What is a secondary offering?

Before diving into what is a secondary offering of shares, let’s quickly recap the basics regarding primary and secondary markets. In the primary market, companies issue new shares in cash to investors. Earnings from such offerings are used for company financing, acquisitions, and other business purposes. In the secondary market, investors buy and sell the shares of listed companies directly. The company does not issue new shares, nor does it receive any additional capital.

A secondary offering?

In finance, the sale of many public company shares from an existing investor to another in the secondary market. These shares are already sold by the company as part of its initial public offering (IPO). In such cases, the public company will not receive cash or issue new shares. Instead, investors buy and sell stock directly to each other. This is different from the primary offering where the company issues new stock. Revenue from the secondary offering will be paid to the shareholders who sold the shares, not the company.

Private companies considering financing can choose to sell their shares to investors through an initial public offering (IPO). As the name implies, an IPO is the first time a company goes public — offering its shares to the public. These are essentially new securities sold to investors in the primary market. The company may use those sale proceeds for working capital financing, acquisitions, and other purposes.

After the IPO is complete, investors can make offerings on the secondary market, to the general public. The earnings from the secondary offer go directly to the seller, not to the company whose shares change ownership. In some cases, a company may carry out a secondary offering called a follow-on offering. The need to do this can arise to raise funds for debt financing, acquisitions, or funding research and development.

In some other cases, investors may inform the company that they want to cash out their holdings, while other companies may offer follow-on offerings to refinance their debt while interest rates are low.

Example of a secondary offering

An interesting, well-known example is one that occurred in 2013, when Meta (formerly Facebook) CEO Mark Zuckerberg sold about 41 million shares of his stake to other investors. He sold his private stock and received profits directly from investors, not from the company. The reason for the reported sale was to raise funds for his taxation purposes. In addition to the secondary offering Zuckerberg made, the company also issued several new shares to the public and made some profit for corporate purposes. It is common to make offers that combine primary and secondary sales.

Types of secondary offerings

Secondary offerings come in two different forms. The differences between the two are highlighted below:

• Non-dilutive secondary offerings: This type does not dilute shares that are held by existing shareholders, since no new shares are created. Individual shareholders such as directors, venture capitalists, and other insiders seek to diversify their holdings by selling their shares. Therefore the company may not make any gains on such transactions.

  The increase in available shares permits more institutions to occupy important positions in the company and may benefit the liquidity of the company’s shares. This type of secondary offering, is common in the years following the IPO, once the lock-up period has expired.

• Dilutive Secondary Offerings: This type is also known as a subsequent offering or follow-on public offering (FPO), sometimes incorrectly referred to as secondary offering IPO. It occurs when a company issues new shares into the market and therefore dilutes the value of existing shares. A company's board of directors may for relevant reasons agree and plan to increase the share capital by selling more equity.

  With an increase in the number of outstanding shares, there occurs a dilution of earnings per share (EPS). The consequent influx of cash helps the company achieve its longer-term goals, for financial expansion, or to pay off debt. However, for the shorter-term horizons of certain shareholders, this is not particularly positive.

Effects of Secondary Offerings

Secondary offerings can affect investor sentiment and corporate stock prices. For instance, investors may expect bad news if a major or key shareholder sells a large number of shares like in the case of Capri Holdings. The company announced a secondary offering of 25 million shares on February 19, 2013. As a result, the company's share price fell by more than 10%.

A dilutive secondary offering usually lowers the stock price, but the market may react unexpectedly even. For example, CRISPR Therapeutics’ share price rose after announcing a secondary offering for 5 million shares on January 4, 2018.

The exact reason for the rise in stock prices following a secondary offering may not always be clear. Investors may react positively to an offer if they believe that the proceeds from the sale will benefit the company. Examples of positively rated offers are when a company uses its funds to pay off debt, make acquisitions, or invest in the future of the company.