Jul 24, 2014 Investment Education – Primary and Secondary offerings
When a company issues new stock, it is called a primary offering. In a primary offering, the money received from the sale of the new shares goes to the company. The number of new shares sold is added to the number previously outstanding to arrive at the new total outstanding.
A secondary offering refers to already outstanding stock being sold from one person or investment fund to another. In this case, the sale of the stock does not increase the total shares outstanding. The stock sale, or secondary transaction, just reflects the ownership of the traded shares changing hands. The proceeds of the sale of the stock do not go to the company. Rather, they go to the shareholder who sold his stock.
If this definition of secondary is understood, it should be clear that any time you or I sell any shares we own, we have technically made a secondary offering. But that is not how the word secondary is commonly used. More typically, a secondary is used to describe an offering of stock by company founders who got their stock years ago when the company was founded, and those shares have never been sold, and never been registered with the Securities and Exchange commission. They are what is called “private shares” rather than public shares. For share to be traded publically, they must first have been registered with the SEC at some time in the past (unless exempt under certain circumstances.) When shareholders of such privately held shares decide to register and sell these not-yet-public shares, this would be a typical secondary offering. When such a sale is completed, the money from the sale of these shares goes to the selling shareholders, not the company. The number of shares the company has outstanding does not change.
Do not confuse a primary offering with an initial public offering (an IPO). An initial public offering is simply the first time stock of a company is being sold to the public. The stock being sold in the IPO might be primary shares; that is, newly issued shares which the company is selling, and the proceeds from that sale go to the company. Or, if the company does not need to raise money, the IPO might be all secondary shares. That is, the shares being sold are already-outstanding shares which are part or all of the private stock holdings of company founders, and in this case the money from the sale of the shares goes to the selling stockholders, not the company.
In practice, IPOs ( initial public offerings), are often a combination or primary shares being sold by the company, and secondary shares being sold by the founders or other early investors in the company.
So here is a question. Let’s say a company is already public. It had its IPO two years ago. Now, the company wishes to raise some more money by having another new stock offering. Would that offering be a primary or a secondary? The answer is that it would be a primary offering because it is the company selling the new stock, and the proceeds of the stock sale go to the company. Also, it cannot be an initial public offering because the company had its initial public offering two years ago. Some people might refer to this new offering as a secondary because it is the company’s second public offering, but that is not correct usage of the term. Nevertheless, I have seen this incorrect usage of “secondary” in the financial press by writers who should know better. Why this matters, I will discuss shortly. But first, let’s learn some more terminology. When a company does another public offering of new stock, that is, sometime after its initial public offering, it may properly be referred to as a follow-on offering, or as the company’s second public offering, or the company’s third public offering, etc. Again, a second public offering is not the same as a secondary.
Why does this matter? Because if a company announces a primary offering, investors know it will dilute the stock, and therefore likely cause a decline in the stock’s price. This would be true whether the primary offering was an initial public offering or a follow-on offering. But if a company announces a secondary offering, using the term correctly, the offering will not dilute the stock because the offering just reflects existing shares being sold from one person to another. However, even though there is no dilution, there may still be some downward pressure on the stock for two reasons. First , just dumping a large amount of stock on the market may depress the price until all that stock is absorbed by buyers. Second, the fact that insiders are selling their stock may be taken as sign that people who are in a position to know more about the company may see some problems brewing that are not visible to outsiders.
But here is the most important thing to keep in mind. If the term secondary offering is being used incorrectly, that is, to really mean a second primary offering, then investors will expect dilution and a lower stock price. Thus they might sell their shares even though the offering will not in fact be dilutive, and any dip in the stock from the announcement of the secondary is likely to be temporary.
In the next few posts, I will provide questions and answers regarding dilution, primary and secondary offerings and public and private offerings. Be sure you understand these important and often confused distinctions.
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