Going public. (Initial Public Offering).

Let's suppose you've found a way of growing truffles indoors. The truffle we're talking about here is an edible fungus that is highly prized by gourmets. Usually, they grow wild on the roots of oak trees and are so rare, tasty, and expensive they are often referred to as "Black Pearls."

You have discovered a method of cultivating these tricky little blighters under controlled conditions. In keeping with the best traditions of business start-ups, your first truffles are grown in your garage. Your product is selling well to local restaurants, but, your company is a very small private business.

With the help of a lawyer, you've set it up as a private corporation. There are two shares, each with a value of $1--you have one share, your sister has the other. The company is called Black Pearl Limited.

Your business does quite well and soon you need bigger premises and some new machinery. But, you don't have $10,000,000 to buy a plant and machinery and the bank won't lend it to you. Even your rich Uncle George won't return your phone calls. What to do? Go public; sell shares in your business to raise the capital you need to expand.

First, you need an underwriter. This will be a financial services company, preferably with a solid reputation. The underwriter does all the heavy lifting. It publishes what's called a prospectus. This is a glossy publication that outlines the history of Black Pearl Limited--what it does, where it plans to go. The prospectus puts as rosy a glow as possible on the company's financial prospects.

You'll also need a board of directors. This should be made up of people with a solid grounding in business and a reputation for integrity. An ex-provincial premier is good to have on the board, as long as it's not one who has left office because of a scandal.

The prospectus is circulated to investors and stockbrokers to create interest in the company. The underwriter establishes a price for the shares, say $5 a piece, and issues two million of them. In most cases, the founders of the company set a bunch of shares aside for themselves. The underwriter buys the remaining shares for resale to its clients; this is called a "bought deal." The clients are usually well-heeled investors and other financial institutions such as banks, stockbrokers, insurance companies, and the like. This is called the primary market and it's the only place where money from the sale of Black Pearl shares actually goes to Black Pearl. The underwriter hands over the ten million dollars from the sale of the shares, minus the fees for arranging all of this. Also, deducted will be the value of the shares held by your sister and yourself. With this money you can build a bigger truffle-growing factory.

The shares are then offered for sale on the open market in what is called an Initial Public Offering (IPO). It's not likely our little outfit will be listed on a major stock exchange. Such small start-ups trade on what is called the Over the Counter (OTC) market.

If we go for a much bigger launch and Black Pearl is seen as a good investment its shares might be listed on a major stock exchange. The stock exchange is a secondary market, it's where Black Pearl shares are bought and sold by anyone with an inclination to trade in Black Pearl shares. None of the money from transactions in the secondary market goes to Black Pearl.

The value of the shares in the stock exchange will go up or down depending on the demand for them. The demand will depend on how well Black Pearl performs. If the expanded company does well, makes big profits, and hands out a honking dividend to its shareholders people will want to own the shares. If the company does poorly, shareholders will want to dump their piece of Black Pearl.

If there are more buyers than sellers, the price of Black Pearl shares will go up, and vice versa. For this example (this is, after all, fiction), we'll assume the price of Black Pearl shares goes up to $7 apiece. Why don't we just issue another two million and stick $14 million in the bank? That might not be such a good idea. Any profits will now have to be shared out among twice the number of shares, meaning each share will earn only half the dividend it did before. This is called "earnings dilution" and will probably make the shares less attractive to investors and drive the price down.

FACT FILE

Most stock exchanges are auction markets, in which prices are determined by competitive bidding.

Websites

Investor Education

Fund--http://www.investoreducationfund.ca/taking_future_1.html

Investor Learning

Centre of Canada--http://www.investorlearning.ca/home/en-ca/index.html

THE BROKER

Being a stockbroker used to be prestigious. However, the scandals of the 1990s have dragged the whole profession into disrepute, even though the scares were only pulled by a corrupt minority.

Stockbrokers must be registered with the exchange in which they trade. Most brokers belong to brokerage firms. Brokerage firms maintain staffs of many brokers, each of whom has experience in the trading of securities of certain companies or those of particular economic sectors, mining, utilities, or technology businesses, for instance. Brokerage firms also tend to trade in the stocks of specific companies; they buy and hold stocks in certain companies in their own accounts.

To become a member of an exchange, a firm must register its brokers by buying seats for them. This is not a place to sit down but simply the right to trade on an exchange. Member firms have the right to vote on exchange policy and must also arbitrate in disputes among customers, In larger exchanges, seats may sell for several hundreds of thousands of dollars. Exchanges attract larger or smaller brokerage firms depending on how high or low their fees are.

SPLITTING

A company that has good products and is well managed generally sees the price of its stock rise steadily. What started out at $10 per share becomes $20. Then, it's $30, $40, $50. Now, the stock is getting out of the price range a small investor can afford.

One strategy companies use to make their shares more appealing to a wider market is to split the stock. Suppose you own 100 shares that are trading at $60 each. If the stock splits in a two-for-one deal, you will now own 200 shares with a value of $30 each. If the pre-split stock was paying a dividend of $1 per share, it will now pay a dividend of 50 cents a share. One advantage of this is that it creates a favourable buzz about the company and that helps to keep pushing the price of its shares up.