Ghost (????????????????????????) busters – edition 4

• Global, South Africa
• Acquisition for shares, Initial Public Offering, IPO, Liquidity, Vendor consideration placement
• June 21, 2020

In this edition, we focus on two concepts that are a core part of equity capital markets. It’s complicated to understand how listed companies work and what the benefits are, but with each term you learn and understand, you’re getting closer.

Initial Public Offering (IPO)

An IPO is a capital raise by a company as part of a new listing. This is known as “coming to market” and it gets investment bankers and lawyers terribly excited because they can earn incredible fees from this process.

Companies issue a document known as a prospectus, which gives potential investors a thorough overview of the company. Investors are invited to subscribe for shares in the company at a particular price.

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The investment bankers tap into their networks to attract anchor investors into the company. This is critical to give smaller investors a sense of comfort around the business. If the big names are investing, it feels less risky to follow them into the company. Of course, sometimes the biggest names in the business get it horribly wrong, so be careful.

If the offering is oversubscribed, it means there is more demand for the shares than supply. The final listing share price will be at the upper end of the suggested range by the bankers and they will allocate the shares taking into account the need to have anchor investors as well as a “spread” of smaller investors.

If the offering isn’t so popular, it may settle at the lower end of the range and the allocation of shares will be less controversial as there is enough to go around.

At an extreme, an IPO can be cancelled if there just isn’t enough investor interest. It’s rare for the bankers to get it so wrong, but it does happen, sometimes for reasons well outside of their control.

Acquisition for shares

Listed companies can use their listed shares as “acquisition currency” – a fancy way of saying that they can buy businesses and pay for them by issuing shares to the seller.

The process is known as a “vendor consideration placement” because the company is placing shares with the vendor (seller) of the business. For some reason, “purchase consideration” is the formal term for the value of the transaction. Don’t blame me for making it so complicated, blame the lawyers.

The ability to issue shares to pay for an acquisition is powerful if the shares are liquid (we dealt with this in the last jargon busters article), because the seller can choose to keep the shares or sell them on the open market and bank the cash.

If the shares are illiquid though i.e. thinly traded, it isn’t very powerful at all. Particularly in the wake of the Steinhoff and EOH debacles where people who sold businesses to them in return for shares lost nearly everything, entrepreneurs are already nervous of being paid in shares and even more so where they can’t immediately sell them.

It begs the question of why small companies with illiquid shares are even listed in the first place, but that’s a discussion for another day.