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Understand the basics of Issuing Shares

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Credits :Team Wall Street Survivor

Understanding the basics of Issuing Shares

Sometimes taking the effort to understand how and why things
work gives us a better sense of control and offers tangible results. We
may never know how the washing machine manages to eat our socks or why
Pluto isn’t a planet anymore, but, by reading this article, you should
have a better understanding of why stocks are issued and how this issue
of shares matters to you.

Once upon a time, there was a company

 

Everything is better with a story….Here’s a typical example of how and why a stock would be issued:

issued stock

Here’s Neha. Neha’s a baker, known for her famous (and delicious)
croissants. She’s just out of university, has a mountain of debts and
works out of a small shop. Lately, the demand for her croissants is so
high that she knows it’s time to expand her operations. Neha is smart
and did the math – she knows she’ll need $100,000 for a bigger space,
extra staff and inventory.

issues shares

Only problem: Neha only has $10,000 in the bank and taking a loan is out of the question – she has only just started paying down her student debt. So what is Neha to do?

 

How does the issuance of stock work?

 

So Neha decides to issue shares of her company to friends and family in return for cash. These shares represent ownership in Neha’s Bakery. Neha
finds 9 people to invest $10,000 each and she invests her own $10,000.
Because 10 people (Neha and her 9 friends) invest equally, they all own
10% of Neha’s bakery.
Neha was able to raise the money she needs to expand, and her 9 friends now each own part of her booming business.
And they all lived happily (and financial independently) every after. The End. Sort of…

 

Issuing shares for cash

 

Ever heard the expression, “it takes money to make money”? Well, at a
certain point, every business will need money to propel it’s growth. In Neha’s case, she needed to hire workers, expand her shop and buy
inventory. Oftentimes, companies will issue stock either privately (like Neha), or publicly (on the stock market) to raise the cash they need to invest in their growth.
The pro: Companies are able to raise money without being required to pay anybody back (like they would if it was a bank loan)
The Con: The company gives some
ownership. In Neha’s case, after raising money, she only owns 10% of
her company (90% owned by here investors).

 

How to Issue Shares

 

In Neha’s case, issuing shares was pretty straight-forward issuing: 9
investors paid an equal amount for equal ownership. But in the real
world, companies issue shares to millions of people, and those people
purchase different amounts. That would be more than a little
overwhelming for someone like Neha. Enter the banks. But not just any
bank. The kind of bank that can arrange this type of deal can only be
an investment bank, like Goldman Sachs (GS) and Morgan Stanley (MS), for example.

 

What Do These Banks Do?

 

Issuing shares of stock

After the company and the bank sit down together and discuss their
intentions, the bank starts to gather information on the company;
financial statements, interviews with suppliers, and creditors and all
other company info. Their analysts sift through all this information
very carefully to come up with a precise value for the company.

 

How is the price of the first shares determined?

 

After the company and the bank sit down together and discuss their
intentions, the bank starts to gather information on the company;
financial statements, interviews with suppliers, and creditors and all
other company info. Their analysts sift through all this information
very carefully to come up with a precise value for the company.

 

Sale of Shares

 

The bank then takes these 100,000 shares and can do at least two things with it.

  1. Offer to buy it all from the company for a discount (like 9$ instead
    of $10), and then turn around and sell it into the stock market
    (pocketing the difference). This is called the bought deal method.
  2. Sell it into the stock market for the company as best as they can.
    In return they will get a commission for the overall sale. This is
    called the best-efforts method.

 

 

And finally, the market

 

It’s done. The private stock that belonged to only a few is now a
public stock available to everyone. The money that came from the sale of
stock is used for whatever purposes the original owners needed it for.
The stock trades on the public stock exchange increasing in price if the
company does well, and decreasing if it does badly. In return, the
company has to show their financial statements to the public and answer
to shareholders who own the stock.

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