Flotation Cost

Flotation cost is the total expense a company pays to issue new securities to the public. It covers underwriting fees, legal and accounting costs, SEC registration fees, printing, and marketing. When you sell new stock or bonds, you do not keep every dollar investors pay. The gap between what investors pay and what your company actually receives is the flotation cost. It reduces the net capital raised and raises the effective cost of that capital above whatever rate you quoted.

If your stock sells at $25 per share and flotation costs consume $1.25, you net only $23.75. Your cost of equity calculation has to reflect the actual proceeds, not the offer price.

Typical Flotation Cost Ranges by Security Type

Costs vary based on security type, issuer size, and market conditions. Larger, better-known issuers pay less proportionally because fixed expenses are spread across more shares or a larger principal.

• Initial public offerings: Total flotation costs including underwriting spread typically run 5% to 10% of gross proceeds. Small-cap IPOs land at the high end.
• Follow-on equity offerings: Typically 3% to 5% because the company already has a trading history.
• Investment-grade bond issuances: Typically 0.5% to 2% depending on maturity and deal size.
• High-yield bond issuances: Typically 2% to 4% because of more intensive underwriting diligence.

How Flotation Costs Enter the Cost of Capital

Two approaches exist for incorporating flotation costs into your weighted average cost of capital. Both are conceptually valid. The choice affects how you allocate the cost across projects.

The first approach adjusts the cost of equity directly by dividing the expected dividend by the net price after flotation rather than the full market price. A stock expected to pay a $2 dividend growing at 5% annually and priced at $40 with 5% flotation costs uses a net price of $38. The cost of equity becomes $2 divided by $38 plus 5%, rather than $2 divided by $40 plus 5%.

The second approach treats flotation costs as an upfront cash outflow that you subtract from the net present value of the investment directly. Most corporate finance professionals favor this approach because it treats flotation costs as a project-level expense rather than a permanent change to the firm's baseline cost of capital.

Flotation Costs Raise the Hurdle for External Equity

High flotation costs widen the gap between your cost of retained earnings and your cost of new equity. Projects that cleared the hurdle rate using internally generated funds may no longer be economically viable when funded with new shares, because the one-time flotation cost must also be recovered.

This is one concrete reason mature companies prefer retained earnings over new equity for capital investment. Internal funds carry no flotation cost. New equity always does.

Sources

• https://www.sec.gov/cgi-bin/browse-edgar
• https://www.sifma.org/resources/research/us-bond-market-statistics/