Chapter: 3 Corporate issues of securities in capital market

Common stock: Common stock is a security that represents ownership of a company or corporation. Ownership in
the company is determined by the number of shares a person owns divided by the total number of shares outstanding.
For example, if a company has 1000 shares of stock outstanding and a person owns 50 of them, then he/she owns
5% of the company.
Preferred stock: Preferred stock is as special form of stock having a fixed periodic dividend that must be paid prior
to payment of any common stock dividends.
Characteristics of preferred stock
1. Dividends: Owners of preferred stock receive payment of predetermined percentage of dividends before the
owners of common stock.
2. Convertibility: Often, preferred stock can be changed or converted into common stock.
Public Issues: Public issue means the issue of stock on a public market rather than being privately funded by the
companies own promoter(s), which may not be enough capital for the business to start up, produce, or continue
running. By issuing stock publicly, this allows the public to own a part of the company, though not be a controlling
factor.
Cash offer is an offer to pay for something in cash. Specially, an offer to pay in cash, especially an offer to pay cash
when buying shares in a takeover bid.

General cash offer

A General Cash Offer refers to a public offering of securities (shares or bonds) made to every interested investors,
rather than being limited to existing shareholders. It may be carried out with or without the involvement of an
underwriter who helps sell the issue to the public. In contrast, a rights issue is offered only to the current stockholders.
In the U.S., general cash offer is the most common method of selling debt (bond) & equity (stock).
Basic Procedure of Public Issue
1. Management gets the approval of the Board of Directors.
2. The firm prepares and files a registration statement with the BSEC.
3. The BSEC studies the registration statement during the waiting period.
4. The firm prepares and files an amended registration statement with the BSEC.
5. If everything is copasetic with the BSEC, a price is set and a full-fledged selling effort gets underway.
The process of A Public offering

Step in public offering Time

1. Pre-underwriting conferences Several months
2. Registration statements 20-day waiting period
3. Pricing the issue Usually on the 20th day
4. Public offering and sale After the 20th day
5. Market stabilization 30 days after offering
Types of Stock
1. Common socks: A Common Stock is a part of ownership of a corporation.
2. Preferred stocks: A special form of stock having a fixed periodic dividend that must be paid prior to payment
of any common stock dividends.
3. Blue chip stocks: are stocks of well-established companies that have stable earnings and no extensive liabilities.
They have a track record of paying regular dividends, and valued by investors seeking safety and stability.
4. Penny stocks: are low-priced, speculative and risky securities which are traded over-the-counter (OTC); i.e.
outside of one of the major exchanges.
5. Income stock: offer a higher dividend in relation to their market price. They are especially attractive to investors
who are looking for current income that will gradually grow over the years as a way to offset inflation.
6. Growth stocks: are securities which appreciate in value and yield a high return. Their profits are typically re-
invested to expand the business. Investors gain because the stock prices increase as the business grows.
 7. Value stocks: are securities which investors consider to be undervalued. They feel that the stock is being traded
below market value, and they believe in the long-term growth of the issuing company.

When is a stock sold an initial public offering (IPO)?

A firm “goes public” through an IPO when the stock is first offered to the public.
Prior to an IPO, shares are typically owned by the firm’s promoters, key employees and the venture capital providers.

Common shareholder’s Right and Privileges

1. The right to receive dividend payments
2. The power to sell the stock
3. The right to vote to elect directors
4. Residual ownership
5. The right to receive a proportionate distribution of assets on corporate liquidation
6. Residual claim on income and assets
7. Limited Liability
A premium Issue
Generally, most shares have a face value (i.e. the value as in a balance sheet). The difference between the offer price
and the face value is called the premium. A new company can offer shares to the public at a premium provided that
(as per Bangladesh Securities and Exchange Commission):
1. The promoter company has a 3 years consistent record of profitable working.
2. The promoter takes up at least 50 per cent of the shares in the issue.
3. All parties applying to the issue should be offered the same instrument at the same terms, especially regarding
the premium.
4. The prospectus should provide justification for the propose premium. On the other hand, existing companies
can make a premium issue without the above restrictions.
A company’s aim is to raise money and simultaneously serve the equity capital. As far as accounting is concerned,
premium is credited to reserves and surplus and it does not increase the equity.
A primary offering is usually done to help a young, growing company expand its business operations, but it can also
be done by a mature company that still happens to be a private company.
Primary offerings can be followed by secondary offering, which serve as a way for a company that is already publicly
traded to raise further equity capital for its business. After the offering and the receipt of the funds raised, the
securities are traded on the secondary market, where the company does not receive any money from the purchase
and sale of the securities they previously issued.
The underwriting process
Getting a piece of a hot IPO is very difficult, if not impossible. We need to know how an IPO is done, a process
known as underwriting.
Underwriting is the process of raising money by either debt or equity. The company and the investment bank will
first meet to negotiate the deal. The Items of discussion usually include the amount of money a company will raise,
the type of securities to be issued and all the details in the underwriting agreement. The deal can be structured in a
variety of ways.
For example, in a commitment, the underwriter guarantees that a certain amount will be raised by buying the entire
offer and then reselling to the public. In a best offer agreement, the underwriter sells securities for the company but
doesn't guarantee the amount to be raised. Also, investment banks are hesitant to bear all the risk of an offering.
Instead, they form a syndicate of underwriters. One underwriter leads the syndicate and the others sell a part of the
issue. Once all sides agree to a deal, the investment bank puts together a registration statement to be filed with the
SEC. This document contains information about the offering as well as company info such as financial statements,
management background, any legal problems, where the money is to be used.
The SEC then requires a cooling off period, in which it investigates and makes sure all material information has been
disclosed.
Once the SEC approves the offering, a date is set when the stock will be offered to the public.
During the cooling off period the underwriter puts together what is known as the red herring. This is an initial
prospectus containing all the information about the company except for the offer price and the effective date, which
aren't known at that time.
With the red herring in hand, the underwriter and company attempt to advertise and build up interest for the issue.
They go on a road show - also known as the "dog and pony show" - where the big institutional investors are invited.
As the effective date approaches, the underwriter and company sit down and decide on the initial share price. This
isn't an easy decision: it depends on the company, the success of the road show and, most importantly, current market
conditions. Of course, it's in both parties' interest to get as much as possible. Finally, the securities are sold on the
stock market and the money is collected from investors.

Firm commitment
1. Under a firm commitment underwriting, the investment bank buys the securities outright from the issuing firm.
2. Obviously, they need to make a profit, so they buy at “wholesale” and try to resell at “retail”.
3. To minimize their risk, the investment bankers combine to form an underwriting syndicate to share the risk and
help sell the issue to the public.

Best Efforts
1. Under a best effort underwriting, the underwriter does not buy the issue from the issuing firm.
2. Instead, the underwriter acts as an agent, receiving a commission for each share sold, and using its “best efforts”
to sell the entire issue.
3. This is more common for initial public offerings than for seasoned new issues.
Steps of Public Issue
1. If a company decides to raise capital by issuing stock, it must file a formal registration statement with the
Securities and Exchange Commission (SEC) that details the business's financial history, current financial
situation, the proposed public issue and future projections.
2. The company must also prepare a preliminary prospectus that contains information similar to that of the
registration statement for potential investors.
3. After a 20-day waiting period, the registration statement is considered accepted unless the SEC sends a letter of
comment asking for changes.
4. The securities can be sold, and a final prospectus is issued at the conclusion of the waiting period.
5. An investment bank will act as an underwriter to affect the sale, which is known as the initial public offering or
primary offering. A primary offering is the first of issuance of stock for public sale from a private company.
An underwriter is a firm which:
❖ Buys an issue of securities from a company and resells it to the public.
❖ Also provides the issuing company with procedural and financial advice, shepherding it through the public
issue process.
This is the means by which a private company can raise equity capital through the financial markets in order to
expand its business operations.
Right Issue
▪ If a defensive right is contained in the firm’s articles of incorporation, the firm must offer any new issue of
common stock first to existing shareholders.
▪ This allows shareholders to maintain their percentage ownership if they so desire.
Mechanics of Rights Offerings
The management of the firm must decide:
❖ The exercise price (the price existing shareholders must pay for new shares).
❖ How many rights will be required to purchase one new share of stock.
These rights have value:
❖ Shareholders can either exercise their rights or sell their rights.
 Example of Right Offering
▪ Popular Delusions, Inc. is proposing a rights offering. There are 2,00,000 shares outstanding trading at Tk.
25 each. There will be 10,000 new shares issued at a Tk. 20 subscription price.
▪ What is the new market value of the firm?
▪ What is the ex-rights price?
▪ What is the value of a right?
▪ What is the new market value of the firm?
▪ There are 2,00,000 outstanding shares at Tk. 25 each. There will be 10,000 new shares issued at Tk. 20
subscription price.
Tk.25 Tk.20
▪ Tk.52,00,000 = 2,00,000 shares  + 10,000 shares 
share shares
▪ What is the ex-rights price?
▪ There are 2,10,000 outstanding shares of a firm with a market value of Tk. 52,00,000.
▪ Thus the value of an ex-rights share is:

Tk.52,00,000
= Tk.24.7619
2,10,000 shares

Shelf Registration
Shelf registration permits a corporation to register an offering that it reasonably expects to sell within the next two
years.
Not all companies are allowed shelf registration.
➢ Qualifications include:
❖ The firm must be rated investment grade.
❖ They cannot have recently defaulted on debt.
❖ The market capitalization must be > $75 m.
❖ No recent SEC violations.
Private Placement
❖ Avoid the costly procedures associated with the registration requirements that are a part of public issues.
❖ The SEC restricts private placement issues not more than a couple of dozen knowledgeable investors
including institutions such as insurance companies and pension funds.
❖ The biggest drawback is that the securities cannot be easily resold.

Advantages of Shelf Registration

1. Flexibility in Timing: The firm can issue securities whenever market conditions are favorable without re-
filing each time.
2. Reduced Costs and Time: Avoids the expense and delay of multiple registration processes for each issue.
3. Quicker Access to Capital: The company can raise funds rapidly when opportunities arise or when financing
is urgently needed.
4. Market Responsiveness: Management can take advantage of favorable interest rates or stock prices,
improving financial efficiency.
5. Administrative Convenience: Simplifies regulatory compliance for multiple offerings within the approval
period.