In lesson 9 we introduced a new series on Investing, and we started with Bonds that pay a fixed rate of investment, this week, we look at Equities.
Equity represents a share in the ownership of a company. All limited liability companies are created by the selling of shares by the promoters of the company. A company with “Limited” suffix is a limited liability company. If you buy or own a share in any limited liability company, you become a shareholder in that company and you hold equity in that company. This means you share in the profits of that company as well as the losses.
Remember Ngozi Restaurant Limited? Well she paid off all her debts, now she wants to raise cash to build new restaurants in Abuja and Lagos. She needs N10m, she does not want to borrow again, what can she do?
When a business is incorporated, it creates ordinary shares and in some cases PREFERENCE SHARES, those shares are allocated to the members of the public who invest in the shares. The Ngozi Restaurant Limited can thus raise cash by creating new shares and selling, or simply selling a part of already existing business to new investors.
So what do they do? the words in CAPS are key words
- They hire an INVESTMENT BANK to value their restaurant. An Investment bank is licensed to prepare and advise clients on the issuance of shares and engages in the institutional purchase and sale of shares. The Investment Bank determines that the value of Ngozi Restaurant restaurant is N20m. Ngozi and Kenny decide to sell 50% of the business for N10m to raise cash for the restaurant expansion. The Investment Bank advises Ngozi Restaurant that to raise N10m, the Restaurant should sell, 50,000 ordinary shares at N200 each.
- The Investment Bank then draws up a PROSPECTUS. A Prospectus is like a brochures that tells investors about Ngozi Restaurant business and why it wants to sell shares. It also defines where the sales proceeds will go. The Prospectus will also detail its financial figures, its ownership, its future plans etc ….
- The Investment Bank will also ask Ngozi Restaurant if they want to sell shares privately or to the general public. If it’s a private sale it’s called a PRIVATE PLACEMENT. Ngozi however wants to sell the shares to the public.
- The Investment bank will then apply to the REGULATOR the Securities and Exchange Commission to sell the shares of Ngozi Limited to the public.
- If Ngozi Restaurant creates new shares to sell to the public for the first time, that is called an INITIAL PUBLIC OFFER or IPO. So in this case it’s an IPO. if Ngozi Restaurant has sold shares before and want to sell new shares again, it’s called a Public Offer, no INITIAL
- If the public offer is a sale of the shares owned by Ngozi and Her Husband, that sale is called an OFFER FOR SALE.
- So the Investment bank ISSUES the shares of Ngozi Restaurant at N200 a share. If the shares are FULLY SUBSCRIBED i.e. if the shares are fully bought by the public, Ngozi raises her N10m. note that the Initial Public Offer was not sold on the STOCK EXCHANGE. The first time the shares are sold, the transaction is between Ngozi Restaurant and the investing public, this is called a PRIMARY MARKET transaction because it’s the first time Ngozi Restaurant shares are sold.
- After the IPO, Ngozi Restaurant shares will be LISTED on the Nigerian Stock Exchange. Listing means the shares are available on the exchange. Its shares price is now no longer determined by the promoters but by the forces of demand and supply. If the demand of the share goes up the share price goes up and vice versa
- Now the James Family bought 100 units of Ngozi Restaurant shares for their daughter. The shares cost them N20,000 (100 shares by N200). Now if the James Family want to sell 50 shares of Ngozi Restaurant, they ask a STOCK BROKER to sell it for them on the Stock Exchange. A Stock Broker is a trader licensed to buy and sell shares on the Stock Exchange. This transaction is called a SECONDARY MARKET transaction because it’s the second time the shares have been sold after the Primary Market sale. Going forward all transactions after the shares are listed on the Stock Exchange are Secondary market transactions
- After the Initial Public Offer sale, Ngozi Restaurant Plc will issue new members who invested in their offer a share certificate, a physical share certificate. It’s that share certificate that is the evidence of membership by new investors of Ngozi Restaurant Plc. Note where there is an electronic Central REGISTRAR you don’t need to hold a paper certificate. . The Registers acts as the administrator of the company shares. It keeps a register of the members. So if you bought shares during a public offer or have a physical certificate, it’s advisable to talk with your Stock Broker to domicile your physical certificates with the electronic registrar. You get a CSCS certificate that shows you “certificate has been electronically moved to your account.
- Ngozi Restaurant name will now change to Ngozi Restaurant PLC or Public Liability Company. The “Plc” suffix shows their shareholders are members of the public that bought their shares and own a part of their company. This also means their shares are publically traded, unlike the “Limited” appellation which implies an investor cannot freely become a member of the company. The “Plc” appellation also puts responsibilities on Ngozi Restaurant Plc. The responsibilities include
- They MUST publish an ANNUAL REPORT every year to tell the public that own their shares how well their company is doing eg Sales, expenses, profits bank and balances, Ngozi cannot hide any detail. An Annual Report is a statement of affairs of the company that indicates the financial, operation and human capital performance of the public company.
- Ngozi Restaurant Plc has to hold regular Annual General Meetings and inform the shareholders of that meeting well in advance.
- Ngozi Restaurant Plc has to keep books of accounts and appoint an auditor to confirm and certify the books of accounts Ngozi Restaurant Plc maintain
- Important decision are now by voting of the members of the company.
At the end of the trading year, by law Ngozi Restaurant Plc will hold an Annual General Meeting and tell its shareholders how the business performed the past trading year. At that AGM the members of the company that own shares will vote on many proposals including paying of dividends. Dividends are returns the shareholders get for owning shares of the company. The divide can be a cash dividend or a dividend of more shares of the company.
If Ngozi Restaurant Plc shareholders agree to pay a dividend, it will send the payment to the REGISTER of Ngozi Restaurant Plc who will then send out the dividend warrants to the shareholders. So as you buy and sell shares your name gets into the register of that company.
Now the payment of a dividend is not mandatory, the shareholders of the company may agree not to pay a dividend. This is a key difference between buying Shares and a Bond. a Bond must pay a coupon, on the other hand a company can decide not to pay a dividend.Also a dividend does not have to be the same amount or increase every year. A company can decide that it needs the cash generated to grow the business.
Ok so this week we have learned all the key terms about stocks, next week we will talk about how to trade in shares, how to select a stock and a disciplined method to invest in shares.
Financial Jargon of the week
What’s a preference share?
A share which entitles the shareholder holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends. So a preference share is like a share that behaves like a bond, you buy ownership but you get a fixed rate of return.
Question of the Week
What method is better to raise cash for your business? Debt via a bond or selling shares in your business?
