Example of Listing Process

It can be useful to understand how companies that are listed on the ASX got to be there; the following describes a hypothetical process using ABC Ltd as an example.

Formation & Venture Capital

John and Mary have decided to go into business together and choose a corporate structure to do so.  They form a new private company and name it ABC Pty Ltd.  To provide the company with capital, they both invest $100,000 by buying new shares in the company.  The issue price of the share is arbitrary, and they decide to issue 1c shares, meaning 10mil shares are issued to each investor.

At formation, the capital structure of the company is therefore.

John 10 million shares (paid 1c each)
Mary 10 million shares (paid 1c each)
Total 20 million shares

 

At this early stage, ABC is a private company.  Private companies must have no more than 50 shareholders, and cannot be listed on an exchange such as the ASX.  Transfer of shares in a private company can only be made through private arrangement.

After two years, ABC Pty Ltd is performing well and John and Mary want to expand the business nationally.  They work out that this will require the company to expend $1 million.

Expansion & Seed Capital

The company could fund its expansion by borrowing money (debt) or by selling shares (equity).  Both methods of funding have some advantages and disadvantages.  Debt funding means that John and Mary’s ownership is not diluted, however, the company would have to service the debt, which will impact the performance of the company.  Alternatively, equity funding will dilute their shareholding, but the company is not required to pay back these funds.

John and Mary decide to go down the equity funding route and manage to convince a venture capital firm of the merits of making an investment in ABC Pty Ltd.

At this time, the company removes the restrictions of being a private company by adopting the constitution of a public company.  The company is still unlisted, but the public classification provides more flexibility in raising capital.  The name of the company becomes ABC Ltd, signifying the change to a public company.

It is agreed that the venture capitalist will purchase $1 million shares at 10 cents each.  This is 10 times the price that John and Mary paid for their shares, signifying the now much greater value of the company.

The shareholdings are now made up as follows.

John 10 million shares (paid 1 cent each)
Mary 10 million shares (paid 1 cent each)
Venture Capitalist 10 million shares (paid 10 cents each)
Total 30 million shares

Initial Public Offering

After several years of successful operation, the directors of ABC Ltd have decided that the company is at a now at a stage where it can expand internationally.

With consultation with advisors, the directors decide that $10 million is needed in order to fund the intended expansion.  They also decide that it would be difficult to raise this amount of capital without offering potential shareholders the ability to sell their shares on an open market.  For this reason, a listing of the shares on the ASX is proposed to occur immediately after the capital raising is complete.

Now starts the process of an IPO.  Lawyers, accountants and stock brokers work with the company to produce a prospectus which includes all of the material information required for a prospective investor to make an informed decision about whether to invest in ABC Ltd.

The company’s stock broker offers the 10 million shares to their clients, pursuant to the prospectus at a price of $1.00 each.

The price of the shares means that the market capitalisation of the company is now $40 million (post offer).

The capital structure of the company after this capital raising would be:

John 10 million shares (paid 1c each)
Mary 10 million shares (paid 1c each)
Venture Capital 10 million shares (paid 10c each)
Public (Float) 10 million shares (paid $1 each)
Total 40 million shares

It is clearly evident in this example that shareholders are rewarded for the risk they take.  The earliest stage investment that John and Mary made was extremely risky (most businesses fail), and they make the greatest return.  The public who buy at the IPO are taking by far the least risk.

Once listed, the price of the shares in the company is determined by supply and demand for the shares.  If demand is greater than supply, the price will go up as buyers compete to purchase shares from the fewer sellers.  There are many reasons why people would buy and sell shares in this company.  These reasons may include the performance of the company, the general economic environment, or the number of stockbrokers who are recommending the share to their clients.

Shares purchased by earlier investors may also be sold once the company is listed at the prevailing share price.  Usually, the ASX would restrict the founders from selling shares for two years from the date of listing.  This is called escrow and it is in place in order to protect the new shareholders.

Now that ABC Ltd is listed it is also required to report regularly to their shareholders and to the investing community by issuing reports.