What is a Secondary Offering IPO: Meaning & Types
All you need to know about Secondary Offering IPO
Investors often need clarification on different types of issues by the companies. A secondary offering involves the selling of shares in the secondary market. Based on who is involved in such transactions, secondary offerings can be classified into dilutive and non-dilutive offerings.
In this blog, we're going to cover the following:
- What is a secondary offering in an IPO?
- How does a secondary offering work?
- Types of secondary offering
- Should you invest in it?
What does secondary Offering in IPO mean?
As the name suggests, secondary offering involves selling shares held by investors in the secondary market. Shares sold in the secondary market are the same that were once sold to the public during Initial Public Offering.
In an IPO, the proceeds from selling shares to the public are collected by the company. But since investors in secondary holding are the owners of the shares being sold, proceeds are collected by them only.
The term is not restricted to the above definition. Sometimes a public company that has already issued shares during an IPO may issue additional shares which are also called follow-on offerings.
Working of a secondary offering in an IPO
Let's understand the working of a secondary offering in detail.
- A company needs funds. There can be many reasons, such as expansion, paying off debt, etc.
- The client company decides to issue an IPO to the public. The issue will happen in the primary market.
- Investors buy the shares being offered by the company for the first time. Proceeds from the sale of shares go to the company.
- Once an IPO is issued, it becomes a publicly-traded company. Its shares are listed on the stock exchange.
- Now, if these investors want to sell their shares further, they will sell them in the secondary market. It is the market where trading (buying and selling) of shares happens.
- Now, since the ownership of shares is with the investors, the proceeds from the sale of shares will be collected by investors, not the company.
- Companies may also perform secondary offerings by selling new shares. This is also known as a follow-on offering, often done to finance R&D activities, pay off debt, etc.
In other words, a secondary offering in an IPO means selling shares by investors/companies to interested individuals in the secondary market.
Secondary Offering Types
Two broad types of secondary offerings are dilutive secondary Offerings and non-dilutive secondary Offerings. We've discussed them in detail below.
Non-dilutive secondary offering
A non-dilutive secondary offering does not involve the dilution of shares, as the shares being sold were formerly issued in the IPO. In this, only an exchange or trading of shares happens. Also, since no new shares are created, the issuing company may not benefit from them.
A non-dilutive secondary offering often takes place once the lock-up period ends or a few years after issuing an IPO.
Dilutive secondary offering
It is the opposite of a non-dilutive offering. Also known as a Follow on Public Offering (FPO), the issuing company creates and offers new shares to be purchased by the investors. Since it dilutes the ownership of existing shareholders, it is called a dilutive offering.
The company's board of directors plays a major role in the decision-making process of issuing new shares.
Should you invest in a secondary offering?
To decide if you should invest in such offerings, you must be aware of the risks and rewards associated with participating in such transactions.
For example, if it is a non-dilutive public offering, look for reasons behind the selling of shares by investors. The reasons can be both positive and negative. Do not be biased, and do your research.
But if the offering is dilutive, it means ownership of existing shareholders will reduce. Now since there are more outstanding shares, the value of stocks may fall. You should also consider the amount of volatility involved. But keep in mind that volatility is often less than the period after an IPO.
The decision to invest in a secondary offering is relatively easy to make as the company's past information is available to investors. Unlike an IPO, where you have no idea how the company's shares have performed before, you have an idea and information here.
A company might say a zillion of good things about them, but you must research well. For example, a company is presenting all the good things about it during an offering, but it actually needs funds to pay off a considerable debt. However, this doesn't happen every time.
So, filings with SEBI will help you know the number of shares a company is selling and how it will use the proceeds. The information will help you make wise decisions.
An overview of important terms:
Initial Public Offering: It refers to the issue of shares by a company for the first time to the public. The issue happens in the primary market.
Secondary Offering: It refers to buying and selling of shares in the secondary market among investors. When investors sell their shares, no dilution of ownership happens in the company.
Follow-on Offering: It is any offer, whether involving the issue of new shares or secondary issuance taking place after an IPO.
There are three types of offerings you must be aware of. An Initial Public Offering means selling shares of a company for the first time in the primary market.
A follow-on offering means all the subsequent offerings taking place after an IPO. And a secondary offering means selling shares by investors to other investors in the secondary market.
This guide was about secondary Offering in IPO and whether you should invest.
Your decision to invest (in a dilutive offering) must depend on two factors. One is the information presented by the company. Second, on the research, you do about how many shares are being issued and how the proceeds will be utilized.