Equity financing sells partial ownership of the company in exchange for cash. Unlike debt, there's no repayment obligation — the new shareholders are part-owners and bear the risk and reward proportionally. The tradeoff: existing shareholders are diluted (their proportional ownership falls) unless they participate.
Common vs preferred shares
- Common (ordinary) shares: standard equity. Voting rights, residual claim, no fixed dividend. The default form of equity ownership.
- Preferred shares: a hybrid. Typically no voting rights. Fixed dividend (like a coupon). Priority over common in liquidation. Often used in VC investments (where preferred gives downside protection) and in some bank capital raises.
- Convertible preferred: preferred shares that convert into common at a defined ratio. The standard VC instrument — downside protection of preferred + upside potential of common.
IPO — the initial public offering
An IPO is a company's first sale of shares to the public. It's a complex, expensive, and consequential transaction — typically 9-12 months of preparation, $5-25m in fees, ongoing public-company disclosure obligations that don't reverse. The process:
- Pre-IPO: company hires investment bank advisors (book-runners), lawyers, auditors. Restructures if needed. Audit financials for the past 2-3 years.
- S-1 / Prospectus: prepare the disclosure document — typically 200-400 pages. Filed with the regulator (SEC in US, CMA in Kenya). Includes business description, risk factors, financial statements, management discussion.
- Roadshow: management and bankers meet potential institutional investors. Build the order book. Refine the price range.
- Pricing: night before listing, bookrunners and management agree the final price within the range, allocating shares to institutional investors and retail.
- Listing: shares begin trading on the exchange. First-day pop / drop is closely watched.
- Post-IPO: lock-up period (typically 90-180 days) prevents insiders from selling. Public-company reporting cadence begins (quarterly earnings, annual reports).
The IPO's irreversible consequence
Going public changes a company's regulatory environment permanently. You must report quarterly. You must disclose insider transactions. You face shareholder lawsuits when things go wrong. You answer to public-market expectations every 90 days. Many CEOs of small public companies privately wish they hadn't gone public. The decision is sometimes financially right but operationally heavy. Most large successful companies eventually IPO; many regret it.
Follow-on offerings
Once public, a company can issue more shares. Methods:
- Marketed follow-on: similar to an IPO process but compressed. Investment banks market new shares to institutional investors. Typical for material new raises.
- Accelerated bookbuild (ABB): launched overnight, priced the next morning. Used when speed matters. Limited to companies with deep trading liquidity.
- Rights issue: existing shareholders are offered the right to buy new shares at a discount, proportional to their existing holding. Common in Africa (Kenya's Bamburi, Co-op Bank, etc. have used rights issues). Protects existing holders from dilution if they participate.
- At-the-market (ATM) program: shares dribbled into the market at prevailing prices, in small lots. Used by some US REITs and biotechs for ongoing equity needs.
Rights issue mechanics
A rights issue at a 30% discount to current price means each existing shareholder can buy 1 new share for every 3 they hold (typical ratio) at the discounted price. The 'theoretical ex-rights price' (TERP) is the weighted-average price after the issue. Shareholders who don't participate are economically diluted by the gap between current price and TERP — they can sell their rights in the market if they don't want to subscribe.
Equity financing in Kenya
Equity financing through the NSE has been thin for years. The 2014 IPOs of Britam, Kenya Re, and Britam went well; few significant IPOs followed. Kenya Power, KenGen, Safaricom were earlier and successful. Recent equity raises have mostly been rights issues by listed banks (Co-op, KCB, NCBA) and the occasional follow-on. The CMA has been promoting GEMS (Growth Enterprise Market) for smaller IPOs but uptake has been limited. For most Kenyan corporates, equity financing means private placements or rights issues, not new IPOs.
Exercise
A Kenyan listed company with KES 8bn market cap wants to raise KES 2bn for an acquisition. They're evaluating: (a) marketed follow-on at a 5% discount to current price; (b) rights issue at a 25% discount, 1-for-3 ratio; (c) accelerated bookbuild at a 7% discount. Walk through the tradeoffs.