Assignment 1
SiriP
Chapter19-RaisingCapital.pptxFinancial Statements Analysis and Financial Models
Chapter 19
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Key Concepts and Skills
Describe the venture capital market and its role in financing new businesses
Articulate how securities are sold to the public, and the role of investment bankers
Explain initial public offerings, and the costs of going public
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Chapter Outline
19.1 Early-Stage Financing and Venture Capital
19.2 Selling Securities to the Public: The Basic Procedure
19.3 Alternative Issue Methods
19.4 Underwriters
19.5 IPOs and Underpricing
19.6 What CFOs Say about the IPO Process
19.7 SEOs and the Value of the Firm
19.8 The Cost of Issuing Securities
19.9 Rights
19.10 Dilution
19.11 Issuing Long-Term Debt
19.12 Shelf Registration
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19.1 early-stage financing and Venture Capital
Private financing for new, high risk businesses in exchange for stock
Individual investors (angels)
Venture capital firms
Venture Capital
Financial intermediaries that raise funds from outside investors
Play an active role
Look for an exit strategy
IPO, merger
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Exit Outcomes
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Venture Capital Stage Financing
Contingent upon specified goals at each stage
Stages
Seed Money
Prove concept or develop product
Start Up
Marketing and product development
First Round
Additional money to begin sales/manufacturing
Second Round
Working capital
Third Round
“Mezzanine” financing: firm is breaking even
Fourth
“Bridge” financing for firms likely to go public
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19.2 Selling Securities to the Public
Management obtains permission from the Board of Directors
Firm files a registration statement with the SEC
SEC examines the registration during a 20-day waiting period
Securities may not be sold during the waiting period
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Selling Securities to the Public (Continued)
A preliminary prospectus, called a red herring, is distributed during the waiting period
- If problems, the company amends the registration, and the waiting period starts over
Price per share determined on the effective date of the registration and the selling effort begins
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Tombstone
Investment banks in syndicate divided into brackets
Firms listed alphabetically within each bracket
“Pecking order”
Higher bracket = greater prestige
Underwriting success built on reputation
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19.3 Alternative Issue Methods
Public Issue
Registration with SEC required
General cash offer = offered to general public
Rights offer = offered only to current shareholders
IPO = Initial Public Offering = Unseasoned new issue
SEO = Seasoned Equity Offering
Private Issue
Sold to fewer than 35 investors
SEC registration not required
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Methods of Issuing New Securities
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19.4 Underwriters
Underwriting services:
Formulate method to issue securities
Price the securities
Sell the securities
Price stabilization by lead underwriter in the aftermarket
Syndicate = group of investment bankers that market the securities and share the risk associated with selling the issue
Spread = difference between what the syndicate pays the company and what the security sells for in the market
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Firm Commitment Underwriting
Issuer sells entire issue to underwriting syndicate
Syndicate resells issue to the public
Underwriter makes money on the spread between the price paid to the issuer and the price received from investors when the stock is sold
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
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Best Efforts Underwriting
Underwriter makes “best effort” to sell the securities at an agreed-upon offering price
Issuing company bears the risk of the issue not being sold
Offer may be pulled if not enough interest at the offer price
Company does not get the capital and they have still incurred substantial flotation costs
Not as common as it used to be
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Dutch or Uniform Price Auction
Buyers:
Bid a price and number of shares
Seller:
Work down the list of bidders
Determine the highest price at which they can sell the desired number of shares
All successful bidders pay the same price per share.
Encourages aggressive bidding
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Dutch or Uniform Price Auction Example
The company wants to sell 1,500 shares of stock.
The firm will sell 1,500 shares at $15 per share.
Bidders A, B, C, and D will get shares.
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Green Shoe Provision
“Overallotment Option”
Allows syndicate to purchase an additional 15% of the issue from the issuer
Allows the issue to be oversubscribed
Provides some protection for the lead underwriter as they perform their price stabilization function
In all IPO and SEO offerings but not in ordinary debt offerings
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Lockup Agreements
Not legally required but common
Restricts insiders from selling IPO shares for a specified time period
Common lockup period = 180 days
Stock price tends to drop when the lockup period expires due to market anticipation of additional shares hitting the Street
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19.5 IPOs and Underpricing
IPO pricing = very difficult
No current market price available
Dutch Auctions designed to eliminate first day IPO price “pop”
Underpricing causes the issuer to “leave money on the table”
Degree of underpricing varies over time
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IPO Underpricing Reasons
Underwriters want offerings to sell out
Reputation for successful IPOs is critical
Underpricing = insurance for underwriters
Oversubscription & allotment
“Winner’s Curse”
Smaller, riskier IPOs underprice to attract investors
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19.6 What CFOs Say About the IPO Process
Most Common Motivations for IPO:
Create Public Shares for Use in Acquisitions
Establish Market Value of the Firm
Enhance Reputation of Firm
Diversify Ownership and Owner Wealth
Most Common Reasons for Underpricing:
Compensate Investors for IPO Risk
Increase Post-Issue Trading Volume
Curry Favor with Institutional Investors
Increase Publicity on Opening Day
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Figures 19.7 and 19.8 provide more detail
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19.7 SEOs and The Value of the Firm
Stock prices tend to decline when new equity is issued
Managerial Information: If management believes equity is overvalued, they would choose to issue stock shares. Usually benefits current shareholders but new shareholders anticipate the superior information and bid down the price of the stock over time.
Debt usage: Issuing stock may indicate firm has too much debt and can not issue more debt
Issue costs
Issue costs for equity – direct and indirect - are significantly more than for debt
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19.8 The Cost of Issuing Securities
Total direct costs ≈ 10.4%
Direct costs very large, especially for issues < $10 million (25.22%)
Underpricing cost ≈ 19.3%
Average spread = 7%
Patterns:
Substantial economies of scale
Costs of selling debt < issuing equity
IPO costs > SEO costs
Straight bonds < Convertible bonds
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The Cost of Issuing Securities (continued)
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19.9 Rights
A rights offering is an issue of new common stock to existing shareholders
Shareholders are issued options to purchase specified number of shares at a fixed price and specified period of time
Rights (sometime called warrants) are often traded on exchanges and OTC
Efficient market theory dictates that there is no long term price advantage to acquiring shares via rights versus the open market
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Rights (Continued)
Shareholders can exercise their rights or sell them.
In either case, the shareholders neither win or lose.
If investors do not exercise or sell their rights, undersubscription can occur.
In such a case, underwriters will often take up the undersubscribed portion of the offering in exchange for a standby fee.
Most US new equity issues are sold without rights. Paradoxically, issuance costs would likely be less with rights.
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19.10 Dilution
Dilution is a loss in existing shareholder value caused by issuance of more stock
Three types of dilution are extant:
Dilution of percentage ownership
Dilution of market value
Dilution of Book Value and EPS
Dilution of percentage ownership can be overcome with rights
Dilution of value is not a result of expanded financing; it typically results from less than optimal use of the financing
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19.11 issuing Long-term Debt
Bonds – public issue of long-term debt
Private issues
Term loans
Direct business loans from commercial banks, insurance companies, etc.
Maturities 1 – 5 years
Repayable during the life of the loan
Private placements
Similar to term loans with longer maturity
Easier to renegotiate than public issues
Lower costs than public issues
No SEC registration
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19.12 Shelf Registration
SEC Rule 415
Permits firm to register a large issue with the SEC and sell it in small portions
Reduces flotation costs
Allows company more flexibility to raise money quickly
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Shelf Registration Requirements
Requirements
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 preceding three years
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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 are some of the characteristics of private placement debt?
What is shelf registration?
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BidderQuantity Bid
A500$20
B400 18
C250 16
D350 15
E200 12
BidderQuantity BidΣ Qty
A500$20 500
B400 18900
C250 161,150
D350 151,500
E200 121,700
NY NQ
| NYSE vs NASDAQ | ||
| NSYE | NASDAQ | |
| Founding date | May 17, 1792 | 1971 |
| Physical location/trading floor | Yes | No; computer network |
| Typcially referred to as: | "The listed market" | "The over-the-counter market" |
| Brokers | Yes; specialists | No |
| Dealers | Yes; specialists | Yes; market makers |
| Market maker per stock | 1 specialist | Multiple market makers |
| Electronic trading | SuperDOT System | All electronic |
| Signature Index | NYSE Composite | NASDAQ 100 |
| Listing requirements | Yes | NMS - Yes |
NY NQ 2
| NYSE vs NASDAQ | ||
| NSYE | NASDAQ | |
| Founding date | May 17, 1792 | 1971 |
| Physical location | Yes | No; computer network |
| Typcially referred to as: | "The listed market" | "The over-the-counter market" |
| Brokers | Yes; specialists | No |
| Dealers | Yes; specialists | Yes; market makers |
| Market maker per stock | 1 specialist | Multiple market makers |
| Electronic trading | SuperDOT System | All electronic |
| Signature Index | NYSE Composite | NASDAQ 100 |
| Listing requirements | Yes | NMS - Yes |
Dutch Auction
| Bidder | Quantity | Bid | |
| A | 500 | $20 | 500 |
| B | 400 | 18 | 900 |
| C | 250 | 16 | 1150 |
| D | 350 | 15 | 1500 |
| E | 200 | 12 | 1700 |
Dutch Auction (2)
| Bidder | Quantity | Bid | |
| A | 500 | $20 | 500 |
| B | 400 | 18 | 900 |
| C | 250 | 16 | 1,150 |
| D | 350 | 15 | 1,500 |
| E | 200 | 12 | 1,700 |
Orders
| Market | Limit | ||
| Buy | Price | Best price available | Best price; not > limit |
| Execution | Immediate | Only if limit met | |
| Sell | Price | Best price available | Best price; not < limit |
| Execution | Immediate | Only if limit met |
INDEXES
| Shares | Price per Share | ||||||
| Stock | Outstanding | BOY | EOY | PPS | |||
| ABC | 20 million | $50 | $52 | 4% | 20 | $1,000 | $1,040 |
| XYZ | 100 million | $25 | $30 | 20% | 100 | $2,500 | $3,000 |
| Price-Weighted Index | 38 | 41 | 9% | ||||
| Value-Weighted Index | 3500 | 4040 | 15% |
INDEXES (2)
| Shares | Price per Share | Total Market Value | ||||||
| Stock | Outstanding | BOY | EOY | BOY | EOY | |||
| ABC | 20 million | $50 | $52 | 4% | $1,000 | $1,040 | 4% | 20 |
| XYZ | 100 million | $25 | $30 | 20% | $2,500 | $3,000 | 20% | 100 |
| Price-Weighted Index | 38 | 41 | 9% | |||||
| Value-Weighted Index | 3500 | 4040 | 15% |
split
| Shares | Price per Share | ||
| Stock | Outstanding | EOD | BOD |
| ABC | 20 million | $50 | |
| 40 million | $25 | ||
| XYZ | 100 million | $25 | $30 |
| Price-Weighted Index | 37.50 | 37.50 | |
| Divisor | 2 | 1.4665 |
Reindex
| Base | Reindexed | |
| Index Value | Value | |
| Year 1 | 210 | 100.00 |
| Year 2 | 244 | 116.19 |
| Year 3 | 289 | 137.62 |
| Year 4 | 310 | 147.62 |
| Year 5 | 325 | 154.76 |
IPO
| COMPANY | INVESTMENT BANKER | ||
| Select Investment banker | |||
| Design the stock issue | |||
| Arrange underwriting | |||
| Prepare preliminary prospectus (red herring) | |||
| Submit prospectus to SEC | |||
| Circulate prospectus | |||
| SEC approves preliminary prospectus | |||
| Finalize prospectus | |||
| Tombstones placed | |||
| Sell shares |
NY NQ
| NYSE vs NASDAQ | ||
| NSYE | NASDAQ | |
| Founding date | May 17, 1792 | 1971 |
| Physical location/trading floor | Yes | No; computer network |
| Typcially referred to as: | "The listed market" | "The over-the-counter market" |
| Brokers | Yes; specialists | No |
| Dealers | Yes; specialists | Yes; market makers |
| Market maker per stock | 1 specialist | Multiple market makers |
| Electronic trading | SuperDOT System | All electronic |
| Signature Index | NYSE Composite | NASDAQ 100 |
| Listing requirements | Yes | NMS - Yes |
NY NQ 2
| NYSE vs NASDAQ | ||
| NSYE | NASDAQ | |
| Founding date | May 17, 1792 | 1971 |
| Physical location | Yes | No; computer network |
| Typcially referred to as: | "The listed market" | "The over-the-counter market" |
| Brokers | Yes; specialists | No |
| Dealers | Yes; specialists | Yes; market makers |
| Market maker per stock | 1 specialist | Multiple market makers |
| Electronic trading | SuperDOT System | All electronic |
| Signature Index | NYSE Composite | NASDAQ 100 |
| Listing requirements | Yes | NMS - Yes |
Dutch Auction
| Bidder | Quantity | Bid | |
| A | 500 | $20 | 500 |
| B | 400 | 18 | 900 |
| C | 250 | 16 | 1150 |
| D | 350 | 15 | 1500 |
| E | 200 | 12 | 1700 |
Dutch Auction (2)
| Bidder | Quantity | Bid | |
| A | 500 | $20 | 500 |
| B | 400 | 18 | 900 |
| C | 250 | 16 | 1,150 |
| D | 350 | 15 | 1,500 |
| E | 200 | 12 | 1,700 |
Orders
| Market | Limit | ||
| Buy | Price | Best price available | Best price; not > limit |
| Execution | Immediate | Only if limit met | |
| Sell | Price | Best price available | Best price; not < limit |
| Execution | Immediate | Only if limit met |
INDEXES
| Shares | Price per Share | ||||||
| Stock | Outstanding | BOY | EOY | PPS | |||
| ABC | 20 million | $50 | $52 | 4% | 20 | $1,000 | $1,040 |
| XYZ | 100 million | $25 | $30 | 20% | 100 | $2,500 | $3,000 |
| Price-Weighted Index | 38 | 41 | 9% | ||||
| Value-Weighted Index | 3500 | 4040 | 15% |
INDEXES (2)
| Shares | Price per Share | Total Market Value | ||||||
| Stock | Outstanding | BOY | EOY | BOY | EOY | |||
| ABC | 20 million | $50 | $52 | 4% | $1,000 | $1,040 | 4% | 20 |
| XYZ | 100 million | $25 | $30 | 20% | $2,500 | $3,000 | 20% | 100 |
| Price-Weighted Index | 38 | 41 | 9% | |||||
| Value-Weighted Index | 3500 | 4040 | 15% |
split
| Shares | Price per Share | ||
| Stock | Outstanding | EOD | BOD |
| ABC | 20 million | $50 | |
| 40 million | $25 | ||
| XYZ | 100 million | $25 | $30 |
| Price-Weighted Index | 37.50 | 37.50 | |
| Divisor | 2 | 1.4665 |
Reindex
| Base | Reindexed | |
| Index Value | Value | |
| Year 1 | 210 | 100.00 |
| Year 2 | 244 | 116.19 |
| Year 3 | 289 | 137.62 |
| Year 4 | 310 | 147.62 |
| Year 5 | 325 | 154.76 |
IPO
| COMPANY | INVESTMENT BANKER | ||
| Select Investment banker | |||
| Design the stock issue | |||
| Arrange underwriting | |||
| Prepare preliminary prospectus (red herring) | |||
| Submit prospectus to SEC | |||
| Circulate prospectus | |||
| SEC approves preliminary prospectus | |||
| Finalize prospectus | |||
| Tombstones placed | |||
| Sell shares |
