How do companies use the stock market to raise money? It’s a question that comes up, even among seasoned traders who buy and sell shares on a daily basis. When you decide to sell your XYZ stock to another buyer, the company, the fictitious XYZ in this case, receives no money at all. The transaction involves only three parties, the buyer, the seller, and a broker, who gets a small commission for making the deal legal.
In fact, XYZ got nothing at all, and never will for those outstanding shares. The key thing to remember is that corporations make their profit several other ways, primarily through initial public offerings (IPOs), subsequent issues of shares to syndicates and brokers, and in a few other, more complex ways. Here’s a look at how companies raise much-needed capital by selling shares of their own stock.
Initial Public Offerings
Once an organization gets the green light from the government and a stock exchange, they become a listed firm, and are allowed to offer their first batch of shares to special middleman organizations called syndicates. Some of these syndicates are licensed brokers and some are banks. If the corporation was able to create a positive buzz about the IPO, and if respected analysts rate it as a good buy, then the corporation stands to raise a huge sum of capital by selling perhaps several million shares. Individual investors usually have to wait to get a shot at buying any of the IPO offering for a few days or weeks after the original sale. The IPO is the main way that newly listed firms raise money by selling fractional ownership rights.
There’s a very large up-front expense for a company to get listed on an exchange, but the income from the IPO more than offsets the listing and legal fees associated with the move. Also note that some companies decide to never go public. They’d rather retain the privacy and total control over their finances by staying off the exchanges. One of the world’s most famous candy companies, Mars., Inc., has never gone public, which is why you can’t buy their stock even if you wanted to.
Another way listed organizations can raise funds through stock trading is to simply issue more shares. The process is similar to an IPO but there’s no initial component to the deal. If XYZ shares are trading way above their IPO value, maybe because the corporation have enjoyed immense success during its first year or two of operations, then they might decide the time is right to re-issue more shares and take in more funds from a second public offering.
The Down Side
There’s a negative side to the entire process of raising corporate capital. After an IPO, some organizations don’t do well, and their stock price begins to sink. When that happens, even a subsequent public offering might not bring in enough capital to turn things around. At this point, the firm might decide to remove itself from the exchange, go private, go out of business, or declare bankruptcy.