If a company’s goal when raising capital is to create value for itself and its investors, why do stock prices decline when a firm does a capital raise?
Capital raising is one of the most reliable ways for companies to raise money and grow their business. Most companies raising capital are striving to fund operating costs or acquisitions, grow their customer bases, expand infrastructure, or invest in research and development.
However, raising capital can significantly affect the share price. This is commonly referred to as “dilution.” Dilution happens when new shares are issued, which raises the number of shares in your company. As a result, the earnings per share will decrease because earnings are usually spread over a bigger number of shares.
Of course, if a shareholder doesn’t participate in the capital raising, his or her share of the company will remain low, and of lower value.
How companies prevent dilution
Companies can prevent their shareholders from excessive dilution. Limiting the share capital that the company can raise through share placements to institutional investors is the most common approach to prevent dilution.
But it’s important to note that dilution isn’t necessarily a huge concern. The effect of capital raising depends on what the capital is being used for. For instance, if capital is raised to expand business operations, or to produce more products or services, the share price could likely rise in the long term – providing more value for shareholders.
For investors, while this isn’t financial advice, here’s a snapshot of recent capital raisings:
- Anthropic raised US$1.25 billion in its latest round. The AI company inked a deal with Amazon which allows the e-commerce titan to invest up to US$4 billion. The immediate investment of US$1.25 billion will see Anthropic use Amazon Web Services data centres to build, train and deploy its models.
- Sierra Space raised US$290 million. The round values the Colorado-based commercial space startup at US$5.3 billion. Sierra has been in development of the first commercial space station for five years and will use the new cash to forge new partnerships.
- Seattle-based biotech firm Avalyn Pharma raised US$175 million. The company plans to use the cash to continue developing its portfolio of inhalation therapies for lung disease.
And now that you’ve been caught up on why stock prices decline during capital raises, be sure to check out The Deal Room for the latest companies raising capital.
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