What is Flotation?
Flotation is the process of issuing and selling shares to public investors. In other words, it is when a company goes public and issues new shares to raise capital. It is a term commonly used in the United Kingdom.
Floating a company allows it to raise capital for the purpose of acquiring external financing for equipment, research and development (R&D), or new projects or to expand the business.
There are various methods to float a company. Depending on its objectives and business needs, each company will need to determine which flotation method is the most feasible. Some methods of floating a company will sell securities on a public stock exchange, while other methods will offer securities to private investors.
Methods of Flotation
1. Initial Public Offering (IPO)
One way to float a company is to issue an initial public offering (IPO), where a private company will go public by issuing shares for the first time. Floating a company using an IPO typically involves an investment bank that undertakes the underwriting process and determines the specific details of the IPO, such as the share price and the number of shares to be issued.
Additionally, the investment bank will develop the investment prospectus required for the IPO and go on a roadshow to promote the new stock offering to potential investors.
2. Offer through Sale
In addition to an IPO, a private company can pursue flotation by offering securities for sale using an intermediary, such as a stockbroker. In this case, the issuance of new shares is not available to the public. Usually, a company that pursues such a flotation method is in its early stages of operations, or it wants to mitigate from issuing shares to the public due to high flotation costs.
3. Rights Issue
A company can also be floated by issuing new shares that are available only to a group of existing investors, who are given the opportunity to purchase new shares before the shares officially get offered to the public.
4. Private Placement
A private placement is also another way to float a company. Under the private placement, an intermediary would purchase securities from a company at a predetermined price and sell these securities to certain individuals and institutional investors. Again, it helps a company avoid incurring high flotation costs and raise more capital quicker than pursuing an IPO.
Benefits of Flotation
- Instead of using retained earnings, a company can raise more capital from external sources by issuing new shares to fund capital projects, mergers/acquisitions, and other costs.
- An IPO can be used to promote and raise more awareness about a company’s brand in order to attract institutional investors.
- It establishes an exit strategy for venture capitalists to realize profits from their investments.
Drawbacks of Flotation
- A number of flotation costs are associated with issuing new shares. For example, there are costs incurred with legal fees, underwriting fees, and other administrative expenses.
- The company’s share price will be subjected to market fluctuations and other macroeconomic factors.
- It is required that public companies disclose their audited financial statements and maintain investor relations. Additionally, there is more pressure for companies to increase the transparency of their business operations.
- Issuing more shares will diversify ownership of the company (loss of control).
- Once a company goes public, the company will be subject to regulatory constraints and management restrictions in order to comply with the securities commission.
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