Every investor who buys individual stocks, funds, or ETFs directly ultimately buys stock companies and hopes for a return from them. While there is a lot of talk about the mechanisms and laws of the financial markets, Initial Public Offering, it is rarely asked how public companies themselves think, act and act.
Ultimately, what counts is whether a strategy and an investment work. But why are companies listed at all? Why are they giving out money? What conflicts of interest are there? Where does the return come from?
Strictly speaking, a newly founded company is “private equity .”These companies are not easy to buy—the gas station around the corner, the medium-sized craft business, or the supermarket chain Lidl.
These are private companies.
We mainly look at listed companies. Their shares are traded as shares on the stock exchange. Anyone can buy these shares; the claims are valued at any time by the share price.
These are public companies.
So what are the differences between private and public companies?
Now suppose that a private company goes public. How does this happen, and what are the specific considerations that the company should make?
There are good reasons to keep a company private and seek a public listing. It mainly depends on the owners and the company’s goals.
Now our company has concluded that the initial public offering(IPO) should take place. How does this work now?
Even before it goes public, a company belongs to someone: the founders, employees, or existing investors, for example.
When going public, there is one big goal: to raise capital. In other words, money that flows into the company can be used to expand and further develop the company.
How does a company go public?
In an initial public offering (IPO), existing shareholders sell their shares (in whole or part). New investors buy these new shares after the latest issue, and money flows into the company.
When subscribing to the new shares, large banks and institutional investors, in particular, will be brought on board to buy the shares directly. After the initial public offering(IPO), any investor can purchase the shares.
Another way companies go public has become popular in recent years: Special Purpose Acquisition Companies (SPACs).
They’re shell companies that are ultimately just a pile of money raised by an investor. They then look for a private company that wants the money to buy it out and get it public quickly, at less cost, and with fewer disclosure requirements.
There is always criticism here: false incentives for the initial organizer of the SPAC, fewer disclosure requirements, and a flood of initial public offering(IPOs).
The company is now listed on the stock exchange. What does it mean now for the day-to-day business of the company? What exactly is changing?
We now know why companies go public, the advantages and disadvantages, and the obligations and opportunities. But are there any conflicts of interest?
With a new issue, new money flows into the company, which comes from the share buyers.
Once a company is public, a share only changes from ex-shareholder to new shareholder. The company has nothing to do with it. One investor sells the stock to another and gets their money in return.
But does the stock price impact that can result from high demand for the stock?
A rising share price means an increasing market value. That sounds great for the company, but it makes the shareholders happy. Just because the price is rising, the company no longer has money available, and the stock market value has no direct impact on the business.
However, an increased share price can have indirect effects: the more valuable the company’s shares, the
The management of a public company is often interested in increasing the share price and market value through financial incentives. These financial incentives are not clear.
A CEO who only sees himself at the company for two years will be reluctant to initiate expensive and unpopular projects that only pay off in the long term. Investments could be deferred and short-term profitability optimized.
Our company has mastered the IPO, published the first reports, and considered how to minimize conflicts of interest. Now the first profit of the year is due. What should happen with it?
When deciding on the appropriation of profits, the most critical question is the capital requirement: does the company need money to grow? So can it profitably invest the profit in its own company? Or is the money superfluous?
If the company needs the money and can use it profitably, e.g., for international expansion, developing of new products, or buying other companies, the profit should stay in the company.
If that’s not the case, meaning there are no profitable opportunities within the company, the money should be returned to shareholders to decide for themselves what to do with it.
There are different ways to do this, which are more or less suitable depending on the situation.
The best known is the distribution of profits by dividend. Alternatives are buying back your shares or paying off debt. When is which variant recommended?
The opposite may also occur: no profit is to be distributed, or there is none. At the same time, new capital is to be raised to grow further and more strongly or to be able to repay debts.
How is the company financed now?
There are two options for financing: taking out loans or issuing shares. Let’s take a quick look at both options.
A company can take out a loan from the bank and pay interest on it, just like private individuals do. An alternative is to issue a bond.
It is determined which volume should be collected, how high the interest should be for the bond buyers, and when the bond should be repaid in full. Such a bond is then issued and usually traded on the stock exchange like a share.
A capital increase describes how a public company increases the number of shares issued to raise new money.
There are different ways of increasing capital (e.g., ordinary, conditional, or authorized capital increase), the details of which I will omit here for reasons of space.
This will be decided at the general meeting. New shares, i.e., additional shares, are issued. Subscription rights can also be given.
These can sell existing shareholders or exchange them for new shares to keep their previous stake in the company constant.
A loan is more expensive in the first step because interest costs are incurred. But investors also expect returns. Typically, when investors expect a return of 8% per year, they’d rather see the company borrow at 2% per year than dilute their stake.
Depending on the situation, a different financing structure is available. In practice, most companies use both. Especially with historically low-interest rates, there are hardly any companies that do without cheap loans.
The cheaper the stock is valued, and the cheaper the credit, the more likely a company will borrow or issue bonds. The higher the stock is valued and the more expensive a loan would be, the more likely a company will choose a capital increase.
Now we have learned a lot about how a company itself thinks and acts. But how does all this result in return for the shareholder?
Ultimately, three main factors also ensure that stock markets will rise 99.9% in the long term :
So there are different reasons why we expect positive returns from stock companies. The long-term average is 7 – 10% per year.
Of course, not every public company will achieve this: some will greatly overperform, and others will fail. On average, however, investing in stocks works and makes them the strongest of all asset classes.
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