What Is a Flotation Cost and Its Key Components?

Flotation costs represent the various expenses companies encounter when they raise capital by issuing new securities. These costs are a consideration in financial decisions, impacting the overall efficiency of capital acquisition. Understanding these expenses is important for businesses contemplating public or private offerings.

Defining Flotation Costs

Flotation costs are the direct expenses a company incurs when issuing new equity or debt securities to investors. These expenses reduce the actual capital received from the sale of securities. They are viewed as a reduction in the proceeds from capital-raising activities, rather than an operating expense.

Key Components of Flotation Costs

Flotation costs encompass several distinct categories of expenses. Underwriting fees, often the largest component, are paid to investment banks for their services in facilitating the offering, covering their risk, and managing the sale of securities to investors. For Initial Public Offerings (IPOs), these fees commonly range from 4% to 7% of the gross proceeds, although for general securities issuance, they can range from less than 1% to over 7%.

Legal fees are incurred for drafting essential documents, ensuring compliance with securities laws, and conducting due diligence. These can range from several hundred thousand dollars to over a million for a standard IPO, with some flat fees for registration statement preparation starting as low as $75,000. Accounting fees cover the preparation and auditing of financial statements required for regulatory filings, often costing between $500,000 and $1 million for IPOs, or tens of thousands to several million for more complex situations.

Registration fees are paid to regulatory bodies, such as the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). The SEC registration fee is $153.10 per $1,000,000 of the aggregate offering amount. FINRA charges a flat fee of $500 plus 0.015% of the proposed maximum aggregate offering price, with varying caps.

Printing and administrative costs involve the production of prospectuses, certificates, and other necessary documents, which can cost between $0.3 million and $0.5 million for an offering. Marketing and roadshow expenses cover the promotion of the offering to potential investors, with roadshows typically costing around $500,000 to $1 million for IPOs.

Occasions for Incurring Flotation Costs

Companies incur flotation costs during various capital-raising activities. Initial Public Offerings (IPOs) are a primary instance, where a private company first offers its shares to the public market. This process involves significant expenses due to the extensive regulatory requirements and marketing efforts needed to introduce a new company to public investors.

Seasoned Equity Offerings (SEOs), also known as follow-on offerings, occur when a company that is already publicly traded issues additional shares. While often less expensive per share than an IPO due to existing public reporting, SEOs still involve substantial flotation costs for underwriting, legal, and regulatory compliance. Debt issuances, such as the sale of corporate bonds, also generate flotation costs, including fees for underwriters, legal counsel, and registration with financial regulators.

Flotation Costs and Capital Raising

Flotation costs directly impact the net proceeds a company receives from a securities offering. The capital actually available to the company is the gross amount raised from investors minus these associated expenses. For example, if a company raises $100 million in an offering but incurs $7 million in flotation costs, the net proceeds available for its operations or investments are $93 million.

These costs also effectively increase a company’s cost of capital. The company must generate a return on the net funds received that is sufficient to cover not only the expected return to investors but also the expenses paid to acquire those funds. This means the actual cost of financing is higher than the stated interest rate on debt or the dividend yield on equity.