> Yes, duh, shareholder's equity remains constant. Shareholder DILUTION however is substantial. If they collect $1 million on a patent and issue a special dividend, I'm getting $1,000 instead of $100,000.
Clearly that payout was not priced into the original share price a the time of the capital raise so the new shareholders indeed got a great benefit at the expense of the old ones. At the moment of the transaction though the company went from being valued at 10$ to being valued at 100$ and for that to happen 90$ in cash was added to the company. The company could have turned around and used the same 90$ to buy back the same shares, which is why the transaction itself is neutral to shareholders. As the share price changes over time that may turn out to be a good or a bad idea.
At the moment of the transaction the books said the company had $90 more. But this does not matter much because shares were issued. In your imagined impossibly-simple company where market cap always equals cash on hand you can ignore this. In the real world, where the Earnings Per Share suddenly dropped by a factor of 100, perhaps you can imagine what will happen to the share price.
> In your imagined impossibly-simple company where market cap always equals cash on hand you can ignore this. In the real world, where the Earnings Per Share suddenly dropped by a factor of 100, perhaps you can imagine what will happen to the share price.
I never said market cap equals cash on hand, I'm talking about the normal valuation of the company. You have a company that is valued as a whole at 10$ by the market, not just cash, everything. You raise 90$ of capital by issuing 90 new shares, bringing the total up to 100 shares. That company is now worth the original 10$ plus the new 90$ that were put in. So it's worth 100$ in total and still 1$ per share. This is just the basic math of a capital raise or dividend/share buyback, there's no way around it.
You're confusing book value with market capitalization and shareholder's equity. In your magic company they're always identical. In the real world they never are.
More germane to HN: I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie? C'mon dude, admit you're wrong and move on.
> You're confusing book value with market capitalization and shareholder's equity. In your magic company they're always identical. In the real world they never are.
No I'm not. I've always referred to market cap, never accounting.
> I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie?
At the moment of the transaction yes, it's neutral. You could use the money you just raised to buy back the shares you just issued and be back to square one. That's all I am saying and it's a basic point taught in finance classes. In fact if what you suggest happened, and the share value tanked you'd have a perpetual money making machine. Just raise a bunch of capital, watch your stock tank, buy back shares and end up owning the whole company again plus some left over cash.
That doesn't mean that raising capital can't in the long term add or destroy value in a company, it's just not the transaction that does it, it's what you do or don't do with the money. If you use the money so that the total employed capital has a higher rate of return than just the original one, the value goes up, if not it goes down.
At the moment of the transaction I've also lost control of my company. So, hardly neutral. You keep ignoring dilution.
Also, you can't put the genie back in the bottle and buy back as you keep proposing. Because the market gets its say. Even if there were sufficient liquidity (shares available to purchase) there's no reason to expect the price would remain constant. And if I own 49.9% and BigCorp owns 50.1%, you can imagine that share price is not going to be "pedrocr math."
The world doesn't work like a basic bookkeeping class.
>Also, you can't put the genie back in the bottle and buy back as you keep proposing. Because the market gets its say. Even if there were sufficient liquidity (shares available to purchase) there's no reason to expect the price would remain constant.
Ok, so what price would the market set for a share in the company we discussed before? Assume the original 10$ valuation was fair and that there are now 100 shares after issuing 90$ worth of new ones. What's the new price? Above or below 1$?
The company previously had $0 in cash and 10 shares outstanding. Price was $1 at market close. They issue 90 shares. In your world these magically sell for $1 and you can just reverse the transaction and everything's back where you started. Neutral transaction!
However I went from holding 10% of a company to 1% of a company. If I was holding the stock because I thought the company would sell for 100x my investment -- $100 sale to a competitor and that I'd get $10 -- well, now I'm a 1% owner and it doesn't seem like they're going to sell. And I'm also not likely to be interested in holding a $1 stock for potential payoff of $1. (Since I know their burn rate is $10/month and now increasing, I don't give a damn about the cash on hand, never did.)
How about other scenarios?
a) The company announces it's entering a brand new, high-risk market and it's issuing 90 new shares on the open market. Market opens. What's the price?
b) Same as a) but company announces it will be suspending its dividend for 1 year. Market opens. What's the price?
c) Company announces that it entered into a strategic marketing agreement with Salesforce in exchange for a private issue of 90 shares at $1. Market opens. What's the price?
d) Company announces it granted 90 options to its new star CEO and issued 90 shares to cover. Market opens. What's the price?
e) Company announces it borrowed $90 from Warren Buffett at 10% interest and also gave him warrants for 90 shares at $1. Market opens. What's the price?
I think we've finally run out of reply depth (and you've run out of excuses) but the answer is: whatever the market decides. I've decided I want to sell my share. I now have to find someone willing to buy it. The spread alone guarantees I'm not going to get $1 for it.
> I've always referred to market cap, never accounting.
Not true. Which is why my next test question was going to be: the company went public at $10 last year before dropping to $1. So there's $190 in shareholder's equity against 100 shares and $90 cash on hand. Market opens, what's the price?
The core flaw of your argument is that the company can't control the market price. So there's no such thing as a "neutral market cap" transaction that changes the number of shares and you certainly can't "undo" it just because the numbers line up on the balance sheet. Specific to your core error, look up P/B ratio.
This whole thread apparently got linked from elsewhere and "We've limited requests for this url" is the error given. It's been fun guest lecturing here but I believe our overlords signaled that it's time to free up resources.
For anyone who's followed this long, read "Security Analysis" by Benjamin Graham for real insights instead of this incomplete thought experiment gone awry.
> I think we've finally run out of reply depth (and you've run out of excuses)
This is just rude as have been other posts. I haven't made any excuses, just arguments, which you have generally failed to engage and just thrown in more and more complexity into the mix.
> but the answer is: whatever the market decides. I've decided I want to sell my share. I now have to find someone willing to buy it. The spread alone guarantees I'm not going to get $1 for it.
Congratulations, you've found a way to extract free money from the market:
Cenario A: The transaction happens and the price is now above 1$. Great, there is now at least one person out there willing to buy a share for more than 1$. The initial shareholders should be ecstatic, just taking 90$ in exchange for 90 shares has allowed them to sell at least one share for more than 1$, whereas yesterday they could only get 1$ for them. Free money!
Cenario B: The transaction happens and the price is now below 1$. Great, there is now at least one of the shareholders (new or old) that is willing to sell one or more shares for less than 1$. Take 1$ from the 90$ you just raised and buy back the share. The remaining shareholders get to keep the change. Free money!
This doesn't mean that movements in price can't accompany capital raises. But what causes that movement isn't the transaction itself it's what it means. If a bank suddenly announces it has raised capital to cover larger than expected loan defaults the share price will decrease, because of the defaults not the capital raising transaction. If a manufacturing company announces it has raised capital to increase it's capacity in a booming market, the price may very well rise, not because of the capital raise, but because the expectation is that the company will be more profitable in the future.
The point, and this is my final comment, is that raising capital doesn't by itself change the share price of the company, but what the transaction implies may very well do. In the bank case the revelation of past problems lowers the price, in the manufacturing example the expectation of future profits does. Never the transaction itself which is the same in both cases.
> For anyone who's followed this long, read "Security Analysis" by Benjamin Graham for real insights instead of this incomplete thought experiment gone awry.
The book recommendation sounds great to me. I'd add the recommendation for a good finance textbook as it may help find some of those mispriced opportunities that Graham talks about. If you suddenly find a company that has just raised money being valued at less that previous_value+raised_money it may pay to look into if there's an opportunity or if there's a reason the price is lower (the expectation that the company will blow through the money without generating enough profit).
You're deflecting. Creating a bunch of scenarios where other things than just the capital raise happen that impact the valuation of the company. In the simple case of a 90$ capital raise in a company that was previously worth 10$. Nothing else changes. What happens to the price in your opinion?
Clearly that payout was not priced into the original share price a the time of the capital raise so the new shareholders indeed got a great benefit at the expense of the old ones. At the moment of the transaction though the company went from being valued at 10$ to being valued at 100$ and for that to happen 90$ in cash was added to the company. The company could have turned around and used the same 90$ to buy back the same shares, which is why the transaction itself is neutral to shareholders. As the share price changes over time that may turn out to be a good or a bad idea.