Companies need funding to sustain their operations and grow their businesses. One of the most popular ways in which a company gains access to funds is through a new issue. As an investor, you need to know what this term means and the kind of impact it can have on both the company and the investors. Continue reading to find out all about the concept of a new issue and its various advantages and disadvantages.
What is a new issue?
The process through which a company raises funds by issuing its equity shares or bonds to the general public for the first time is termed a new issue. After a successful new issue, the securities issued by the company are often listed on stock exchanges, where they can be freely traded between investors. It is a significant step for a company since the process not only enables it to raise funds but also enhances the company’s visibility and liquidity.
In the case of a new equity issue, the investors who purchase the company’s equity shares become its shareholders and are entitled to a few rights. These include the right to vote on company matters in a general meeting and the entitlement to a share of the profits in the form of dividends.
In the case of a new bond issue, the investors who purchase them become bondholders and are entitled to a few rights of their own. These include the right to receive interest on their investment at predetermined intervals, the right to receive the principal investment amount on bond maturity and the right to receive a settlement during liquidation or winding up proceedings.
Read more: What is the right issue?
Examples of a new issue
Now that you have seen what a new issue is, let us look at a couple of examples to understand how they work.
Example 1
Assume that there is a company called ABC limited. It needs funds to expand its operations beyond its current geographical market. In exchange for funds, the company decides to issue 25 lakh equity shares to the public for the first time through an Initial Public Offering (IPO). The equity shares are priced at Rs. 2,150 per share.
Interested investors can subscribe to the issue by applying for the IPO. Once the application process is complete, the equity shares that the investors applied for are transferred to their demat accounts, making them equity shareholders of the company. ABC limited, meanwhile, gets Rs. 537.50 crores (25 lakh equity shares x Rs. 2,150 per share), which it can use to expand its operations.
This is a classic example of a new equity share issue. Now, once the equity shares are allotted to the investors, they are listed on the stock exchanges, where they are freely traded without any restrictions.
Also read: What are the types of stock trading?
Example 2
Let us take the same company, ABC limited. The company is already listed on the stock exchange and is now planning to raise more capital for research and development purposes. To achieve its objective, ABC limited plans to issue 50 lakh bonds to the public for the first time through a new bond issue. Each bond is priced at Rs. 1,000, carries an interest rate of 10% per annum (payable every quarter) and matures after 10 years.
Through this new bond issue, the company gets Rs. 500 crore (50 lakh bonds x Rs. 1,000 per bond), which it can use for research and development. The investors who purchased the bonds become bondholders and are entitled to quarterly interest payments at the rate of 10% per annum on their invested amount until the bond matures. When the bonds finally mature at the end of 10 years, the company will redeem them by repaying the principal investment amount to the respective investors.
Advantages of a new issue
A new issue has several benefits for both companies and investors. Here is a quick overview of what they are.
- Access to large sums of capital
Through a new issue, companies can raise significantly large sums of money to the tune of crores, which may not be possible through traditional financing options like bank loans. - Access to the wealth-creation potential of companies
When you invest in a new issue, you get to participate in the company’s wealth creation potential early on. As the company continues to grow and perform well financially, you stand to gain from the significant share price appreciation. - Potential for higher returns
Whether the new issue pertains to shares or bonds, the returns that you are likely to get tend to be much higher compared to traditional investments. - Enhances visibility
Once the new issue is complete, the securities are listed and traded on stock exchanges. This significantly enhances the visibility and credibility of the company.
Also read: What is share trading?
Disadvantages of a new issue
Although new issues have several benefits, they also have a few drawbacks. Knowing what they are is crucial for making informed investment decisions.
- Can be a time-consuming and expensive affair
New equity shares and bond issues involve extensive regulatory requirements, significant legal disclosures and hefty underwriting fees. This makes them time-consuming, complex, and expensive. - Carries a lot of risks
A new issue carries inherent risks such as price volatility, a lack of historical performance data and uncertainty regarding the company's future prospects. Investing in the wrong company at the wrong time can result in financial losses.
Conclusion
New issues play a crucial role in the financial markets. They help companies raise capital and provide investors with access to attractive investment opportunities. Despite the potential benefits of new issues like the ability to earn higher returns, they also have several risks, such as price volatility and increased regulatory scrutiny. Therefore, as an investor, it is important to thoroughly research and understand the various risks before investing in a new issue.
