One of the biggest peer-to-peer lenders in the UK, Funding Circle, has announced plans to float on the stock market and raise £300m by selling shares in the company.
Funding Circle is a peer-to-peer lending website that connects up investors looking to grow their money to small and medium-sized businesses who are looking to borrow. Investors lend their money to those businesses in return for annual interest.
Peer-to-peer lenders don’t have the overheads of a traditional bank, so investors can get higher returns than what traditional savings accounts pay. Borrowers can also sometimes secure cheaper rates or get access to money if they’ve been turned down by a high-street lender.
Funding Circle has lent out £5bn to more than 50,000 small business across the world, and is now looking to raise money to expand its operations through an ‘initial public offering’.
But how do they work? And should you consider investing? Here’s what you need to know.
What is an initial public offering (IPO)?
An IPO gives privately-owned companies an opportunity to sell some or all of their stake to raise money to invest in the growth of the business. Sometimes it’s because the owners want to secure a windfall from the value of their business.
A company may have been built on the investments of private shareholders, but going public gives it access to capital from a much wider market of investors. That means bigger sums of money can be raised, and a successful stock market flotation is also a massive publicity boost.
In order to do this, the company lists its share on a stock exchange. The initial public offering allows private investors the chance to buy shares in that company when it first goes public.
The London Stock Exchange is the main venue for buying and selling shares in British companies. If a company is listed there, it’s a Public Limited Company (PLC) and its shares can be freely traded.
Shareholders receive dividends, a distribution of the profit made by the company each year. If the share price goes up, they may be able to sell on their shares at a profit at a later date.
How does an IPO work?
When a company decides it wants to go public, it has to set out a sales pitch to would-be investors. This comes in the form of a prospectus – often running to several hundred pages – which sets out the company’s plan for growth, what shareholders will get out of it and any risk factors that could lead to failure or underperformance.
At this stage, Funding Circle has published a registration document. This outlines the risks that the business faces, as well as the opportunities for growth in the market it operates in.
The sale of shares in a company will be arranged by an investment bank appointed as the bookrunners by the company. Their job is to drum up interest from institutional investors, such as investment funds, and sometimes from the public, too.
There may also be additional investment banks involved as sponsors and underwriters – which sometimes agree to buy any unsold shares from the company floating.
Funding Circle has announced that investment banks Merrill Lynch, Goldman Sachs and Morgan Stanley, as well as Numis Securities, have been approached about playing this role.
How is the share price set in an IPO?
Determining the issue price that investors will pay for shares at an IPO is a bit of a game. The company and the bookrunners have an interest in selling for as much as they can.
A higher price means more cash for the company, and more wealth for its founders and existing shareholders. But set the price too high, and the offer might not get the take-up it needs, or shares could face a price drop as soon as trading begins.
A price range will be published in the prospectus, with a typical margin of 20% between the minimum and maximum prices.
Investors can then place a bid for the number of shares they want to buy, including a price limit if they see fit. In the days and weeks until the flotation, bookrunners will be hoping to coax investors into upping their bids as demand builds.
How do I buy shares in a company through an IPO?
If you want to invest in an IPO, you’ll need to use a stock broker. The UK’s biggest broker, Hargreaves Lansdown, maintains a list of forthcoming public IPOs, or you can ask your broker to keep you in the loop.
While an IPO might be rumoured for months, you’ll usually have just a couple of weeks after the official announcement to apply for shares.
Brokers generally don’t charge commission on IPO share purchases as they get a payment from the bookrunners for participating. But once you’ve bought your shares, the broker’s usual charges apply.
The minimum investment is often around £1,000 to £2,000. Once you’ve submitted your application, it’s a case of waiting for the offer to close to find out the final price.
Should I invest through an IPO?
There is certainly appeal to investing in a company at the earliest stage, and staying with those shares as the company enjoys huge successes and its share price rockets.
However, there is no guarantee this will happen. Funding Circle is one of the best-known peer-to-peer lenders, but it is by no means a household name and therefore it can be difficult to know whether the company’s future prospects are sound.
In Funding Circle’s registration document, it goes to great lengths to describe the opportunity it sees for expanding its business to new geographic areas and increased demand for borrowing from small and medium-sized businesses, its target market.
It also, however, discloses that company has made net losses in the past year-and-a-half as it invests in technology. That should not necessarily set alarm bells ringing, as many emerging companies lose money as they seek to grow, but demonstrates that a company going public does not automatically mean immediate profit.
You should be fully prepared for your shares to potentially fall in value, as well as rise. Demand for share in an IPO is key to this. If there is not enough demand for shares in a company when it lists, the price is likely to fall below the amount you bought them for.