Methods of raising additional equity financeeffect on the price. The London Stock Exchange (2006) estimated this IPO discount at
between 10 and 15 per cent.
At these levels of cost, the effect on the cost of equity is profound. We saw in
Chapter 7 that the average cost of equity over the twentieth century averaged about
6.5 per cent p.a. This means £6.50 for each £100 of equity. If the explicit issue costs are,
say, £10, and the IPO discount a further £10, the net proceeds are only £80. Thus the
effective cost of equity would be £6.50/£80, or 8.13 per cent. This probably explains the
small number of public issues, particularly where an alternative exists, and why they
tend mainly to occur in cases where neither the rights issue nor the retained profits
option exists.Uncertainty of public issues
The relative certainty of success associated with rights issues does not exist with issues
to the public. As we have discussed already, the use of underwriters and/or issuing
by tender can overcome the problem to some extent, but at a cost.Pricing of issues is critical
If the interests of existing ordinary shareholders are to be protected, the pricing ques-
tion is one of vital importance. Issuing by tender does, to some extent, overcome the
problem. Capital market efficiency suggests that offers will rationally and fairly price
the issue.Dilution of control
Clearly, dilution of control for existing shareholders is going to occur with issues to
the public. It is probably the price that the original shareholders have to pay to obtain
access to additional equity finance when rights issues and retained profits are not
possibilities.Rights issues
Rights issuesare offers to existing ordinary shareholders to take up additional shares,
for cash, at a price usually significantly below the current market price of already
existing shares. In November 2007, the UK building and civil engineering business
Costain Group plcmade a one-for-four rights issue that raised £60 million.
Rights issues have generally represented an important method of raising new
equity finance in the UK over recent years. Table 8.1 shows that they averaged 39 per
cent of SEOs between 2000 and 2007. They may, however, be losing their appeal in
favour of placings; in 2007 only 8 per cent of funds raised through SEOs was through
rights issues. With IPOs, there is not really the rights issue option because the business
would not normally have a sufficiently large shareholder base from which to launch a
rights issue.
The law requires, in normal circumstances, that any new equity issue must be
offered first to existing shareholders in proportion to their individual shareholdings;
that is, it must be a rights issue. Shareholders can, however, waive these ‘pre-emption
rights’, and some businesses ask their shareholders to agree to do so. The UK property
investment businessBritish Land Co plcasked its shareholders to agree to waive their
pre-emption rights in June 2007. The existence of pre-emption rights is sometimes seen
as a restriction on the ability of directors to take advantage of some other source of
equity finance.‘