by elmads

Finding ways to make our hard-earned money work for us has never been easier due to our digital and technological advancements in our society. We find a lot of articles, electronic books, videos and audibles that show us methods on how to do it, and one of the most popular strategy is investing into different companies. This process is commonly known as stock market investing, which has been made easier by our electronic devices such as smart phones and laptops.

That being said, with the easy access to stock market investing comes the rising number of individuals doing such endeavour due to its popularity worldwide. People now a days get very excited in entering this market because of the fact that we could gain massive amounts of money from our initial invested capital. Nevertheless, not all who invest in the stock market knows what it is and how it works.

Financing

Each and one of us have certainly experienced the need to get money for our own personal individual endeavours in life, such as for starting a business, to renovate a house, for emergency purposes, for education, to invest for monetary gains or even to pay our outstanding debts.

There are two ways that we can take as individuals to raise capital, and that’s through:

• Taking money from our specific savings pot and/or
• Go into debt.

It is exactly the same with companies worldwide. But, unlike with us individuals, companies have one additional method that they can take other than tapping into their cash (savings) and go into debt, and that is through Equity financing.

The most common way to raise massive amounts of capital for corporations via equity financing, is by undergoing “Initial Public Offering (IPO)”.

Private and Publicly listed companies

So how does an IPO start then? well it first begins with companies. To start, there are two types of companies in terms of ownership, which are Private and Publicly traded companies.

On the one hand, private companies are owned by groups or individuals (namely family, friends, and business investors). Each owner has a percentage of ownership of the company.

These owners can transact between themselves. Meaning they can buy or sell shares from other individual owners of the company that want to buy/sell a piece of their ownership in the company, and vice versa. In here the company’s shares are not offered to the general public. Hence the name, Privately held corporation/company.

Popular private companies are LEGO, IKEA, and MARS. Below is an illustration of LEGO group’s ownerships breakdown.

As illustrated on the above picture, you could see that LEGO group’s shares are not owned by the general public, which clarifies their ownership status as a private company.

On the other hand, public companies just like their private companies counterpart are also owned by groups or individual persons. The only dissimilarity is that the percentage of ownership of publicly listed companies are offered to the general public and other institutions. See below example of the breakdown of Apple company’s ownership as per December 2020.

As these two types of companies have been defined clearly to you, we’ll now move forward with the story and background of the most famous Mr. Capital Markets.

The Narrative of Initial Public Offering and the Primary Markets

It all begins with private companies who want to raise capital for various purposes. Some private companies choose to go for Initial Public Offering (IPO), which is to give some of the ownership of their company to the public via the primary markets. The common reasons for this are as follows:

• For the company’s geographical expansion of its operations (expansion to other countries or continents)
• To finance their new products and services ideas (new food, equipment, device, shipping services and others)
• To give liquidity or returns to their initial capital investors (this is via the secondary market which will be discussed later.)
• To pay off their debts (not a big fan of this!)

Furthermore, there are steps that need to be taken by companies before they are able to go for an IPO and have the capital for their endeavours. The following below are the basic steps needed to be taken by the companies before they get approved for an IPO;

1. Companies need to find an investment bank to help them with the IPO process, this bank will audit all of the company’s finances. They will also assist for drafting a prospectus, which is like an advertisement where all of the information are indicated. Namely, the company’s background, history, what is their operations, how it works, their financial health, who are the management and most importantly what is the reason, like: why they need the capital for? and how will they utilise it? (the more transparent the company is the better, as it somehow gives a sense of confidence for investors to invest with them as they see fit depending on the investor’s principles and strategies).
2. Companies need to register and be approved from their country’s Securities and Exchange Commission (SEC) where they operate. They are the government agency that regulates the securities/stock markets to protect investors from fraud and other possible problems. This SEC government agency name is different for some countries. Here in the UK it is called Financial Conduct Authority (FCA).
3. Once the company’s registration has been approved by the SEC, the company will then need to set an allocated number of shares for their company, and the price they want to sell for each share.
   Nevertheless, the price amount per share which will be decided initially by the company is not yet final, because it will boil down to the investment bank’s decision what will be the final price depending commonly on: 1^st the valuation of the company and 2^nd the price demand for the share.
4. Subsequently, when the price has been decided, the shares will be then turned into a security (this is a representation of a fraction of ownership of a company, before it used to look like a diploma certificate) and be sold by investment banks, as the handler of transactions. This will now be then sold to big institutional investors (are a company or organisation that invest money in behalf of their clients and members.) who purchase millions of shares at a time. Below is an example of the large institutional investors worldwide;

As depicted above, this example shows the top 10 institutional investors who own apple stock securities as of September 2020. They usually own millions and billions worth of shares of other companies they invest in.

A newly IPOed company.

Once the institutional investors have the stock certificate which signifies a piece of ownership of the company. The company will now be able to proceed on financing whatever is their plan for it, which is usually for the growth of the company. Down below is a straightforward recap of the primary market.

Just to add, the previous private company who went into the IPO method is now a legal Publicly listed company. This is the story behind the whys and hows of the Initial Public Offering of different companies, and how it goes into the primary markets, but wait there is still more!

The Secondary Markets

Some of you might be asking, so where does the stock market comes in all this grand scheme of things? It comes after the primary markets.

Primary market is where a company decides to go for the IPO process and sells their shares to institutional investors via the investment banks who are the intermediary transaction holders.

What comes next is the secondary market, which are transactions that takes place after the Initial Public Offering (IPO). The story starts with Institutional investors (is a company or organisation that invests money in behalf of its clients and members) who bought the shares from the company who went for IPO.

These Institutional investors will take their company stock securities into different public stock exchanges that are available in their country, sometimes in other countries as well. The top 5 public stock exchanges in the world are the New York Stock Exchange (NYSE), Nasdaq stock market (NASDAQ), London Stock Exchange (LSE), Japan Exchange Group (JPX) and Shanghai Stock Exchange (SSE).

Their primary reason for this action is to gain more money from the stock securities that they have bought from the IPO of a certain newly publicly listed company. “How does that happen?” That is where we come in. It is us, small capitalised investors (individual/retail investors who can only and usually purchase less than a million’s worth of shares of a stock.) who buys it from these institutional investors via the secondary market or commonly known by the majority as the stock market. So when people say that they invest in the stock market as an individual, this also means that they invest in the secondary market.

Nonetheless, not all institutional investors immediately sell their shares in the secondary market as some of them just hold the stock for a long time and wait for its price to reach higher levels for a better gain or just hold it for years or decades.

To give you context about the Primary and Secondary Markets I will give you an analogy based on simple transaction.

The following below are the variables:

• Shares = Shoes
• Primary Market = Nike Store
• Institutional Investor = Yourself
• Secondary Market = Lazada / Shopee / Facebook Nike shoes market place / StockX online platform
• Individual Investors = Buyers who purchase shoes in these kind of applications or online market place

I bet that you immediately get the idea, but I’ll just explain it further. Let’s say you went to a Nike store branch in your place and saw a Jordan 11 OG black/red colour-way, which you immediately bought at a retail price of $220. The main reason you bought that pair of shoes is to sell it to others for an additional profit. So, you went to a secondary market place (in this case the StockX online market place) which has a high demand for the shoes you bought. You decided to sell it for $300, then after a few days someone bought your listed shoes in StockX.

Therefore, the Jordan 11 OG black/red pair of shoes is now owned by another person as he/she bought it on the secondary market where you sold it. Whereas you as the seller, who originally bought it in the main Nike store at $220 is able to make a profit of $80 in the process.

As you have noticed, the prices for the primary market is dictated by both the company and investment bank based mostly on the company’s general valuation of their finances, operations and future growth. While, in the secondary market, it is predicated on the supply and demand by both retail/individual and institutional investors who are buying and selling shares of companies.

Just an additional information, sometimes companies have what they call share buybacks. It is literally them buying back the shares of their own company.

Trivia on the top IPOs in the US, UK & Philippines

1.) Alibaba Group Holdings Limited (in the US)

An online e-commerce company based in china and founded by the famous Chinese businessman Jack Ma. The company went public on 18^th of September, 2014 and was listed in the New York Stock Exchange. Alibaba Group was able to raise 21.8 billion USD. Their reason for the IPO process is for the expansion of their business in other countries and continents.

“After we go public in the U.S., we will expand strongly in Europe and America, because after all we’re not a company from China, we are an Internet company that happens to be in China.” -Jack Ma.

2.) Glencore International PLC (in the UK)

A multinational commodity trading and mining company who went for IPO in May 2011. The company raised 10 billion USD which made it the largest IPO in London Stock Exchange since its foundation. One of the reason for this massive IPO for Glencore is to finance the plans to boost their marketing activities and to increase their stake into acquiring a refinery and mining operations.

3.) Robinsons Retail Holdings Inc. (in the Philippines)

Is a multi-format retailer in the Philippines and owned by the well renowned Gokongwei family in the said country. The company was able to raise 28.1 billion PHP or 584.2 million USD in 2013. Their IPO is considered one of the largest in the Philippine Stock Exchange. The company used the IPO capital for expansion of their goods and services.

To Sum It Up

Knowing the method how company shares are made, decided, and how it goes into both the primary and secondary markets are not too complex as everyone thought (It is actually a straightforward process). It only looks overwhelming because its approach is at a larger scale compared to my given example of a pair of Nike shoes.

Furthermore, understanding the methods of the market are like understanding why we do our work, by knowing as much as possible the ins and outs of our job mitigates the risk of committing further and major mistakes.

It is by knowing what we do not know that gives us the leverage from the unknown.

-ELMADS

Knowledge is my Sword and Patience is my Shield,

elmads

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This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.