Contents of this article
After an IPO and listing on a stock exchange, a company’s capital raising continues, because the need to expand production and business is always a real and pressing one. In this article, we look at the differences between the 3 most common ways listed companies raise capital:
- Rights issues to existing shareholders.
- Private placements of shares.
- Increasing capital from retained earnings.
These issues are usually approved in a resolution of the company’s Annual General Meeting of Shareholders, as proposed by the Board of Directors.
Issuing and Offering Shares to Existing Shareholders
When it needs working capital, a company can raise more from its existing shareholders by issuing additional shares and offering them to those shareholders, usually at a steep discount to the market price. The new shares are offered in proportion to the shares each existing shareholder holds.
Example: a 1:4 rights issue to existing shareholders means that for every 4 shares held, a shareholder has the right to buy 1 new share at a preferential price.
The advantage of this method is that it preserves the existing shareholder structure and ownership percentages – strengthening shareholders’ commitment to the company. The risk is that shareholders may not want to, or may not have the money to, invest more. In that case, they can transfer their subscription rights (sell their rights) to other existing shareholders or outside investors. If existing shareholders and rights holders do not subscribe for all the shares on offer, the Board of Directors may sell the remaining shares to company shareholders or other investors. This can create new shares offered to outside shareholders, diluting the old shareholders’ ownership as they give up part of the “pie” to new ones.
The capital-raising “game”
The offer price to existing shareholders is usually well below the stock’s market price on the exchange. To encourage existing shareholders to put more money into the company, management may resort to tactics such as “pumping” positive news or “pushing up” the share price on the exchange, making the gap between the offer price and the market price more attractive.
Private Placements
Unlike the method above, a private placement offers shares to outside investors. Under Vietnamese rules, a private placement is limited to fewer than 100 investors, and the shares cannot be transferred for at least 1 year from the end of the offering. The offer price is usually based on the stock’s market price close to the time of the offering.
The advantage of this method is that it broadens the shareholder base and can raise larger amounts of outside capital. When shares are issued to strategic partners, especially foreign partners with financial strength and management expertise, the company can gain benefits such as:
- Transfer of new technologies.
- Support with management and operational capabilities.
- Support with sourcing raw materials.
- Support in developing new markets for its products…
Typical examples can be found in the pharmaceutical industry, where Vietnamese drug makers benefit from technology transfer, patents and the financial strength of strategic partners that are large foreign pharmaceutical groups.
Another variation is for the company to issue convertible bonds to strategic investors: it first borrows from them through bonds, with a clause allowing conversion into shares after a set period.
However, this way of raising capital also has a significant effect on the existing shareholder structure, which can make it harder for old and new shareholders to agree on how the company should be run.
A special form of this kind of issue is the ESOP share issue (Employee Stock Ownership Plan) – issuing a set percentage of shares to employees at a preferential price to reward them and build their loyalty to the company.
The capital-raising “game”
When offering shares to outside investors, companies usually base the price on the stock’s average market price over the most recent trading sessions (typically the last 10–30 sessions). This gives companies a strong incentive to push the share price up close to the pricing date, while also making the offer more attractive to new shareholders.
Increasing Capital from Retained Earnings
This is a common way to increase capital and the one with the least effect on the shareholder structure: the company reinvests the profits from its business instead of paying them out to shareholders as cash dividends. It is usually done by issuing stock dividends.
We have covered this in detail in another article on dividends, which you can read here.
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