Seasoned equity offerings, secondary offerings, initial public offerings it is easy to become confused about the many types of offerings companies can conduct. Because each offering has distinct qualities, it is important to understand the differences that exist in order to make informed and beneficial decisions about a company’s financing and about the owners’ liquidity.
This article will help those seeking to better understand the following topics:
- Purposes for Conducting a Seasoned Equity Offering or a Secondary Offering
- Share Price Movements at Announcement
- Alternative Names for Seasoned Equity Offerings and Secondary Offerings
- Differences Between Seasoned Equity Offerings and Initial Public Offerings
Purposes for Conducting a Seasoned Equity Offering or a Secondary Offering
Seasoned Equity Offering
After companies have successfully completed an Initial Public Offering (IPO), they may later wish to issue additional shares.1 Companies issue these additional shares through seasoned equity offerings. In other words, seasoned equity offerings are a method for raising additional funds. One of the most common reasons that companies choose this route is to fund high levels of growth. They may plan to use the funds to build additional plants or warehouses, to acquire a company, to replace equipment, or to fund a myriad of other expansion-focused options.
Additionally, in times of high interest rates, companies may choose to raise money through a seasoned equity offering to pay down or refinance their debt.
On the other hand, some companies may conduct a seasoned equity offering simply because they have run into financial issues and need cash.
Secondary offerings are conducted to sell existing shares2 held by company insiders. Most often, the company insiders who own a large enough proportion of shares to conduct a secondary offering are top-level executives.
These top executives hope to gain liquidity, but if they were to sell their shares directly on the open market, the market would be flooded with a supply of shares that overwhelms demand. This imbalance could cause a drop in the share price. Although the share price might still dip during a secondary offering, executives are trying to create more stability in the market by selling the shares to large institutional investors that potentially have the demand to match the supply (because they can afford to purchase the high number of shares), rather than selling them directly to smaller, retail investors on the open market.
Both seasoned equity offerings and secondary offerings occur only after a company has completed an IPO. The main difference between seasoned equity offerings and secondary offerings stems from the type of shares offered. In seasoned equity offerings, additional primary shares are issued to raise additional funds. In secondary offerings, secondary shares (generally pre-IPO shares owned by top executives) are sold, generally to gain personal liquidity.
Share Price Movements at Announcement
Seasoned Equity Offering
When companies conduct seasoned equity offerings, they are issuing additional shares. The increase in supply has the potential to bring down the share price if there is not a match in demand.
Additionally, the newly issued shares may dilute3 existing shareholders’ ownership percentages (specifically, those who do not have or exercise pre-emptive rights),4 which can create negative sentiment within those existing shareholders who are watching their voting rights decrease. These existing shareholders may decide to sell their shares because of the dilution, which then increases supply even more and potentially depresses the share price further.5
Also, shares sold through a seasoned equity offering are generally sold slightly below market price to entice the large investors to purchase them, which naturally decreases the share price, as well. (Cline, Brandon. The Journal of Financial Research. “What Determines SEO Offer-Day Returns?” 2012). Lastly, if the market suspects the offering is a sign of financial trouble, the share price will certainly fall.
However, the market does not always react negatively to seasoned equity offerings. If the public understands that a company is growing rapidly and believes in that company’s trajectory, shareholders may be willing to overlook the dilution to reap future payouts that are trusted to come as the company uses the capital raised in the offering to fund value-added projects. Research has indicated that if specific plans for the funds are clearly divulged to outside investors, the market reacts more favorably (Walker, Mark. SSRN. “Seasoned equity offerings: What firms say, do, and how the market reacts.” 03 November, 2006.). In such cases, share prices may stay somewhat constant or even rise at the announcement of a seasoned equity offering.
Tesla announced a seasoned equity offering6 in February 2020 of about $2 billion common stock. Although the share price did initially drop at the announcement in pre-market trading, it closed at a price 5% higher than the day before the announcement. Many news outlets interpreted this rise in share price as originating from the public’s awareness of Tesla’s consistent growth and expansion.7
When a company conducts a secondary offering and executives sell off some of their shares, some research has indicated that the market may react negatively if it is worried the sale may be a negative sign regarding an executive’s outlook on the company. (Glen, Parker. Fordham Journal of Corporate & Financial Law. “The Efficient Capital Market Hypothesis…”. 2005). The company can work to overcome some of this potential alarm by expounding on the executives’ continued dedication to and stake in the company8 and/or by potentially sharing any understandable needs for personal liquidity.9
In May of 2019, Papa John’s Founder, John Schnatter, sold about 300,000 shares (worth close to $16 million). The share price dropped over 4% during the week of his sales, and CNN tied the drop to the founder’s sale of shares. However, CNN also notes other events (e.g., negative press and declining sales) also played into the drop.10
However, some research indicates that the market does not significantly react to insider sales (Rogers, J.L., Skinner, D.J. & Zechman, S.L.C. “The role of the media in disseminating insider-trading news.” Rev Account Stud 21, 711–739. 2016.). In fact, many news outlets and websites that provide tips to new investors admit that insider sales do not always signal negative news about the company, since executives often are simply trying to gain some personal liquidity for their personal expenses or diversify their investments.11
Thus, companies cannot always be certain of what the market’s reaction will be to their secondary offerings.
Alternative Names for Seasoned Equity Offerings and Secondary Offerings
Seasoned equity offerings and secondary offerings can be referred to by many names. Some of the most common names for each are listed below.
Seasoned equity offerings (SEO)
- Seasoned issue
- Follow-on offering
- Follow-on public offering (FPO)
- Subsequent offering
- Dilutive secondary offering
- Secondary public offering (SPO)
- Non-dilutive secondary offerings
In theory, seasoned equity offerings and secondary offerings are always distinct. In reality, many companies will offer a mix of both primary and secondary shares, which can lead to some of the names listed above being used interchangeably.
For example, some companies and professionals may use the term “seasoned equity offering” to refer to any post-IPO offering, whether that offering includes primary shares, secondary shares, or a mix of both. Other companies and professionals may do the same thing but use the term “secondary offering” to refer to any post-IPO offering no matter the mix of shares.
Although the interchangeability of names may be confusing at times, differentiating between offerings by specifying whether they include primary or secondary shares (or both) can clear up any terminology differences. Accordingly, the details of the offering are more important than the specific label used.
Differences Between Seasoned Equity Offerings and Initial Public Offerings
Seasoned equity offerings12 should not be confused with initial public offerings (IPOs). Although both types of offerings are conducted to raise funds and provide personal liquidity to insiders and early investors, they also have many differences.
Because SEOs are conducted after the company is already public (rather than being the process by which companies go public), they can be conducted many times. Additionally, because the company is already public during an SEO, more information regarding the company has been disseminated, which allows for a shorter marketing timeframe than what an IPO demands. However, one similarity between the two types of offerings is that shares offered/sold through IPOs and SEOs are often offered at a discount or under-priced (Cline, Brandon. The Journal of Financial Research. “What Determines SEO Offer-Day Returns?” 2012). See our article on IPO Underpricing Causes for more information on IPO under-pricing.
Seasoned equity offerings and secondary offerings are viable methods for companies to raise funds or offer personal liquidity to insiders and early investors, yet each may draw different reactions from the market. Understanding the differences between the types of offerings companies can conduct is vital to any company considering conducting a post-IPO offering.
- 4 Things to Know About Secondary Offerings
- Abraham, Rebecca, Charles, Harrington. International Journal of Business, Humanities and Technology. “Seasoned Equity Offerings: Characteristics of Firms”. Nov 2011.
- Carlson Debbie. Ticker Tape. “What Is a Secondary Public Offering? Learn About the Risks and Opportunities”. Sep 2021.
- Chen, James. Investopedia. Seasoned Issue. 02 April, 2020.
- Cline, Brandon, Fu, Xudong, Tang, Tian, Wiley, Johnathan. The Journal of Financial Research. “What Determines SEO Offer-Day Returns?” 2012.
- Cramer, Jim. CNBC. “Secondary offerings—an unexpected sign of strength?” Apr 2015.
- Davie, Alexander. Strictly Business Law Blog. Venture Capital Term Sheet Negotiation — Part 12: Preemptive Rights.” 07 July, 2014.
- Glen, Patrick. Fordham Journal of Corporate & Financial Law. “THE EFFICIENT CAPITAL MARKET HYPOTHESIS, CHAOS THEORY, AND THE INSIDER FILING REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934: THE PREDICTIVE POWER OF FORM 4 FILINGS”. Page 86. 2005.
- Lee, Inmoo. The Journal of Finance. “Do Firms Knowingly Sell Overvalued Equity.” September, 1997.
- Sarath. Eqvista Inc. “WHAT IS A SECONDARY OFFERING AND HOW DOES IT WORK?” Jun 2021.
- Secondary Offering
- Walker, Mark. SSRN. “Seasoned equity offerings: What firms say, do, and how the market reacts.” 03 November, 2006.
- These additional shares would be called “primary shares” because they are initially sold on the primary market. In other words, the seller is the issuing company (rather than a person or institution that already bought the shares and is simply trading them). Issuing additional shares is sometimes referred to as “increasing the share float” because more shares are now available for trading.
- These shares are often pre-IPO shares. Pre-IPO shares are shares that the company sold or awarded before the company went public through an IPO. They are generally owned by large institutional investors (e.g., hedge funds) or company executives and employees who worked for the company before it went public.
- For example, if Company XYZ has 100 shares outstanding and Shareholder A owns 10 of those shares, he/she owns 10% of the Company. Now if Company XYZ issues 100 more shares through a seasoned equity offering, and Shareholder A does not buy additional shares, his/her ownership percentage has been diluted from 10% to 5%.
- “The term “pre-emptive rights” refers to the right to purchase a company’s new shares before they are offered to anyone else.” If investors choose to exercise their pre-emptive or “anti-dilution” rights, they can purchase the appropriate number of shares to maintain their ownership percentage. Pre-emptive rights are often provided to early investors to motivate them to purchase shares.
- Chen, James. Investopedia. Seasoned Issue. 02 April, 2020.
- On their Investor Relations site, Tesla calls the offering an “underwritten registered public offering,” which reiterates the point that in practice SEOs may be referred to by many names (Tesla. “Tesla Announces Offering of Common Stock.” Feb 13 2020.)
- For two examples, see CNBC’s article, “Tesla shares rise, reversing early losses following $2 billion stock offering” and MarketWatch’s article, “Tesla jolts market with $2 billion stock offering, SEC subpoena.”
- Many executives sell-off only a small portion of their shares. In this case, they can show the before and after ownership stakes in the company to prove their continued dedication to the company. For example, if an executive or group of executives owns 80% of the company and will still own 78% of the company after the secondary offering, that high post-secondary-offering ownership percentage can be used as a proof-point that the executive(s) is/are still invested in the company and simply desire some personal liquidity.
- Companies sometimes conduct roadshows along with the offerings and include pitch decks that detail the numbers of shares being sold and the executives’ continued stakes in their company after the sale. This allows the company to control and clarify the narrative around the sale.
- Wiener-Bronner, Danielle. “What’s moving markets today: May 16, 2019.” CNN. 16, May 2019.
- To see a few examples, read the following articles. Sather Research LLC’s article, SEC Form 4 Explained for Beginners. Investopedia’s article, Insider Selling Isn’t Always A Bad Sign. CNN’s article If the CEO is selling company stock, should you?.
- Because many post-IPO offerings include both primary and secondary shares, in this section “seasoned equity offering” or “SEO” will refer to any post-IPO offering – no matter the mix of primary or secondary shares – so they can be more easily compared to initial public offerings.