Interactive Investor

Don’t be shy, ask ii…why do companies list on the stock exchange?

11th March 2021 09:06

Lee Wild from interactive investor

No question is a stupid one, so whether you want to find out what you need to do to start investing or how the stock market works, don’t be shy, ask ii.

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Graham Boys asks: One thing that has always confused me is once a company has gone public, listed on a stock market and issued shares and received that initial capital injection, what are the benefits of having its shares traded thereafter, in terms of future injections of capital into the company?

I can’t see how a transaction in a publicly traded company once the shares have started trading further benefits the company in terms of capital for future investment when their shares are sold by Mr Jones to Mr Smith via a broker, the money flows between the two individuals and not into the company?

Lee Wild, Head of Equity Strategy, interactive investor, says: Once a company has decided to list its shares on a stock exchange, the stock must be available to trade on the exchange it has chosen, be it the London Stock Exchange’s main market, AIM, New York Stock Exchange, Nasdaq etc. Investors who have participated in the initial capital injection will want an eventual exit route at some point in the future. A stock market listing matches buyers and sellers. If the shares were not tradeable on a stock exchange, it would be more difficult to sell them.

At any point in time, a company will have a fixed number of shares in issue, which could be owned by a director of the company, an investment fund, member of the public or other interested party.

The buying and selling of shares on the so-called secondary market, is normally of little concern to the company itself. It doesn’t matter whether Mr Jones sold to Mrs Smith via a broker or vice versa. However, it does matter if one shareholder begins to build a large stake in a business. The larger the holding, the greater the influence a shareholder can exert on the business itself. You may have heard of activist investors, typically hedge funds, who seek to get their voice heard and change the way a company is run by building a big stake.

Benefits of having your shares traded publicly can be significant, whoever owns them. It certainly raises a company’s profile, and it carries kudos and perceived respectability. Crucially, it also gives companies access to new money which they can use to invest in the business, generate growth, increase profits and, usually, the share price.

For the most part, successful companies generate enough cash and make big enough profits to be self-sufficient. Many also return money to shareholders via dividends. But they may require a large injection of cash for an acquisition or other one-off event. Existing institutional shareholders with deep pockets are typically a company’s first port of call when new funds are required. They might also sometimes allow retail shareholders to participate via open offers and rights issues. The latter are often used not to grow the company, but to save it. If a business is doing well, it will not need to tempt potential investors with cheap shares via a rights issue.

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