What are Floatation Costs in the Stock Market? Meaning and Components

Floatation costs refer to the expenses incurred by a company during the process of issuing new securities, such as stocks or bonds, to the public. These costs include underwriting fees, legal fees, registration fees, and other expenses associated with the process of going public or issuing new securities. Floatation costs can significantly impact the net proceeds a company receives from the sale of its securities and therefore are an important consideration in the pricing of the offer.

Components of Floatation Costs

Underwriting Fees

These are fees paid to the underwriters (financial institutions that manage the issuance and distribution of new securities) for their services. They represent a percentage of the gross proceeds of the securities sold.

Legal Fees

The process of issuing new securities involves a considerable amount of legal work, including the preparation and review of documents to ensure compliance with regulatory requirements. Legal fees are payments made to law firms for these services.

Registration Fees

Companies are required to register their securities with financial regulatory bodies, such as the Securities and Exchange Board of India (SEBI) in India, before they can be sold to the public. The fees associated with this registration process are included in floatation costs.

Printing and Distribution Costs

Issuing new securities involves printing prospectuses and other marketing materials, as well as distributing these materials to potential investors. The costs associated with these activities also contribute to the overall floatation costs.

Impact of Floatation Costs

Floatation costs reduce the total amount of capital a company can raise through the issuance of new securities. For example:

• If a company issues shares worth ₹100 million and incurs floatation costs of ₹5 million, the net proceeds from the share issuance would be ₹95 million.

This reduction in net proceeds is an essential factor for companies to consider when deciding on the pricing of new securities and the total amount to be raised through an issuance.

How Companies Deal with Floatation Costs

Some of the strategies companies may use to manage floatation costs include:

• Negotiating with Underwriters: Companies might negotiate lower underwriting fees or opt for a competitive bidding process to reduce costs.
• Timing the Market: Companies could choose to issue new securities when market conditions are favorable, potentially reducing the percentage of floatation costs relative to the total proceeds.

Conclusion

Floatation costs are a significant consideration for companies looking to raise capital through the issuance of new securities. These costs can impact the net amount of funds raised and thus affect the company's financial planning and strategy. Understanding and managing floatation costs effectively is crucial for maximizing the capital raised in public offerings and ensuring the long-term financial health of the company.