Underwriting a share issue

Underwriting is where an institution (usually an investment / merchant bank), for a consideration, undertakes to take up all the shares in an issue in the event of the public not subscribing for the issue (an unusual occurrence). Clearly this also means that in the case of a partial subscription the underwriter will take up the shares not taken up by the public.

The Companies Act covers this obligation by the underwriter. Section 153 of the Act ("Where the issue is underwritten") determines that:

"(1) No prospectus containing a statement to the effect that the whole or any portion of the issue of the shares offered to the public, has been or is being underwritten shall be registered until there is lodged with the Registrar a copy of the underwriting contract and a sworn declaration by the person named as underwriter, or, if such person is a company, by each of two directors of such company, or if such company has only one director, by that director, that to the best of the deponent's knowledge and belief the underwriter is and will be in a position to carry out his obligations even if no shares are being applied for."

An underwriting of an issue has two main advantages (assuming that the underwriter is a prominent institution):

• It gives the potential investor comfort, and thus improves the probability of the issue being successful

• The relevant company is assured of the required amount of capital.

Other sources of primary issue of listed equity

Introduction

There are a number of other sources of the primary issue of listed equity. As noted above, the main methods of listing are:

• An introduction.

• A private placing.

• A public offer - an offer for subscription.

• A public offer - an offer for sale.

The other sources of primary listed equity are:

• Warrant exercising.

• Convertible bonds.

• Treasury shares.

• Rights offer.

• Renounceable offer.

• Capitalisation issue.

• Issue for cash or acquisition.

• Claw-back offer.

Warrant Exercising

As noted, a warrant (not the South African definition) is a call option to purchase the shares of a listed company for cash on or before the expiry date at a pre-determined price (strike price). Clearly, the option will only be exercised if it is profitable for the holder to do so, i.e. if the price of the share is higher than the strike price.

Convertible bonds

Bonds are sometimes issued with the option to convert the bond into the shares of the issuer of the bond at predetermined conditions.

Treasury shares

Companies are permitted to purchase their own issue of shares up to certain maximum percentages laid down and as agreed by shareholders at an AGM (subject to the requirements of the Companies Act). It will be apparent that when the company buys its own shares on the exchange, the number of shares in the market falls. These shares, however, are not cancelled in most cases but held as "treasury shares (or stock)". The company has the right to re-issue these shares in exchange for cash or for the exchange of shares (in a takeover or acquisition). This action will add to the number of shares in the market.

Rights issue (offer)

A rights issue (or rights offer) is an offer of additional shares (part or all of the unissued shares under the control of the directors) by a listed company to existing shareholders in proportion to their shareholding in the company. This is done by means of the issue of a document (usually a letter of allocation or a letter of rights), and the letter may be "renounceable", i.e. to relinquish the right to the shares. The document is tradable as either "nil paid" or "fully paid" for a stipulated period (usually 3 weeks).

Renounceable offer

A listed company can make a renounceable offer. This is where the listed company has the rights to the shares of an issuer (already listed or the applicable shares are to be listed), in proportion to its shareholding in the issuer, and it renounces part or all of the rights to the issuer's shares, in favour of its shareholders in proportion to their shareholding.

Capitalisation issue

A capitalisation issue is where a listed company makes an offer of new shares to existing shareholders in lieu of dividends. This is usually done to retain the liquid capital of the company. A capitalisation issue can also be made from the reserves of the company, but this is unusual because the shareholders have the right to the reserves in any case.

Issue for cash or acquisition

An issue for cash or acquisition is where a listed company is given approval by existing shareholders (general mandate or specific mandate) to issue new shares for the purpose of acquiring new funds or for the purposes of a merger or an acquisition (in which case the shares are issued in consideration for the shares of the company purchased or taken over).

Claw-back offer

A claw-back offer is where the listed company offers new shares for cash to a third party, and the third party offers them to the listed company's shareholders as in the case of a rights offer, i.e. in proportion to their shareholding.

Summary

The primary equity market is the market for the issue of new shares, and it plays an important role in the economy in terms of the raising of capital for business. The listing of new equity on an exchange has many advantages, one of which is the raising of capital easily and at a cheaper price, but there are disadvantages, such as the cost. One of the major cost items is the number of professionals that are required to be involved. The financial requirements are also onerous.

However, in many countries these disadvantages are lessened by the formation of a "board" for the listing of smaller companies.

There are three methods of listing and for all a detailed prospectus (= one of the major costs) is required. There are a number of other sources of primary market issue of equities, such as rights offers, convertible bonds, warrants and so on.

Bibliography

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Reilly, FK and Brown, KC, 2003. Investment analysis and portfolio management. Mason, Ohio: Thomson South Western.

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