Flotation: A Process Explained

Companies need money at every stage. Whether they are in their initial phase, growth phase, or survival phase, ‘money’ is a common denominator. Big companies tend to have larger retained earnings that act as an internal source of funds. Although, they need to depend on external sources sometimes. Flotation is one such way companies can pursue to acquire finance from external sources.

This article guides the readers on flotation meaning, how flotation works, methods of flotation, and the benefits of flotation.

Flotation

Flotation is a process where a private company goes public by issuing new shares and acquiring finance from external sources, such as the general public or a group of investors. The term ‘Flotation’ is mostly used in the United Kingdom.

How does Flotation Work?

The company considering flotation hires an investment bank as an underwriter. Starting from the amount the company needs to raise from the investors to documentation, to preparing a draft prospectus for the road show, and finally, to decide on the final price of IPO, the underwriter plays an important role.

The roadshow is an attempt by the company and underwriter to persuade potential investors before the IPO. The roadshow ultimately helps to decide the number of shares to be issued and the final IPO price.

However, Flotation brings along various costs for the company such as underwriting costs, legal expenses, audit charges, registration charges, etc. Such costs range between 2% to 8%.

Methods of Flotation

There are various methods of Flotation. The company can opt for the method that best suits its needs and objectives.

• Initial Public Offering (IPO):

  A well-known method for Flotation is Initial Public Offering (IPO). IPO is a way for private companies to go public by offering new shares to the general public for the first time. Existing investors of the company can also take an exit by offering shares to the general public via IPO.

  Investors can subscribe to the issue and become partial owners of the company. However, the IPO method of Flotation is expensive.

• Offer through prospectus:

  The company can also choose to float the shares by offering a prospectus. They invite the general public to invest, by publishing prospectus in advertisements, magazines, etc.

  A prospectus is a crucial document that describes all the necessary information related to securities offered for sale. The prospectus displays the purpose of the issue, the company’s financial performance, future outlook, etc. It should be according to SEBI and investor protection guidelines.

• Offer through sale:

  The offer through sale method of Flotation also aims at the general public for seeking funds. However, the offer is not made directly to them. Rather, the company sells the securities to intermediaries, such as brokers, at a predetermined price. The Brokers, then, sell those securities to the interested investors.

• Private placement:

  Through the private placement method, the company aims at institutional investors and some individual investors for acquiring funds. A private placement is a relatively quicker and less costly way of procuring funds. The company saves time and cost for underwriting and related expenses, which are required when issuing securities to the general public.

• Rights issue:

  In this method, the company first offers new Shares to existing investors. The existing stockholders can subscribe to new shares in proportion to the number of shares they hold. They are then offered to the general public.

Benefits of Flotation

Flotation brings the following benefits.

• Accessibility to huge capital:

  The companies often require a hefty amount for research & development, capital projects, or transactions, such as mergers or acquisitions, etc.

  For such an instance, Flotation can open a new door for the company by providing access to huge capital. The company can issue fresh shares and acquire finance from external sources, such as the general public or a group of investors.

• Better debt-to-equity ratio:

  Equity is not the only way for companies to procure the required funds. There are other sources such as retained earnings, bank loans, issuing debt instruments, etc. However, excessive debt worsens the debt-to-equity ratio for the company.

  The debt-to-equity ratio shows the proportion of debt a company uses to finance its operations, compared to equity. If the percentage is higher, it can affect the company’s reputation. Flotation can help improve the debt-to-equity ratio to collect funds in the future.

• Helps the company to gain publicity:

  Flotation, especially when the new issue is for the general public, gains the company immense publicity. People are aware of the company and attempt to understand its products and operations. It may attract new customers and increase their market share.

• Exit strategy for existing venture investors:

  When Flotation opens the door for many new investors, it can be a way of exiting the existing investment for venture investors. Venture investors can make money by selling their investments when the company chooses to float the shares.

To conclude, Flotation is the process by which private companies go public by issuing new equity shares. The companies benefit by having access to huge capital and an improved debt-equity ratio. However, the costs related to the process are higher. Moreover, Flotation results in diversified control due to diversified ownership.