What Is the Issuance of Stock and How Does It Work?

What is Stock Issuance

Stock issuance is how a company sells ownership shares to investors to raise capital. This increases outstanding shares. Companies issue stock to fund business needs or strategic initiatives.

Companies issue stock through different offerings. An Initial Public Offering (IPO) is when a private company first sells shares to the public, transitioning to public ownership. After an IPO, a company may conduct subsequent offerings, often called secondary or follow-on offerings. While ‘secondary offering’ can refer to existing shares traded between investors, a company-initiated secondary offering creates and sells new shares to raise additional capital, increasing the total share count.

Why Companies Issue Stock

Companies primarily issue stock to raise capital without incurring debt. Proceeds from stock issuance are commonly used for business expansion, investing in new projects, or launching new products.

Companies issue stock to improve financial health, such as paying off debt. Reducing liabilities through equity improves the debt-to-equity ratio, appearing less risky to investors and creditors. Stock also serves as employee compensation, aligning interests with company performance. Companies may also use stock as currency in mergers and acquisitions, offering shares to purchase another business.

Types of Stock

Companies issue two main types of stock: common or preferred. Each type carries distinct characteristics regarding ownership, voting rights, and claims on company assets and earnings.

Common stock represents basic ownership and is the most frequently issued type. Holders possess voting rights, influencing corporate decisions like board elections and major policies. While dividends are not guaranteed and fluctuate, common shareholders have potential for capital appreciation. However, common stockholders have the lowest priority in receiving payments during liquidation, paid after creditors and preferred stockholders.

Preferred stock combines features of both stocks and bonds. Preferred shareholders do not have voting rights. Their benefit is a fixed dividend payment, paid before common stock dividends. In liquidation, preferred stockholders have a higher claim on assets than common stockholders, receiving payment after creditors but before common shareholders. This “liquidation preference” provides downside protection.

The Issuance Process

The stock issuance process involves several stages, ensuring compliance and effective capital raising. A company’s board of directors must first authorize the issuance, determining the number of shares and general terms. For public offerings, companies select investment banks as underwriters. Underwriters assess financials, determine offering price, and assume the risk of selling shares.

Underwriters prepare documentation, such as a prospectus, providing detailed information about the company and offering. This document is submitted to regulatory bodies, like the Securities and Exchange Commission (SEC), for review. Once regulatory requirements are met, the offering is marketed to potential investors through various channels, including roadshows. Underwriters then manage the sale and allocation of shares, with proceeds going to the issuing company to fund operations.

Impact on the Company and Investors

Stock issuance has implications for both the issuing company and its investors. Issuing new shares alters the company’s capital structure by increasing equity and potentially reducing reliance on debt. This enhances financial ratios, making the company appear more stable. The funds raised provide capital for growth and strategic initiatives.

For existing shareholders, new stock issuance can lead to dilution. Dilution occurs as new shares increase the total outstanding, reducing existing shareholders’ ownership percentage. This can also decrease their proportional voting power and impact earnings per share, though capital influx may increase company value. For new investors, stock issuance presents an opportunity to acquire ownership, benefiting from future growth and capital appreciation.