A new issue describes a security – generally equity or debt – that is registered in a publicly-traded market for the first time. A common new issue is known as an Initial Public Offering (IPO), which takes place when a business or company sells securities on a stock market for the first time. Companies issue new stocks or bonds to raise capital for growth and expansion. A company has two primary ways to raise capital: one is through debt – such as issuing bonds, and the other is through equity – issuing stocks. A good mixture of both types of instruments is important for good capital management and minimizing the company’s WACC.
When a business issues debt or stock for the first time, it distributes the new issue in the primary market. Unlike in the secondary market where investors trade among themselves, the primary market allows companies to sell directly to investors. The primary market allows companies to raise long-term equity capital when starting a new business, expanding their operations, or engaging in other capital-intensive activities. Once the issue period has closed, the bonds or stocks are then traded in the secondary market.
How to record a new issue
When a company issues new stock, the shares may be issued at par, above par, or below the par value. When issued at par, the proceeds from the issue are debited in the cash account while the paid-in capital account is credited. If issued above par, the proceeds from the issuance are debited in the cash account, the paid-in capital is credited for the par value (multiplied by the total number of issued shares), and the excess of cash above the par value is credited to the additional paid-in capital account.
When the stocks are issued below par, the total cash received is debited from the cash account, while the paid-in capital is credited for the total par value. The discount on stocks issued is debited through the discount on capital account. The transaction also appears as a deduction from the equity accounts on the balance sheet. The new issue of stock is recorded as paid-in capital in the balance sheet.
Investors’ perspective on a new issue
Investors have mixed views on how they perceive new issues of stocks and bonds. Most investors prefer new issues because they present new avenues for price appreciation. Price increases are often brought about by the huge demand for new shares, especially if they are being sold by known companies with a good track record with investors. When these shares trade in the secondary market and the demand continues, the investors benefit from increased prices and, hence, a bigger return on their investments.
On the other hand, new issues are often highly volatile. The limited initial offer period may result in rapid increases and decreases in the price of stocks. Investors who take the risk may benefit from short-term gains, while at the same time face the risk of short-term and long-term losses depending on how the market reacts to the stocks.
When investing in new stocks, investors should be aware of the risk associated with products that have not been on the market for long. They should review the issuer’s prospectus before deciding on whether to buy or not to buy the new issue stocks.
New bond issues
One of the ways that companies use to raise large sums of money is by selling bonds in the public market. By selling bonds, the company is essentially borrowing money from investors, in exchange for periodic interest payments.
Advantages of new bond issues
Tax advantages: Selling bonds on the market can reduce the amount of tax a company owes the tax authorities. This is because the interest payable to lenders is a tax-deductible expense that reduces the overall tax liability.
Can be issued whenever the company needs money: A company that requires a large sum of money can issue bonds more than once. The practice makes bonds the more preferred option since issuing more stocks dilutes the ownership of a company every time they are issued to the public.
Risker than other sources of capital: Even though debt has its advantages, it carries a higher risk since the company may be unable to service the debts later and end up in bankruptcy. Borrowing too much money will require the business to formulate a concrete plan on how to repay the principal and interests to lenders on time.
New stock issues
Companies can also raise capital by selling stocks in the primary and secondary markets. Investors who buy the stocks of the company get to own a piece of the company depending on the number of shares they own.
Less expensive: Selling stocks to the public does not add more debt to the company. Instead, it allows investors to become owners of the company and get a share of the annual profits. The investors also participate in the decision-making process of the company.
No stellar credit rating: Startups and other companies without a known track record may be unable to access credit facilities that are available to successful companies. This is because lenders may view them as too risky and deny them the needed capital. However, with equity, these companies can attract investors who are willing to wait and grow their investments in the company. The investors become real owners of the business and get to participate in dividend and profit sharing.
Dilute ownership: Every time a company makes a new issue of stock, it dilutes the ownership of the existing shareholders. The current shareholders’ ownership stakes and voting powers decrease as new members join as shareholders and acquire ownership interests in the company.