In chapter one, we discovered why you may want to buy a stock. However why does a company want to offer you that stock in the first place?

The healthiest reason for a company to offer shares, or equity in itself is to raise some money, or capital for expansion. Let's imagine that you and a friend have started a company selling a brand new Gin you have developed. You are equal partners, so each own 50%.

After a few years, your sales are thriving but it is costing you so much to pay someone else to bottle the Gin that it wipes out your profit margin. To build your own small bottling plant will cost you £1m, but it will save you £1m in costs every year. Sounds like a good plan. However the banks are being cautious and don't want to lend you the money when your business is only a few years old and not making any profits (because of the high bottling costs!).

Another friend has watched the company grow and wants to invest. (Think of the tv programme "Dragons Den" or "Shark Tank"). She offers you the £1m for 20% of the "equity" of the business, meaning you and your friend will only own 40% each now. However it will allow your company to grow AND to become profitable. So in theory you will own 40% of a company that will grow to be much more valuable in the future.

Would you rather own 50% of a company worth £5m or 40% of a company worth £10m?

This is a very simplified example of why some small and medium sized companies (SME's) may want to launch on to the stock market. What if they are trying to raise £100m rather than £1m? Then they need to market the offer to lots of different investors. This actually happened to the clothing retailer "SuperDry" back in 2009. Julian Dunkerton had grown the business from a market stall into a hugely popular High Street brand, selling more in the UK than Abercrombie & Fitch did. He wanted two things... to grow the business by opening stores all across Europe, and to expand the online offering. He also wanted to allow all his family, friends and suppliers to participate in the success of the company!

So in early 2009, an exhausted Dunkerton and his Finance director walked into my office at 5pm, with two huge bags of SuperDry clothing. It was their 8th investor meeting of the day, and they had carried these bags all around London! But the "launch' onto the stock market was only a few weeks away, so getting the story out there was of huge importance. As I was their last meeting of the day, and to give them a break from spouting the same script for an eighth time, I offered to change the meeting venue to the bar downstairs! They were extremely grateful!

This launch onto the market is called an IPO, or Initial Public Offering. It is the initial occasion that shares of this company will be offered and traded on a certain stock exchange, in this case the LSE (London Stock Exchange). Once shares are on the market, then its called "Secondary trading", because shares are being exchanged between investors, not between the company and investors.

To put some numbers on the example, Dunkerton was selling 32% of the business onto the stock market, and it was valued by experts at £400m. 68% of the shares remain tied up by the current owners, but the company will receive the cash for 32% of the £400m. So the company would receive around £128m. The shares were being offered at 500p per share (Or £5.00 each).

Downstairs in the bar, they explained to me the history, the growth plans and what they believed the potential of the brand was. I was secretly already a big fan, with a large amount of their t-shirts, joggers and shorts in my wardrobe. So I was an easy target. But it also sounded like a great investment. We went ahead and bought 1% of the shares that were being offered, to suddenly become a very interested party on how busy SuperDry stores were!

Within a year after the launch onto the market, the stock price went up from 500p a share, to 1800p a share!! The valuation of the company had risen from £400m to £1.5bln! Over the next three years, their growth was huge and opened up in major airports all across Europe, in part thanks to the £125m of capital they had raised to open new stores. The stake held by Dunkerton had actually grown in value despite him selling off 32% of the company to hundreds of new shareholders.

So in conclusion, if a company is launching on to the stock market for good reasons, then it can be a great time to invest. Deciding if it is for a good reason is up to you to do your research! (We will discover in later lessons what the bad reasons for issuing shares can be!).

An IPO can be much more volatile an investment than buying shares on the "secondary market', which is what 99% of investments and trades are. The early months of a companys shares trading are largely a price discovery period. Has this valuation by the "experts" been accurate? Is there demand for the shares at this level, or are buyers more aggressive than sellers at a much higher or lower level?

However this example was to explain why a company offers shares in itself at all. Now you understand why it is possible to buy a part ownership of the future earnings of a company instead of them keeping all the money to themselves!