The Follow-On Offering: Who Actually Gets the Cash?
Ridgeway Components, Inc. has 40,000,000 shares outstanding and trades on Nasdaq at $22.00. The board approves a firm-commitment offering: 8,000,000 newly issued shares plus 4,000,000 shares sold by two early venture investors. The underwriter charges a 6% gross spread and sells the entire 12,000,000-share deal to the public at $22.00. Ridgeway's CFO tells the board the company will 'raise over $250 million, because the whole deal is priced at the same price.' A director asks how the offering affects her percentage ownership if she buys nothing, and whether the venture investors' block is 'new money' for the company.
1. Compute the net proceeds to Ridgeway and to the selling shareholders. Which tranche is a primary-market transaction and which is secondary?
Read the worked answer
Split the deal by seller, not by price:
- Company tranche (primary market): 8,000,000 x $22.00 = $176,000,000 gross; spread = 6% x $176,000,000 = $10,560,000; net to Ridgeway = $165,440,000.
- Venture tranche (secondary market): 4,000,000 x $22.00 = $88,000,000 gross; spread = $5,280,000; net to the selling shareholders = $82,720,000.
Only the 8,000,000 newly issued shares create new capital for the issuer. The 4,000,000 venture shares already existed; the company receives nothing from them. Total deal value is $264,000,000, but Ridgeway's claim that it 'raises over $250 million' is wrong by roughly $99 million - the CFO has confused gross deal size with issuer proceeds.
2. The director owns 800,000 shares (2.0% of the pre-deal total) and does not participate. What is her post-deal ownership percentage, and what does that number tell you about the purpose of the offering?
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Post-deal shares outstanding = 40,000,000 + 8,000,000 = 48,000,000. The venture block does not change the count because those shares simply change hands.
- Director's stake: 800,000 / 48,000,000 = 1.667%, down from 2.0%.
This is dilution caused purely by share issuance, not by any change in her holdings. Because the company keeps $165.4 million in cash, the drop from 2.0% to 1.67% is not automatically a loss - the question is whether the capital is deployed at a return above the cost of the shares issued. If this were instead a secondary-only deal (all 12,000,000 from existing holders), there would be no dilution at all and no new capital; that distinction is the tell for what the offering is actually for.
3. A client calls and says, 'I want in on the IPO price - I read the shares will trade at $22 before the public does.' How do you describe the mechanics of the offering and the underwriter's role?
Read the worked answer
The $22.00 'offering price' is the public price; there is no separate cheaper tranche available to ordinary buyers.
- The firm-commitment underwriter buys the whole 12,000,000-share block from the issuers at a 6% discount (about $20.68 per share) and resells at $22.00, bearing the risk that the deal does not sell.
- Allocation is at the underwriter's discretion; a retail client cannot demand shares.
- Once the shares begin trading on Nasdaq, all buying and selling is in the secondary market at whatever price supply and demand sets - which may be above or below $22.00.
So the honest answer is that 'getting the IPO price' is an allocation privilege, not a right, and any expectation of guaranteed first-day profit is a red flag that needs to be corrected before an order is entered.