Companies sometimes need capital to help with acquisitions and expansions. While an initial public offering (IPO) can help with that early in a company’s life, a company may have to return to the public sale of shares to generate more money. However, while post-IPO offerings can help a corporation, they can dilute the value of existing shareholders’ stocks. Consider working working with a financial advisor when mulling the opportunity to participate in a secondary offering.
What Is a Secondary Offering?
A secondary offering is the offering for sale of a public company’s shares by an investor or the creation, by the company, of new shares and then the offering of those newly created shares for sale to the public. Companies use secondary offerings for various reasons, to fund new projects, complete acquisitions or meet operating expenses.
Shareholders and corporations sell secondary offerings on the secondary market, otherwise known as the stock market, i.e., the New York Stock Exchange and the NASDAQ. It is called a secondary offering because the transaction exchanges shares after the company’s first public distribution.
Some secondary offerings may come with restrictions. For example, you could purchase some shares during a secondary offering, but they come with a lock-up period that stops you from reselling for a certain amount of time. Restrictions are typically rare, though.
Dilutive secondary offering
Some people use the term secondary offering interchangeably with “follow-on” offerings. In this case, the company releases shares of stock that have been held in reserve or creates new ones. Investors purchase these shares, which generates capital for the company to use. However, this can devalue the shares. That’s because while the company’s market capitalization has remained relatively stable, the number of shares outstanding has increased. In other words, additional shares now account for (more or less) the same value.
When more shares of stock are issued or stock options are exercised, your ownership share in the company shrinks. In other words, it dilutes your stake. A good analogy is to think of it in terms of slicing a pie. When the pie is split four ways, you can claim a 25% ownership share. But if a pie is re-sliced into eight pieces, your ownership share is now cut in half to 12.5%.
You still own part of the pie, i.e. the company you’ve invested in. However, there’s more of it to go around for other investors. As a result, you now own less of it than you did before the dilution.
Non-dilutive secondary offering
Not all secondary offerings dilute the value of existing shareholders’ shares. For example, a major shareholder of a company, such as a mutual fund, could sell all of its shares on the open market. This transaction is solely between investors, which means the original corporation does not make any money on these sales. Only the trader selling shares makes a profit.
Because such a move does not increase the number of the company’s shares outstanding such a transaction does not water down or dilute the value of the shares. They merely change hands.
The securities in such a seconary offering may be bonds, mutual funds, stocks or other types of securities.
Secondary Offering Example
One notable example of a secondary offering occurred in 2013 involving social media giant Facebook and its CEO. The company and Mark Zuckerberg opened up an opportunity for investors to own some of the company’s stock following its May 2012 IPO. Between the company and Zuckerberg, a combined 70 million shares were sold on the market.
Zuckerberg sold his own shares, approximately 41 million, to other investors, which means the proceeds went directly to him. Based on reports, he sold the shares to help raise money for a personal income tax bill. At that time, the sale decreased his voting power on the board from 58.8% to 56.1%.
Primary Offering vs. Second Offering
A primary offering comes into play when a private company goes public on the stock market. When the business first puts out stock for sale to the public, it is called an IPO. New or growing companies do this to help raise capital for future business operations. However, it is also possible for a long-term private company to have an IPO if it decides to go public as well.
If a company wants to sell its shares publicly as a primary or secondary offering, it has to file it with the Securities and Exchange Commission (SEC). This makes it easy and straightforward for investors to find out about the sale. They can search through the SEC’s EDGAR database as well as the NASDAQ’s up-to-date listing of offerings. They’re typically highlighted in stock news feeds and company press events as well.
The difference between a primary offering and a secondary offering comes with the timing, then. A primary offering is the first time a company issues shares for investors to purchase. In contrast, a secondary offering occurs after that.
The Takeaway
Secondary offerings can be dilutive or non-dilutive. Regarding the former variety, publicly traded corporations make secondary offerings to fund acquisitions, pay for new ventures or cover operating expenses. Sometimes secondary offerings are called follow-on offerings. Be aware that some secondary offerings may come with restrictions, such as a lockup period during which the securities may not be resold.
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