How stock market floats work
Summary Description Newswire's 5 Minute Guides
looks at the mechanics of putting a company on the stock
exchange.
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Roullas Top10 Simon Vandore
Newswire
No
Editorial InformationArticle Location
Article Topic 5 Minute Guides
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Story Group 000813
Post Date 14/08/2000 08:06 AM Status Posted Entered by Simon
Vandore on 09/08/2000 09:39 PM
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What does it mean when a company 'floats' on the stock
exchange?
In financial terms a 'float' means allowing the markets to
determine the value of something. A company can exploit its
perceived value by selling shares of ownership on a public market
to raise capital for its operations. Floating a company is also
referred to as 'going public' or 'listing' on the stock exchange.
The Australian Stock Exchange (ASX), which is a listed company
itself, is the market which handles the sale and purchase of such
shares in Australia. Purchasers become part-owners of the company
involved, and when it makes money they receive dividends. They
can vote at shareholder meetings (such as the company's annual
general meeting or AGM) and are consulted on other matters of
significance. With time, the perceived value of a company may
rise or fall, meaning shares often change hands as people
speculate or realise the newfound value of their investment.
For venture capitalists with an investment in the company, a
stock exchange float is seen as 'an exit', meaning a chance to
recoup their investment and access the return on that investment.
How does a company go about floating?
To float on the exchange, a company must gain ASX approval that
there is a demand for its shares and must then follow ASX rules,
informing the market in advance of any occurrences which may
affect its perceived value. An assets test is imposed, and the
ASX may impose extra conditions on the float if the value of
assets is not immediately apparent.
If the company's proposed float is approved, it is then required
by Australian corporations law to issue a prospectus -- a
document outlining what the company does and what it proposes for
the future, containing a share purchase application form. This is
distributed to all interested parties and prospective
shareholders. To distribute its shares into the marketplace, the
company must go through an underwriter who is a member of the
ASX. This agent, usually a financial institution, will take a
commission and liaise with the first buyers. The underwriter also
agrees to purchase any shares not sold, guaranteeing a fully
subscribed float for the company.
Some IT companies have been known to gain 'back door' entry into
the ASX through mergers with failing mining companies that listed
some time ago. This saves the hassle of gaining ASX approval
(though the mining company must announce the move to the stock
exchange).
It is also possible for companies to list on overseas stock
exchanges, though this is unusual -- the demand for ownership is
usually perceived to exist in the company's home country.
What determines the value of the shares?
The initial value is determined by agreement between the
underwriter and the company wishing to float. The ongoing value
is determined by market demand as shares are bought and sold.
Financial statements submitted to the stock exchange at required
intervals will reveal the company's performance over time and
this will affect the speculative value of its stock. Significant
one-off events, such as acquisitions, mergers, major capital
expenditure, or announcements of great successes or disasters,
may also cause quick changes in share value and lead to
high-volume trading between investors.
A company that is perceived to perform steadily over time will
see its share value rise slowly and be referred to as a 'blue
chip' stock, while newer companies or those which have just met
with adversity tend to be the most volatile.
What are the advantages of putting a company on the stock
exchange?
Obviously a company and its original owners benefit greatly from
an injection of funds when listing on the stock exchange. It's
simply a way of raising cash for the company to do new things, or
of realising the value of what its founders have built.
Rather than selling the company outright for a one-time value,
its founders might elect to retain a certain percentage of the
shares for themselves, whether or not they remain involved in the
company's day to day affairs. If the company continues to succeed
and its shares go up, the original owners continue to benefit.
Famous examples include Microsoft founders Bill Gates and Paul
Allen -- while Allen has not been involved in Microsoft for many
years, on paper he remains one of the wealthiest people in the
world thanks to his significant shareholding.
Employees are also sometimes issued with shares as a performance
bonus, or simply as a form of motivation -- if the company does
well through the performance of its employees, then the value of
the shares held by those employees will rise.
Does every business ultimately aim to go public in this
way?
No. It's not for everyone. Significant costs are involved in
putting a company on the stock exchange -- the ASX charges many
levels of administration fees -- as well as significant
preparation time. The obligations placed on management by the
stock market may also feel too restrictive. For example, the
requirement for openness about operations might be seen to
advantage a privately owned competitor. There are also simpler
ways for a company to gain a cash injection, such as venture
capital or loans.
Most big IT companies eventually go public, but there are some
famous exceptions. Dragon Systems in the US, for example, was
owned by its founders who began the company without venture
capital. Dragon became the biggest player in the speech
recognition market and almost listed on Nasdaq (the tech-heavy US
stock market) in 1999, but withdrew at a late stage and was
eventually sold to a competitor for stock worth US$460 million.
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