4 Ways for Companies to Raise Capital
Companies have now more options than ever to raise funding and go public. Traditionally the only way was to successfully launch an Initial Public Offering or IPO in the stock market. However, nowadays, new forms of funding have emerged. These are direct listings, SPACs and, more recently, tokenization.
In this article we will briefly touch on each on them explaining what they are and their main characteristics.
Initial Public Offering (IPO)
The best known and oldest of the four is the IPO. An IPO is the process by which a private company sells equity to the public for the first time under a new stock issuance.
The first ever IPO in history was held by Dutch East India company in August 1602.
The IPO is the most important moment for a company’s private investors as this is the stage when they can realise the returns they were expecting from the investment. Sometimes, early-stage investors will hold some of the shares into the public market.
IPOs are great ways to raise funding for relatively mature and sizeable companies as millions of investors will now have access to these shares. Private companies typically have a size of $1bn or more before they go public through the IPO path. The IPO could be understood as a decisive stage of matureness for the company as the local regulator will scrutinise the company’s financials and expert investors and bankers will carry an extensive due diligence.
The process can be lengthy and involves many players. It consists of a two-stage process: a marketing stage or road show and the IPO itself. During the road show, the company meets investors to raise the company’s profile and start placing the shares among them. During this stage, the underwriters will gather feedback from interested parties to get an idea of the price at which the shares will be issued in the public market.
- Costs: IPOs are very expensive hence only available to relatively large companies. In addition, companies must meet the obligations established by the regulators, so the IPO costs also are recurring.
- IPO price: The underwriters would market the company over a period of a few weeks in order to set the IPO price. Knowing the IPO price is quite beneficial as proceeds from the IPO are known beforehand.
- Risk that the fundraising is not successful: It is not common to hear that an IPO has not been successful, but a poor roadshow or bad timing could translate in the company rising less capital than expected. This could potentially be fatal if the fundraise was needed for specific purposes.
- Cost of capital: a successful IPO can reduce the cost of capital significantly as it is understood that the market and regulators already have scrutinised the company. This could give access to other sources of financing at better terms than a private company could have. This is also related to prestige.
It could be argued that there is an important conflict of interest for the underwriters. In order to be successful in the IPO and sell all the shares (and get paid the fees), underwriters would typically set the IPO price below the optimal market price. This is one of the reasons why IPO shares frequently go up significantly in price shortly after the IPO. This is a real problem for the company going public as it “leaves” plenty of capital in the table that could have been otherwise used for corporate purposes.
Direct listings are similar to IPOs but without the involvement of underwriters (investment bankers). Simply put, the company lists and offers its shares in the stock market without any underwriting from banks.
It is obviously more cost-effective as all fees from underwriters are saved but it also is riskier. There is a significant trade-off between IPO and Direct Listings. In an IPO you know beforehand the proceeds from the fundraise, whereas companies don’t know the IPO price in a Direct Listing. This means that the company could sell its shares for a higher price than expected, but it could also mean the opposite.
The first ever Direct Listing was done by Spotify in 2018. According to them, the main reason behind the Direct Listing (instead of the IPO) was to offer early-stage investors and employees a window to realise their investments. No lock-up periods. They could sell whenever they felt like selling. The company was already 10-years old when the listing took place and Spotify’s management argued they wanted to offer this opportunity to investors and employees. The company did not really need liquidity at the time, so it was purely a way for early investors and employees to cash in.
Direct Listings are more suited to large companies with a very strong brand and global presence.
Special Purpose Acquisition Companies (SPACs)
SPACs are a bit different. In a SPAC, the company going public has no operations whatsoever. It is empty! Then the proceeds from the IPO are used to acquire a private company, effectively making this company public.
SPACs are typically run by experts in specific sectors or industries who are trusted by investors to successfully acquire companies. SPAC founders would normally have an acquisition in mind, but they would not disclose the name to avoid extensive due diligence and scrutiny from regulators. This is why SPACs are also called “blank cheque” companies.
Companies that are acquired by a SPAC, benefit from a pre-known sale price, hence knowing beforehand what the acquisition price will be. This is a great route for Private Equity companies that seek an exit from a previous investment with a target exit multiple in mind. Also, these are faster ways to IPO compared to traditional routes.
SPACs have been around for decades, but have regained popularity in recent years. One of the most famous SPACs was Richard Branson’s Virgin Galactic in 2019, valued at over $1.6bn.
SPACs are typically suited for large private companies and/or companies that have received investment from large Private Equity funds or venture capital in late series.
Last but not least, tokenization is the newest route to financing in comparison to the other three. Tokenization was made possible thanks to the blockchain technology, by which the entire registration and issuance process takes place inside a blockchain instead of traditional means.
In a tokenization process, any asset or company can effectively become “public” by splitting itself into shares (called tokens). The tokens will then be registered in the blockchain. This information is completely public and transparent which means that thanks to the blockchain technology, anyone knows at any time who owns what tokens and the underlying asset associated.
IPOs, Direct Listings and SPACs are typically available to large private companies and/or companies with an established global brand. On the other side, Tokenization can be used by real assets (property, land, art, etc.) and also by smaller companies like early-stage start-ups that need to raise funds.
One example relates to small sized companies and start-ups. These companies typically do not have the profile to become public, nor the means. Tokenization can be a great way for these companies to raise capital. Investors from all over the world can now access tokenized companies through the blockchain with attractive minimum capital requirements, and the associated costs of doing so also are significantly lower than the previous methods.
Other examples are real assets, like property. The costs associated with splitting a property among various owners would quickly offset the benefits of doing so. In other words, the legal and regulatory process that is required to be undertaken quickly make it inefficient. However, thanks to tokenization this can now be done in a much more efficient manner by effectively providing the property owners with liquid tokens that receive the same rights and economic benefits, but these tokens can also be transferred to other investors who are interested.
One of the advantages of tokenization is that companies can now raise both equity and debt in the same instrument if desired.
In conclusion, tokenization enables smaller companies to effectively become “public” without the massive size gap that needs to be fulfil ed before reaching the critical level required to cover the costs of an IPO or the profile required. In Brickken we want to facilitate tokenization to everyone to make this possible both at the company level and real asset level. If you are (or know someone) that would benefit from raising capital through blockchain, please feel free to let them know about Brickken and you can also benefit thanks to our Partner’s programme.
For additional information, please send an email to firstname.lastname@example.org. Please also visit our other articles: Tokenization for a better world and , and if you want to know more about us, download our whitepaper!