16
Raising Capital
0
Key Concepts and Skills
➢ Understand the venture capital market and
its role in financing new businesses
➢ Understand how securities are sold to the
public and the role of investment bankers
➢ Understand initial public offerings and the
costs of going public
1
Venture Capital
➢ Private financing for relatively new businesses in
bd09310_
exchange for stock
➢ Usually entails some hands-on guidance
➢ The ultimate goal is usually to take the company
public and the VC will benefit from the capital
raised in the IPO
➢ Many VC firms are formed from a group of
investors that pool capital and then have
partners in the firm decide which companies will
receive financing
➢ Some large corporations have a VC division
2
Venture Capital
➢ To limit their risk, VCs generally provide
financing in stages.
➢ Venture capital firms often specialize in
different stages
⚫ Some specialize in very early “seed money”
or ground floor financing
⚫ Some specialize in the so called mezzanine
level financing where mezzanine level refers
to the level just above the ground floor
3
Choosing a Venture Capitalist
➢ Look for financial strength will it have more
finance it different stages
a
➢ Choose a VC that has a management
involvement day to day operation of monthly reports only
in
style that is compatible with your own
successed in other
➢ Obtain and check references
➢ What contacts does the VC have?
business relationship
➢ What is the exit strategy? bd09310_
short term investor
not long term
eat when there is other
opportunities
4
Selling Securities to the Public
go to primary market before
L ➢ Management must obtain permission from the Board of
Directors do
Security
prepare Ehsaan
2 ➢ Firm must file a registration statement with the SEC
➢ SEC examines the registration during a 20-day waiting
period cannot sell
any shares legalf
⚫ A preliminary prospectus, called a red herring, is
distributed during the waiting period
⚫ If there are problems the company is allowed to
amend the registration and the waiting period starts
over
➢ Securities may not be sold during the waiting period
➢ The price is determined on the effective date of the
registration
5
Sell maximum shares in the market the remaining return
Table 16.1 - I
companyand
sell atthe
men
mma.is
price
if he cannot
sell all ofthem
highest
VISKJIBI
to the existing
shareholders
6
Table 16.1 - II
hard for companies
money
savetime
company must meet requirements
praetan stabilityf
to
nham
7
III Jg
Underwriters investment bank
➢ Services provided by underwriters
⚫ Formulate method used to issue securities
⚫ Price the securities
⚫ Sell the securities
⚫ Price stabilization by lead underwriter
➢ Syndicate – group of investment bankers that
market the securities and share the risk bonds
forgovernment
one
bank
associated with selling the issue is not enough
➢ Spread – difference between what the syndicate
pays the company and what the security sells for
in the market 8
Firm Commitment Underwriting
Company
➢ Issuer sells entire issue to underwriting syndicate
➢ The syndicate then resells the issue to the public
selling purchasing
➢ The underwriter makes money on the spread
between the price paid to the issuer and the price
received from investors when the stock is sold
➢ The syndicate bears the risk of not being able to sell
the entire issue for more than the cost
➢ Most common type of underwriting in the United
States
➢ How risky is firm commitment underwriting in
Oman? Why?
9
Best Efforts Underwriting
maximum he can
➢ Underwriter must make their “best effort” to sell
the securities at an agreed-upon offering price
➢ The company bears the risk of the issue not
being sold unsold shares
➢ The offer may be pulled if there is not enough
interest at the offer price and the company does
not get the capital and they have still incurred
substantial flotation costs
➢ Not as common as it used to be
10
Dutch Auction Underwriting
uniform price method
➢ Underwriter accepts a series of bids that include number
of shares and price per share highest price maximum
shares
➢ The price that everyone pays is the highest price that will
result in all shares being sold
➢ There is an incentive to bid high to make sure you get in
on the auction but knowing that you will probably pay a
lower price than you bid
➢ The Treasury has used Dutch auctions for years
➢ Google was the first large Dutch auction IPO
11
➢ Example: Assume a firm wants to sell 400 shares
t to public.
Determine the highest price using Dutch Auction Underwriting
method.
➢ At $12, there are bids for 500 shares superior to 400 shares the firm
would sell. There are a sort of allocation ratio of shares offered to
shares bid at the offer price:
number of shares thecompany sell
Allocation ratio = 400/500 =0.8
number the market demand
What will
happen for
theremaining
T O shares
302
400 shares
➢ Total shares sold =80+80+160+80 = 400 shares 12
73 51
Green Shoes 460
shares 2
6
➢ Green Shoe provision 400 Goshares
⚫ Allows syndicate to purchase an additional 15%
of the issue from the issuer at the offering price
⚫ The stated reason is to cover access demand
and oversubscriptions
⚫ Provides some protection for the lead underwriter
as it allows the underwriter to buy shares from
the issuer at the offering price and immediately
resell the shares to the public at the market price
for 30 days
cost for the issue boy 6
y y
13
underpriced shares
Lockups when firstly sold
➢ Lockup agreements
⚫ Restriction on insiders that prevents them
from selling their shares of an IPO for a
stock price will go
specified time period versupply
⚫ The lockup period is commonly 180 days
⚫ The stock price tends to drop when the
lockup period expires due to market
anticipation of additional shares hitting the
street
14
hard to identify P shares difficult find bunchmark
to
the shares are underpriced
IPO Underpricing
➢ InitialPublic Offering – IPO
➢ May be difficult to price an IPO because
there isn’t a current market price available
➢ Underwriters want to ensure that their
clients earn a good return on IPOs on
average
➢ Underpricing causes the issuer to “leave
money on the table”
15
Figure 16.2
1
0
00
negative retur
0
16
Figure 16.3
Issue shares if the
market will observe
theres
0
0 0
companies
will not
gofor IPO
17
Work the Web Example
➢ How have recent IPOs done?
➢ Click on the web surfer to go to the
Bloomberg site and follow the “IPO
Center” link
⚫ How many companies have gone public in the
last week?
⚫ How have companies that went public three
months ago done? What about six months
Web surfer
ago?
18
New Equity Issues and Price
➢ Stock prices tend to decline when new equity is
So
issued
➢ Possible explanations for this phenomenon
whenthemanagers
⚫ Signaling and managerial information knowthat theshares
are overpriced he will
try to sell to his own
⚫ Signaling and debt usage
why interesting iestite
do is
⚫ Issue costs
borrowing reserve is weak not able to
get the hint from market
➢ Since the drop in price can be significant and much
of the drop may be attributable to negative signals, it
is important for management to understand the
signals that are being sent and try to reduce the
effect when possible
19
direct
Issuance Costs indirect
gain for
i the underwriter
➢ Spread
G because the underwriter sell at a higherprice
➢ Other direct expenses – legal fees, filing fees, etc.
➢ Indirect expenses – opportunity costs, i.e.,
management time spent working on issue
not focus on to
day
➢ day operations
Abnormal returns – price drop on existing stock
➢ Underpricing – below market issue price on IPOs
15
➢ Green Shoe option – cost of additional shares that
the syndicate can purchase after the issue has
gone to market 26 Is
no benchmark
to attract customers
20
Rights Offerings: Basic
Concepts
➢ Issue of common stock offered to existing
shareholders to avoid conflict at cataldilougen
interest Codecrease in ownership
➢ Allows current shareholders to avoid the dilution that
can occur with a new stock issue portion
old price Bryce
➢ “Rights” are given to the shareholders
he have to buy rights for extra sharesabove
⚫ Specify number of shares that can be purchased
his her
⚫ Specify purchase price right
⚫ Specify time frame
➢ Rights may be traded OTC or on an exchange
Right 100 share from other shareholders
to purchase 2
wants buy 100right to purchase
21
the additional shares
The Value of a Right
➢ The price specified in a rights offering is
generally less than the current market
price
➢ The share price will adjust based on the
number of new shares issued
➢ The value of the right is the difference
between the old share price and the “new”
share price value of right old p new p
cash ms
cash equilment 22
Rights Offering Example
w
➢ Suppose a company wants to raise $10 million. The
o
subscription price is $20 and the current stock price is $25. The
firm currently has 5,000,000 shares outstanding.
o
⚫ How many shares have to be issued?
⚫ How many rights will it take to purchase one share?
⚫ What is the value of a right?
shares 1 newshare
➢
Tes share
Shares issued = funds to be raised/Subscription price= 10,000,000/20 = 500,000
➢ Rights to buy one share = Old shares/New shares= 5,000,000/500,000 = 10
Rights
➢ Total investment = 10*25 + 20 = 270 (total cost of buying 1 new share) to
purchase
➢ Price per share = 270 / 11 = 24.55 Tshares one new
share
➢
➢
00
Value of a right = 25 – 24.55 = .45 1right 0.45
Buy 10 rights = .45*10 = 4.50 + 20 = 24.50 difference due to rounding
the existing shareholders I share 10 rights 8.4.5
to buy 1 new share
23
More on Rights Offerings
5509N
➢ Ex-rights – the price of the stock will drop by the
value of the right on the day that the stock no
longer carries the “right”
➢ Standby underwriting – underwriter agrees to
buy any shares that are not purchased through
the rights offering
➢ Stockholders can either exercise their rights or
sell them – they are not hurt by the rights
offering either way
➢ Rights offerings are generally cheaper, yet they
are much less common than general cash offers
in the U.S.
advan avoid capital dillosion decrease in ownership
of existing shareholds 24
Dilution
➢ Dilution
is a loss in value for existing
shareholders
⚫ Percentage ownership – shares sold to the
general public without a rights offering
⚫ Market value – firm accepts negative NPV
projects
⚫ Book value and EPS – occurs when market-
to-book value is less than one
25
Types of Long-term Debt
➢ Bonds – public issue of long-term debt
➢ Private issues I companie
governments
⚫ Term loans
• Direct business loans from commercial banks,
insurance companies, etc.
Principle interest
• Maturities 1 – 5 years during the period
• Repayable during life of the loan
⚫ Private placements above 5 years
• Similar to term loans with longer maturity
⚫ Easier to renegotiate than public issues
⚫ Lower costs than public issues
expensive to firms to issue it 26
1 just w 18 more effective
L Twos 11m
Shelf Registration at 4K
I
JW.TW
➢ Permits a corporation to register a large issue with the
SEC and sell it in small portions
➢ Reduces the flotation costs of registration
➢ Allows the company more flexibility to raise money
quickly
➢ Requirements have to meet all
they
⚫ Company must be rated investment grade
⚫ Cannot have defaulted on debt within last three
years
⚫ Market value of stock must be greater than $150
million
⚫ No violations of the Securities Act of 1934 in the last
three years
27
Quick Quiz
➢ What is venture capital and what types of firms receive it?
➢ What are some of the important services provided by
underwriters?
➢ What type of underwriting is the most common in the United
States and how does it work?
➢ What is IPO underpricing and why might it persist?
➢ What are some of the costs associated with issuing
securities?
➢ What is a rights offering and how do you value a right?
➢ What are some of the characteristics of private placement
debt?
➢ What is shelf registration?
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Comprehensive Problem
➢ A company wants to raise $20 million. The subscription price is
$40 and the current stock price is $50. The firm currently has
o
5,000,000 shares outstanding.
o
⚫ How many shares have to be issued?
⚫ How many rights will it take to purchase one share?
⚫ What is the value of a right?
funds subscribtion
➢ Shares issued = $20,000,000/40 = 500,000
➢ Cooldsharenewshares
Rights to buy one share = 5,000,000/500,000 = 10
➢ Total investment = 10*50 + 40 = 540 10 oldshares Inew shares
➢ Price per share = 540 / 11 = 49.09
Value of a right =oldp_
➢
0
50 – 49.09 = .91 49.1
➢ Insants
Buy 10 rights = 1.01*10 = 10.10 + 40 subscription price = mar
equal the share price
1
(difference is due to rounding)
50.10, which
49.1
21 29
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End of Chapter
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