An FPO, or Follow-On Public Offer, is a financial event where a company that is already publicly listed offers additional shares to investors. This step comes after the company has already gone through the process of an Initial Public Offering (IPO), where it first became a publicly traded entity.

The Purpose of FPOs

A business often needs more money than it has in the bank to scale up, start new projects, or improve its services and products. A follow-up offering helps. Companies may launch an FPO to raise capital for growth and expansion.

For companies in debt distress, an FPO can save the day. Selling more shares through an FPO can help the company pay off debts and improve its finances. It's a strategic move, like taking a new path on a familiar road, to strengthen the company's finances.

Another reason for a follow-on offering might be corporate restructuring. For example, if a company wants to change its direction or significantly alter its business model, an FPO can fund this transformation.

How Does an FPO Work?

An FPO can be likened to a familiar tune, picking up where the original left off. After the fanfare of an IPO, where a company makes its market debut, a follow on investment offering represents a continued journey in the public eye, with investors already acquainted with the company's story.

Making the Announcement

Before any shares are sold, a company prepares to share its intent with the world. This starts with a formal announcement that outlines key details: how many shares will be on offer, the price range for these shares, and the reasons behind the FPO. This information reaches the public through detailed press releases and official filings with the stock exchanges. Transparency here is critical – it's about keeping the market informed and maintaining trust with potential and current investors.

Receiving the Approval

Like its IPO predecessor, an FPO requires approval from the market regulators. The company must submit detailed paperwork, which includes financial statements, plans for the use of the proceeds, and risks, ensuring everything is transparent and above board. The review process is thorough – regulators sift through the documents to confirm that the company stands on solid ground and that its follow on investment sticks to the strict rules of the financial markets.

Setting the Share Price

Pricing an FPO is more of an art than a science, but it's not guesswork. Since the company already has shares that are being traded, the FPO price is generally set in a range close to the current market price. It's a balancing act – set the price too high, and you may deter investors; too low, and the company might not raise the funds it needs. The price should reflect the company's value while offering an attractive entry point for follow on investment

Opening the Sale

Investors can buy after the stage is set. Company and underwriters may offer shares at a slightly lower price than current trading. Why? It attracts investors by saying, "Here's a deal you might not want to miss." Not only is selling shares significant, but so is building relationships with investors investing in the company's future.

Different Types of FPOs

We can categorize FPOs into two distinct types:

Diluted Follow-up Offering

A company looking to raise money by selling more shares should consider a diluted follow-on offering. A company doing this is usually thinking long-term, like lowering debt or restructuring its capital structure. Yes, more shares mean lower earnings per share, but if the company plays its cards right, the cash boost can be a game-changer, making the company and its shares stronger in the long run.

Non-Diluted Follow-up Offerings

However, non-diluted follow-on offerings involve founders or early backers selling their shares to other investors. This doesn't require new shares—the selling shareholders profit, not the company. Since the share count stays the same, EPS doesn't change. This follow-on offering is called a secondary market offering.

Impact of FPO on Share Prices

When a company announces a follow-on public offer, it's not uncommon to see its share price react. Often, this reaction includes a drop in the share price as investors anticipate the effects of new shares being added to the mix. This is known as dilution — where the value of existing shares might decrease because more shares are available after the FPO.

For instance, if a company with one million shares outstanding announces an FPO to issue another hundred thousand shares, the slice of the company that each share represents will naturally shrink. Dilution can lower share prices as investors adjust their valuations to the increased share count.

However, the story continues. If the market believes the follow-on investment will fund growth projects, it may improve. It’s like planting a seed; you put it in the ground not for what it is but for what it can become. If the seed (the follow-on investment) has the potential to grow into a strong tree (a profitable project), the initial worry about dilution starts to fade. Data shows that companies that use the proceeds of an FPO effectively can see their share prices rise by an average of 3-5% in the 12 to 18 months post-issue.

FPO vs IPO: Assessing the Investment Risk

The comparison between an FPO vs IPO often comes down to the level of risk and uncertainty involved. With an IPO, a company is making its market debut, which can be a wild ride. It's a first date: the company and investors are just getting to know each other, and many unknowns exist. Statistically speaking, IPOs are considered riskier, with post-IPO stocks being 28% more volatile on average than stocks of similar companies not newly listed.

On the other hand, an FPO is like renewing vows. The company and its investors are already in a relationship. There's a track record, previous earnings to scrutinize, and less guesswork about the company's operations. This prior knowledge can make an FPO a safer bet than an IPO.

Companies often go for a follow-on offering when they are more stable and have specific growth plans. It's not just about raising money but about making follow-up investments in the future. Research suggests that companies with steady revenue growth of at least 5-10% annually are more likely to launch an FPO as a strategic move to capitalize on their market position.