Secondary Offering

How Does a Secondary Offering Work?

A secondary offering refers to the sale of securities by an investor who participated in the primary offering in the secondary markets.

• Primary Market → The primary market is where securities, i.e. shares representing partial ownership, are first sold and distributed via an initial public offering (IPO). An IPO is when a formerly private company decides to raise capital for the first time in the public markets, and its shares then become listed on a trading exchange; hence, an IPO is often referred to as “going public”.
• Secondary Market → The secondary market is where securities are traded among investors, from institutional firms like hedge funds and asset managers to retail investors. The securities sold were previously issued by the now publicly traded company and now belong to the seller, so the proceeds obtained from the sale belong to the seller, as opposed to the company.

In short, the selling of shares in the primary market is a method for the issuer (i.e. the company) to raise capital, whereas the trading activity in the secondary market is for investors.

Non-Dilutive Secondary Offering vs. Dilutive Secondary Offering (Post-IPO)

The term “secondary offering”, however, can also be used to describe a post-IPO company deciding to issue additional shares to the public markets.

• Non-Dilutive Secondary Offering → In a non-dilutive secondary offering, the transactions involve the trading of shares previously issued in an IPO. As a result, there is no additional dilution to the existing equity ownership structure, since it involves the exchange of shares, rather than the creation of new shares to raise capital.
• Dilutive Secondary Offering → In a dilutive secondary offering, otherwise known as a “seasoned equity offering,” the post-IPO public company decides to raise more capital by issuing more shares. Hence, there is additional dilution created, since there are more shares circulating in the open markets once the transaction closes.

Learn More → Investment Banking Primer

Seasoned Equity Offering (Follow-On Offering): SEO vs. IPO

The difference between an initial public offering and seasoned equity offering (SEO) is as follows.

• Initial Public Offering (IPO) → In an initial public offering (IPO), a private company raises capital for the first time in the public equities market, as implied by the name. After the IPO, the private company becomes a public company and is required to abide by the rules set by the Securities and Exchange Committee (SEC) and the stock exchange on which its shares were listed. For instance, the newly public company must file quarterly reports (10-Q) and annual reports (10-K) with the SEC in order to provide full transparency to investors, among many other regulatory requirements and guidelines.
• Seasoned Equity Offering → A seasoned equity offering (SEO) occurs when a company that already underwent an initial public offering (IPO) decides to raise more capital by issuing more shares. Because the company already has shares listed on a public exchange, it is frequently called a “follow-on offering.”

^{Follow-On Offering Definition (Source: LII)}

What is an Example of a Secondary Offering?

A real-world example of a secondary offering, or follow-on offering, was conducted in February 2020 by Tesla (NASDAQ: TSLA) during the COVID-19 pandemic.

In an effort to raise $2 billion, Tesla sold 2.65 million shares at an offering price of $767 per share.

To incentivize more buyers, the follow-on offering was priced at a slight discount (4.6%) relative to the company’s most recent closing share price.

In a public statement, the founder of CEO of Tesla, Elon Musk, stated that the purpose for the secondary offering was “to further strengthen its balance sheet, as well as for general corporate purposes,” while acknowledging that the company would incur significant expenses and delays caused by the outbreak of COVID.

The market reaction to a public company post such an announcement tends to be negative because questions are immediately raised regarding the underlying reason behind the capital raise. Furthermore, external factors such as the prevailing investor sentiment and state of the capital markets on the date of the announcement can all contribute to the market’s perception of the corporate decision to raise more capital.

However, the negative impact on the market share price can be mitigated (or at least, limited) if the company’s management team is transparent and able to offer a convincing rationale supporting the decision.

Otherwise, investors in the market are likely to assume the worst, which for most companies is illiquidity (i.e. a lack of cash on hand to fund operations and spending) and the risk of becoming insolvent.

^{Tesla Secondary Offering Example (Source: CNBC)}