cash flow from this difference in share price. It may utilise the funds to meet its objectives, enter new markets, or settle debts.

Diluted secondary offerings lower the value of existing shares. So, they are typically not in the best interests of existing owners.

Features of Secondary Offerings

Here are the key features and functions of secondary offerings.

1. Provides Liquidity

The ability to impart liquidity is the most important characteristic of secondary offerings. The ability to quickly convert securities into cash is known as liquidity. The quick conversion of assets into cash provides a sense of security for investors. Additionally, there are options to move across long, medium, and short-term investments.

2. Attracts New Investors

The secondary offering serves as a mechanism for current investors to withdraw their investments. The company's current owners often only sell a portion of their shares. The secondary offering helps in figuring out a company's market value. By regulating the new issues, stock exchanges promote improved trading practices. It also educates the public about investing, encouraging individuals to make investments.

3. Works as Economic Indicator

The secondary market (or the stock exchanges) is a reliable indicator of a nation's economic health. The stock prices follow every major shift in a country's economy. Disinvestment and reinvestment assist in investing in the most profitable investment options. This results in capital formation and economic growth.

4. Affects Prices of Securities:

Supply and demand are crucial factors. Due to the strong demand for their shares, profitable companies have high prices. Securities valuation benefits the government, creditors, and investors. Creditors may assess the company's creditworthiness, and investors can determine the value of their investment. Meanwhile, the governments can levy taxes on securities.

5. Safeguards Investors from Frauds

Stock exchanges provide a secure environment for secondary trades. The firms are listed on stock exchanges in accordance with several regulatory procedures and norms. Market regulators like the Securities and Exchange Board of india (SEBI) keep a close watch on all the transactions. So, the risk of fraudulent transactions is vastly decreased.

Impact of Secondary Offerings

Secondary offers can impact the price of a company's shares and investor sentiment. For instance, investors could expect negative news if a large shareholder sells off a sizable portion of their shares. Furthermore, the secondary offerings that dilute share price usually witness price drops. However, the market's response can be unpredictable.

It's not clear why a stock price increases after secondary offerings. Investors may react favourably to an offering if they think the funds raised from the sale will help the business. An offering may be seen positively if the firm uses the capital to pay off debt, start an acquisition, or invest in the company's future.

Conclusion

A secondary offering is the sale of shares to investors in the secondary market. It can be non-dilutive or dilutive. In non-dilutive offerings, publicly listed companies engage in secondary offerings to finance acquisitions, new projects, or meet operational costs. Follow-on offerings are additional shares issues after an IPO. Secondary offerings provide liquidity, affect asset prices, and safeguard investors from fraudulent transactions. However, some of them can have a lockup period that prevents the securities from being sold again. So, research properly before investing in any secondary offering.