8.) Raising Capital using the London Stock Exchange

Question 1

Define why New Issues (IPOs) occur

Answer 1

New Issues (IPOs - Initial Public Offerings) occur when a company is seeking to raise capital from investors for the first time via the primary market on the LSE. The company is looking to float its shares on a public market

Question 2

Define the acronym IPOs

Answer 2

Initial Public Offerings

Question 3

Define the 2 markets which enable companies to make their shares available to the public

Answer 3

The listed securities market (the official list or a full listing)

The alternative investment market (AIM)

Question 4

Define the acronym AIM

Answer 4

Alternative investment market

Question 5

Define the benefits of a company being listed on the stock market

Answer 5

Access to a wider capital base, therefore making it potentially easier to raise capital

Company gains prestige from being quoted due tot he extensive listing requirements

Shares become freely marketable, enabling the company to consider future takeovers and mergers as its shares become consideration

Company may find it easier to raise debt finance due tot greater confidence/credit rating

Can raise further capital via secondary offerings, I.e. rights issues

Improved marketability of the company’s shares, I.e. employee share scheme

Question 6

Define the drawbacks of a company being listed on the stock market

Answer 6

A listing requires a high degree of regulation and disclosure of information, with any adverse factors quickly becoming public knowledge and reflecting in the share price

Adhering to the regulation requirements requires bets practices to be implemented in systems, documentation and employee qualifications and competency levels - this can all become costly for the company

Shareholders are the owners of the company, with investor power resting with the shareholders, and day-to-day management resting with the directors

Shareholders will expect a year on year increase in dividends, which will require the company to perform year on year and manage the expectations of the shareholders also

A listed company will be affected by general market conditions, with its share price being susceptible to volatile movements in markets not attributed specifically to the company

Question 7

Define where one might find the listing requirements for a full listing or admission onto the ‘Official Market List’

Answer 7

Listing requirements for a full listing or admission onto the official list are laid down in the UK Listing Authority (I.e. The FCA’s) Purple Book. This details all the conditions which must be met by all companies before their securities can be quoted on the stock exchange.

Question 8

Define Listing Particulars, in terms of gaining a full listing or admission onto the ‘Official Market List’, and the information included in them

Answer 8

Potential investors and the stock exchange itself must be provided with detailed information about the company to be listed, which takes the form of a published document, called the Listing Particulars

Information included in the Listing Particulars includes:

The name of the issuing house

Details of the capital structure of the company

Names and addresses of directors, bankers, lawyers, auditors

History and description of the company

Details of the directors and their interests

Statement regarding the adequacy of working capital

Full financial information, including profit and loss accounts, balance sheets and cash flow forecasts

Note that the details contained in the Listing Particulars appear in a prospectus for potential investors to review

Question 9

Define why companies issue shares

Answer 9

To raise capital

Question 10

Define the requirements that a company must comply with if it is to be admitted to the Official Market List of the Stock Market

Answer 10

The securities must be freely transferable

Total market capitalisation must be at least £700,000 in shares and £200,000 in debt securities

At least 25% of the issued ordinary share capital must be made available to the public

The company must have a 3 year trading record

Upon approval, the company must undertake to join in Continuing Onligations, I.e. matters which the company must continue to carry out in order to maintain its listing

Issues of securities for cash must be offered to the existing equity shareholders in proportion to their holdings

Question 11

Define the purpose of the AIM

Answer 11

To meet the requirements of small, young and potentially fast-growing companies, which need simple, cost effective access to a capital market

Question 12

Define the requirements that a company must comply with if it is to float on the Alternative Investment Market (AIM)

Answer 12

Appoint a nominated adviser who will be responsible for policing the company to ensure that it meets the markets regulatory requirements

Publish a prospectus which includes details of the company, directors, financial results

Enter into ongoing obligations with the LSE

There are NO minimum requirements for any percentage of share capital to be made available to the general public

A trading record is NOT essential

Question 13

Define obligation

Answer 13

An obligation in finance is the responsibility to meet the terms of a contract. If an obligation is not met, the legal system often provides recourse for the injured party.

Question 14

Define the Alternative Investment Market (AIM)

Answer 14

A sub-market of the London Stock Exchange that allows smaller companies to participate with greater regulatory flexibility than applies to the main market, including no set requirements for capitalization or the number of shares issued.

The Alternative Investment Market is the London Stock Exchange’s global market for smaller and growing companies.

As of 2010, more than 3,000 international companies have joined the Alternative Investment Market (AIM) since its launch in 1995.

AIM seeks to assist smaller and growing companies in raising growth capital.

Early stage businesses, venture capital-backed companies and more established businesses may join AIM to help raise the capital necessary for expansion.

AIM is owned by the London Stock Exchange Group.

Question 15

Define the LSE’s Main (see: official) Market

Answer 15

The Main Market is London’s flagship market for larger, more established companies, and is home to some of the world’s largest and most well-known companies.

It is usually reserved for larger, more established companies, as it has exacting requirements that must be fulfilled in order to join.

Question 16

Define the stages required in order to obtain for a company to obtain a listing on the LSE’s official (see: main) list

Answer 16

The method chosen will depend upon the advice given to the company by its advisors and the amount of capital the company wishes to raise

The stages that will have been undertaken before the shares are floated on the stock exchange include (Note that the following stages can take at least 6 months to complete):

Company securing an issuing house/sponsor

Accountants preparing a long-form report

Documenting the Listing Particulars

Filing the Listing Particulars with the U.K. Listing Authority for approval

Documenting a prospectus for potential investors

Issuing a pathfinder prospectus if required

Determining the number and issue price of the shares

Question 17

Define the main features of using the ‘offer for sale’ method to float a company on the official (main) list of the LSE

Answer 17

If a company chooses to float, using the offer for sale method, the main features of this approach include:

An issuing house purchases the stages from the company

The shares are offered to the public, including institutions

Application forms and prospectuses are advertised in the national press

The offer can be at a fixed price or a tender price

The issue can be either over or under-subscribed. If under subscribed, underwriters will step in

Applications forms and prospectuses are advertised in the ahtionalmpress

Question 18

Define the different methods in obtaining a stock exchange listing

Answer 18

Offer For Sale method

The placing method

The introduction method

Question 19

Define the main features of using the ‘placing’ method to float a company on the official (main) list of the LSE

Answer 19

Also known as Selective Marketing

Shares offered to the public selectively by a sponsoring broker, I.e. to those clients that the broker knows will buy the shares (mainly large institutions)

A placing with financial intermediaries is known as an intermediaries offer

Private investors can apply for the shares through a stockbroker

Question 20

Define the definition of and main features of using the ‘Introduction’ method to float a company on the official (main) list of the LSE

Answer 20

The introduction method is used when a company upgrades from a junior market to the official list, or when a company is already quoted on a foreign stock exchange, and wishes to obtain a UK listing on the LSE. Key features include:

The proportion of shares held in public hands already meets stock exchange requirements

No new capital is raised

Existing shares are simply listed, and there’s no opportunity for new investors to take part

Question 21

Define a capitalisation issue, and why a company will make one

Answer 21

Also referred to as a bonus issue or scrip issue

Made by a company to increase the number of shares in issue, but no new capital is raised. The new shares are first offered to existing shareholders on a pro-rats basis, e.g. one new share for every four shares held (1 for 4)

A company will make a capitalisation issue for several reasons:

Share price is becoming extremely high and shares are less attractive to investors

Shareholder perk and/or replacement of a dividend payment

Book-keeping exercise to ‘tidy-up’ its balance sheet and reserve accounts

Question 22

Define and describe the effect of a capitalisation issue on a company’s balance sheet

Answer 22

The effect of a capitalisation issue is to transfer the company’s reserves (share premium account, revaluation of assets, retained proctors, etc) to share capital, thereby increasing the number of shares and causing the price per share to fall.

The effect on a simplified balance sheet before and after a capitalisation (or bonus) issue is as follows:

Ordinary shares :
(Before)£200,000
(After) £250,000

Share Premium Account
(Before)£60,000
(After) £10,000

Reserves
(Before) £140,000
(After) £140,000

Net Assets
(Before) £400,000
(After) £400,000

Number of Ordinary Shares
(Before) 400,000 X 50p
(After) 500,000 X 50p

Note that the balance sheet is neither stronger nor weaker; the assets remain the same. The company has simply used its reserves (from the share premium account) to fund the capitalisation issue, and as a result there has been a change in the way the shareholder’s funds are shown

Question 23

Define the effect that a capitalisation issue would have on the price of a company’s shares listed on the stock exchange

Answer 23

The price of shares in the market after the capitalisation issue, the ex-cap price, will, all things being equal, fall in direct proportion to the increase in share capital.

For example, a company whose shares were priced in the market at 250p before a 1 for 4 bonus issue, would likely see shares drop in value to 200p:

400,000 shares X 250 = 1,000,000
100,000 shares X free = 0
500,000 shares total = 1,000,000 total
One share is worth 200p

Note that there are a variety of factors that may prevent the ex-cap price from falling in direct proportion to the capitalisation (bonus) issue, e.g. market conditions at the time. The lower share price may make the shares more attractive and therefore increase demand and its price.

Question 24

Define how the number of shares allocated to a shareholder following a capitalisation (bonus) issue are indicated

Answer 24

In order indicate the number of shares allocated to a shareholder following a capitalisation (bonus) issue, the shareholder receives a renounceable certificate showing the number of shares they are entitled to.

Should the shareholder wish to sell their allocated shares, they simply have to sign the reverse of the certificate

Question 25

Define the difference between a share split and a consolidation

Answer 25

A share split occurs when a company REDUCES the nominal (par) value per share, without altering the value of its nominal share capital.

The effect on the share price is the same effect caused by a bonus issue, all things being equal.

A share split INCREASES the number for shares in issue

A consolidation, the opposite of a share split, occurs when a company INCREASES the nominal (par) value per share, without altering the value of its total nominal share capital.

A consolidation REDUCES the number of shares in issue

Question 26

Define a consolidation

Answer 26

A consolidation, the opposite of a share split, occurs when a company INCREASES the nominal (par) value per share, without altering the value of its total nominal share capital.

A consolidation REDUCES the number of shares in issue

Question 27

Define a share split

Answer 27

A share split occurs when a company REDUCES the nominal (par) value per share, without altering the value of its nominal share capital.

The effect on the share price is the same effect caused by a bonus issue, all things being equal.

A share split INCREASES the number for shares in issue

Question 28

Define a rights issue

Answer 28

A rights issue is an issue of new shares to existing shareholders in proportion to the number of shares already held by each shareholder, I.e. 1 new share for every 4 shares held, in return for capital Invetsment

The existing shareholders are simply being asked to invest more in the company, and in doing so the company can raise more capital

Question 29

Define the key features of a rights issue

Answer 29

Existing shareholders have a statutory first right to subscribe for the new shares

The new shares carry the same rights as the old shares - they rank equally with the old shares

The price to be paid for the new shares, subscription price, is usually below the market value of existing shares in order to encourage shareholder take up

The amount of new shares offered depends on the terms of the issue, and is usually expressed as ‘X’ number of shares for every ‘Y’ shares held

Companies will usually have their rights issue underwritten by banks (for a fee) to ensure success of the issues

Question 30

Define the theoretical ex-rights price, and how it is calculated

Answer 30

The markets price of the shares after the rights issue is known as the theoretical ex-rights price. This is the price that all shares, new and old, will be expected to reach once the rights issue has been completed and the new shares are fully paid. It can be calculated as follows:

Company X makes a rights issue on a 1 for 4 basis. Current market price is 160p per share, with subscription price for new shares at 120p, the theoretical ex-rights price would be:

Step 1: 4 old shares at 160p = 640p
Step 2: 1 new share at 120p = 120p
Step 3: 5 shares worth = 760p
Step 4: 1 share worth = 152p is the theoretical ex-rights price

Since the new shares are expected to be worth 152p, and the payment made to the company is 120p, the price of the shares in their nil-paid form will be 32p, I.e. the amount that the company will not be paid, calculated by deducting the subscription price from the ex-rights price

Step 5: 152 - 120 = 32p nil paid form

If the shareholder were to sell the rights attached to an old share, the value of this would be the market price of share prior to the rights issue minus the ex-rights price:

Step 6: 160p - 152p = 8p

Question 31

Define the 3 options an investor has in the way they deal with the extra shares they are entitled to after a rights issue

Answer 31

After a rights issue, the investor will receive a provisional allotment letter that details the extra shares that the investor is entitled to. The investor has roughly 2-3 weeks to decide which of the 3 following choices to make:

Take up the shares in full

Sell the rights

Let the rights lapse

Question 32

Define the option to ‘take up shares in full’, it being one of the options an investor has when choosing how to deal with the extra shares they are entitled to after a rights issue

Answer 32

If the investor accepts the full entitlement, then the shares must be paid for in full.

The investor will pay the amount due and forward payment together with the allotment letter received (detailing the extra shares that the investor is entitled to).

A share certificate will replace the fully-paid allotment letter, which is receipted and returned to the investor

Question 33

Define the option to ‘sell the rights’, it being one of the options an investor has when choosing how to deal with the extra shares they are entitled to after a rights issue

Answer 33

The investor’s rights to the extra shares can be sold through a stockbroker

The cash value of the rights less dealing costs will be he difference between the ex-rights price and the subscription price.

Selling the rights either in full or in part is referred to as ‘renouncing the rights’, and the form of renunciation on the allotment letter can be signed to put this into effect.

Some investors may decide to sell sufficient rights to finance the purchase of the balance of the allotted shares

Question 34

Define the option to ‘let the rights lapse’, it being one of the options an investor has when choosing how to deal with the extra shares they are entitled to after a rights issue

Answer 34

If the investor decides to do nothing at all, or misses the deadline (2-3 weeks, for deciding which of the 3 actions to take regarding their entitlement to the new shares) the company who has undertaken the rights issue will automatically sell the investor’s entitlement and remit the proceeds to the investor.

Commission charges should be negligible as the company can combine numerous small transactions into one large transaction.

However, market forces may dictate that the price of the rights might fall due to a lot of unused rights being sold

Question 35

Define the factors that could affect an investor’s decision on which of the 3 options, for dealing with the extra shares they are entitled to after a rights issue, to go for

Answer 35

The terms and reasons for the rights issue

How the financial press has greeted the news

The rights issue will depress the share price of the shares in the short term