Add-On

What Is an Add-On?

Understanding an Add-On

Businesses sometimes need to raise capital to grow or protect what they already have. One way to generate extra funds is to create new shares of company stock and sell them on to investors.

The beauty of equity financing is that it enables companies to raise large sums of money without having to borrow it. Banks and bond investors might be willing to front the capital the company needs, yet both will expect to be paid back in full and charge a fee in the form of interest payments for their troubles.

Add-ons aren’t completely flawless, though. Issuing additional shares can reduce the current stock price and change the ownership percentage of existing investors. This common problem, known as dilution, generally doesn’t sit well with shareholders.

Important

Add-ons are useful mechanisms for raising capital but often agitate stockholders by diluting the value of existing shares.

Criticism of an Add-On

Add-ons are often looked at with a negative slant by investors and the finance community. When the number of shares outstanding increases, each existing stockholder ends up owning a smaller, or diluted, percentage of the company.

Suddenly, each share already in circulation becomes less valuable. Company profit now must be spread among a larger number of people, reducing earnings power.

Add-ons can result in control dilution, the loss of a controlling stake in an investment, earnings dilution, diminished earnings per share (EPS), and value dilution, subsequent declines in the stock price. In theory, shares will decline in value by a function of the original number of shares, current share price, amount of new offering and the new issue price.

Benefits of an Add-On

News that a company plans to engage in add-on financing almost always makes investors jittery. Still, some may recognize the merits of raising capital this way if the proceeds are used effectively to boost earnings over a long time frame. Reactions to add-ons often depend on how management plans to use the money, the amount it wants to raise, the depth of the discount it offers on the new shares and its track record of delivering on its objectives.

When a company uses the capital infusion to exploit untapped markets, it can create greater profit potential going forward. But that doesn't happen overnight. It can take months or even years for an investment to materialize into bottom line gains.