In recent years, the Sultanate has experienced tremendous growth not only of its national economy and physical infrastructure, but also of its financial system. Oman’s capital markets, in particular, have undergone significant development and modernisation since the legislation passed in 1998 to restructure the Muscat Securities Market.
Equity capital markets transactions, such as IPOs and rights offerings, are key events for the companies that undertake them, and such transactions often take on a larger importance to a nation’s economy and financial system. Yet these transactions tend to be shrouded in so much jargon and mystery that they sometimes can be difficult for laymen, and even experienced businessmen, to understand. Our mission in this article, and in the further articles on capital markets transactions in coming issues of the Client Alert, is to explain how these transactions work and why they are important to companies.
This article describes, at a fundamental level, what equity capital markets transactions are and why companies undertake them. Future Oman Blog posts will explore these transactions in further detail.
What is an Equity Capital Markets Transaction?
An equity capital markets transaction is essentially a sale of stock – ownership shares – in a company to investors. Investors buy stock in a company in order to receive a share of the dividends that the company pays out to its shareholders periodically, or in order to make a profit by later selling the stock to another investor for a higher price.
Large investors may also buy stock in a company with the goal of influencing – or even gaining control over – the management of the company. An investor, or group of investors, that acquires a large percentage of the company’s (voting) stock can vote its representatives onto the company’s board of directors and influence the selection of the company’s management. (Note that some companies have multiple classes of stock, with some classes carrying voting rights, and other classes carrying only economic rights such as the right to receive dividends or the right to be bought out at a specified time and price.)
There are different varieties of equity capital markets transactions, categorised according to who is selling the shares (e.g., the company itself, or its existing shareholders) and to whom the shares are sold (e.g., to existing shareholders, to private institutional investors, or to the investing public).
However, the most well-known type of equity capital markets transaction is an initial public offering, or IPO. In an IPO, the company “lists” its shares – that is, makes them tradable on a stock exchange – and creates and sells additional shares of the company to the investing public.
Another common type of equity capital markets transaction is a rights offering. In a rights offering, a company offers each of its existing shareholders the right to buy additional shares in the company at a specified price within a specified time period. (See the May 2010 blog post on rights offerings and their use in meeting Oman’s increased capitalisation requirements.)
Why do Companies Engage in Equity Capital Markets Transactions?
One of the most fundamental needs of any company is capital. A company needs capital in order to function – to fund the costs of starting up the business; to provide a cushion for the company’s finances during temporary gaps in cash flows; and to fund expansion plans such as hiring more workers, building new facilities or making acquisitions.
Companies can raise capital either by selling stock in the company (i.e., issuing equity) or by borrowing money, typically from a bank (i.e., taking on debt). The advantage to taking on debt is that doing so does not dilute the ownership stakes of the company’s existing shareholders. However, the disadvantage to debt is that the company must typically make regular interest and principal payments on the debt, which can be problematic, for example, to young and growing companies that are investing heavily in their business but are not yet generating significant cash flows.
Issuing equity, while having the disadvantage of diluting the existing shareholders, has the advantage of giving the company financial flexibility – the company can wait to pay shareholders dividends until it has achieved its growth objectives and has begun to generate profits.
Tuesday, November 9, 2010
An Introduction to Equity Capital Markets Transactions
Thursday, November 4, 2010
Anticipated Rule Change Could Spur IPOs of Family Owned Businesses
Family owned businesses play a central role in the economies of both developed and developing regions around the globe. Economic studies estimate that 40 percent of large companies in the United States and Europe are family owned. In the Middle East this percentage is even greater: more than 80 percent of Middle Eastern companies are owned or operated by a single family. However, the ownership dynamics within controlling families is quite fluid. Experts believe that over the next 10 years companies worth approximately US$1 trillion will be passed from one generation to the next within business-owning families.
In Oman, the central role of family owned businesses is even more pronounced. The local press has cited HE Yahya Bin Said Al Jabri, Executive President of the MSM, in reporting that 95 percent of Omani companies are family owned.
For this reason, safeguarding the future of Oman’s family businesses has been a key priority in the Sultanate’s economic development model. Recent plans announced by the Ministry of Commerce and Industry to lower capital dilution requirements suggest that the most promising future path for some family owned businesses may lie in tapping Oman’s public capital markets. This path leads directly to augmented share capital and strengthened corporate governance mechanisms.
According to a report in the Times of Oman, the government is preparing a new set of amendments to the Commercial Law which will lower the minimum capital dilution from 40 percent to just over 20 percent for family owned businesses undertaking initial public offerings (IPOs) on the Muscat Securities Market (MSM). By lowering the percentage of equity in the company that the law requires a family to relinquish, family owned companies should be more likely to float of portion of their shareholdings on the MSM.
The goal of these amendments and the policy behind them is that promoting public flotation will (i) strengthen family owned businesses by allowing them access to public investment capital; (ii) refine their corporate governance practices through adherence to listing standards; and (iii) streamline access to professional strategic and management advice that could fill potential succession gaps.
While Oman’s family owned businesses are currently among the strongest and most respected enterprises in the Sultanate, some family businesses may face vulnerabilities over the longer term. A leading professional services firm recently released a survey indicating that relatively few family businesses in the region survive beyond the third generation. That report also highlighted that only 16 percent of family owned businesses have instituted a clearly defined succession plan.
Another potential area of vulnerability for family owned businesses is the need for larger amounts of capital to compete in an increasingly international, big-player dominated environment. Concurrently, the more restrictive credit environment in recent years and some high-profile defaults by family owned businesses has made borrowing necessary capital much more difficult. Loosening the requirements for tapping the equity markets should afford family owned businesses another source of much-needed funds.
Similarly, as companies in many sectors grow larger, they often need a more formalised corporate governance structure in order to function properly. Becoming a publicly listed company and adhering to the MSM’s corporate governance standards should help provide structure and discipline to family owned companies.
Nevertheless, many family businesses have balked at the prospect of raising funds through IPOs. The current 40 percent capital dilution requirement has meant that any firm listing shares has had to give up a substantial ownership stake to public investors. Given that family control has been a central driver of success for many companies, few family businesses have been willing to relinquish that much ownership and such a degree of control. Further, bringing in outside investors and managers has been thought to risk disrupting the company’s culture and shifting focus from long-term development to short-term profits. Consequently, only eight percent of family businesses in the Middle East are publicly traded.
By lowering the minimum capital dilution percentage, the authorities’ objective is to enable family owned companies to bring in outside investors without giving up as much control. This change should enable more family owned businesses in Oman to partake of the advantages of public flotation, while mitigating its risks.
