Finance HW
Sam's.Tech
chap19raisingcapital-2.pptxRaising Capital
Venture Capital
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
Venture Capital Fund
(Limited Partnerships)
Limited Partners
(Pension Funds, Educational Endowments, Foundations, Insurance Companies, Wealthy Individuals)
General Partners
(“Venture Capitalists”)
raise a fund of a given size from the Limited Partners by convincing them that the GPs have a unique strategy or expertise in a particular sector or sectors of the market.
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How Venture Capital Works?
Look for deals: Private financing for relatively new businesses in exchange for equity
Management investment: Usually entails some hands-on guidance
Harvest: The company should have an “exit” strategy
Sell the company – VC benefits from proceeds from sale
Facebook: $19 billion acquisition of WhatsApp
Google: $3.2 billion on Nest Labs
Apple: $3 billion for Beats
Take the company public – VC benefits from IPO
http:// www.bloomberg.com /news/articles/2015-04-15/ xiaomi -backed- ninebot -targets-u-s- ipo -after- segway -acquisition
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http :// www.bloomberg.com /news/videos/2015-02-18/venture-capital-boom-highest-since-2000-tech-bust
In 2014: about 50% increase over 2013
Top industries:
Software
media
entertainment
biotechnology
consumer products and services
medical devices and equipment
IT services
Top VC investments in Maryland
Woodbrook Capital Inc., Towson, Md., 2013 Md. investments: $27.82 million
J. H. Whitney & Co. LLC, New Canaan, Conn., 2013 Md. investments: $$50 million
Third Security LLC, Radford, Va, 2013 Md. investments: $51.4 million
Sandbox Industries LLC, Chicago, Ill., 2013 Md. investments: $55.81 million
Oak Investment Partners, Greenwich, Conn., 2013 Md. investments: $75 million
Kinetic Ventures : An example
http:// www.kineticventures.com / about.html
Prior Investment:
4/03/2012: Aztek Networks (Acquired by GENBAND)
Genband : IP infrastructure and application provider
Aztek Networks: a leading supplier of switch consolidation and network migration solutions.
Prior to the acquisition, privately held Aztek Networks was backed by a number of notable VC investors, including Verizon Investments LLC.. The Company was founded in 1982 as Aztek Engineering and is based in Boulder, Colo.
State support Angel / Venture Financing in Maryland
state supported investment programs
http :// business.maryland.gov / mvf
http :// www.bio.maryland.gov /funding/pages/angel- vc.aspx
Choosing a Venture Capitalist
Look for financial strength
Choose a VC that has a management style that is compatible with your own
Obtain and check references
What contacts does the VC have?
What is the exit strategy?
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https:// www.youtube.com / watch?v = OkdOEPucfGs
http:// hunterwalk.com /2014/01/05/how- vcs -spend-their-time-err-how-this- vc -spends-his-time /
50% Evaluate New Opportunities
35% Work With Existing Investments
10% General Relationship Building
5% Fund Operations
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Should The Company Go Public?
Advantages:
Reach out to investors at large when cost of privately held capital is too high
Gain higher profiles
Allow founders to cash out
Disadvantages:
High costs
one-time IPO cost
ongoing cost related to being a publicly traded company
Selling Securities to the Public
1. Management must obtain permission from the Board of Directors
2. Firm must file a registration statement with the SEC
3. The SEC examines the registration during a 20-day waiting period
A preliminary prospectus, also 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.
4. Securities may not be sold during the waiting period.
5. The price is determined on the effective date of the registration
What advisors should the firm hire ?
Consultants
Auditors
Lawyers
Underwriters:
Formulate method used to issue securities
Price the securities
Sell the securities
Price stabilization by lead underwriter
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Underwriters
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 initially in the market
Recent years, 7% spread
http:// www.washingtonpost.com /business/ goldman - sachs -says- 1q -net-income-rises/2015/04/16/ de07b59c-e42f-11e4-ae0f-f8c46aa8c3a4_story.html
https:// www.youtube.com/watch?v=gRSJG6QB03I
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Firm Commitment Underwriting
Issuer sells entire issue to underwriting syndicate
The syndicate then resells the issue to the public
The syndicate bears the risk of not being able to sell the entire issue for more than the cost
This is the most common type of underwriting in the United States
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
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Green Shoe Provision
Allows the syndicate to purchase an additional 15% of the issue from the issuer
Allows the issue to be oversubscribed
Provides some protection for the underwriters as they perform their price stabilization function
Lockup Agreements
Restriction on insiders that prevents them from selling their shares of an IPO for a specified time period
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
Conflicts
Between the company and the investment bank
Pricing is just simple in theory, but there exit big conflicts:
company wants the offer price to be high to generate more cash
investment banks is afraid of being stuck with over-valued stock
Best Efforts Underwriting
More common in volatile markets
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
The offer may be pulled if there is not enough interest at the offer price. In this case, the company does not get the capital, and they have still incurred substantial flotation costs
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Dutch Auction Underwriting
Underwriter accepts a series of bids that include number of shares and price per share
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 US Treasury has used Dutch auctions for years!)
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Dutch Auction Underwriting: Rial Company
| Bidder | Quantity | Price |
| A | 100 shares | $16 |
| B | 100 shares | 14 |
| C | 200 shares | 12 |
| D | 100 shares | 12 |
| E | 200 shares | 10 |
Rial Company wants to sell 400 shares to the public. The company receives five bids as follows:
What is the final offer price in the IPO?
Who will receive shares? How much?
After the auction…
| Bidder | Quantity | Price |
| A | 80 shares | $12 |
| B | 80 shares | 12 |
| C | 160 shares | 12 |
| D | 80 shares | 12 |
Background
Dutch Auction: consistent with its auction-based business model (was supposed to avoid a POP)
Aug 14, 2004: completed the auction at $85 for 19.6 million shares
Aug 15, 2004: the stock closed at $100.34 on the first day, a run-up of 18%
Was it a good IPO?
How does the market react to IPO’s?
The short-run IPO underpricing
The long-run IPO underperformance
Underpricing
from 1975-2012, the average 1st day return is 21.7%
to issuing company, these returns “leave money on the table”
IPOs on average provide large first-day returns, their long-term returns over the following 3 years are below average.
In sum, the offering price appears to be too low, but the 1st day run-up is generally too high.
Highest 1st day IPO returns in 2013
| Rank | Company | Offering Price ($) | 1st-day Price($) | Gain |
| 1 | Sprouts Farmers Market Inc. | 18.00 | 40.11 | 123% |
| 2 | Noodles & Company | 18.00 | 36.75 | 104% |
| 3 | Benefitfocus Inc. | 26.50 | 53.55 | 102% |
| 4 | The Container Store Group Inc. | 18.00 | 36.20 | 101% |
| 5 | Foundation Medicine Inc. | 18.00 | 35.35 | 96% |
| 6 | Rocket Fuel Inc. | 29.00 | 56.10 | 93% |
| 7 | China Commercial Credit Inc. | 6.50 | 12.45 | 92% |
| 8 | Qunar Cayman Islands Limited | 15.00 | 28.40 | 89% |
| 9 | FireEye Inc. | 20.00 | 36.00 | 80% |
| 10 | Marketo Inc. | 13.00 | 23.10 | 78% |
Average 1st day return: 21.2% in 2013
The 1st day of Trading: Facebook
Facebook:
broke even on its 1st day, May 18,2012: offering price at $38, opened at $42.05, and closed at $38.23
(would have fallen if the underwriters had not created artificial demand by purchasing the falling shares)
on the 2nd day, fell by 11%
What happened?
Facebook’s amended filings in the week before its IPO may have contributed to its weak first-day performance
Facebook’s amended filings
May 15, 2012: Facebook increased the range of price from $28-$35 to $34-$38.
May 16, 2012: Facebook increased 84 million shares to be sold by insiders
May 16, 2012: offer price $38
Supply vs demand:
Increases in the offer price and the number of shares to be sold, especially 57% of total shares to be sold are from insiders (Google had about 28%, 0% for Amazon)
potentially drove down demand for the stock
Twitter IPO
Offer price: $26
Opened on Nov 7 at $45.10
Closed at $44.90
Issuance Costs
Spread
Other direct expenses – legal fees, filing fees, etc.
Indirect expenses – opportunity costs, i.e., management time spent working on issue
Issuance Costs: More
Abnormal returns – price drop on existing stock
Underpricing – below market issue price on IPOs (money left on the table)
Green Shoe option – cost of additional shares that the syndicate can purchase after the issue has gone to market
Malibu Boats (MBUU)
A manufacturer of watersport boats, went public in 2014
sold 7.142 million shares at an offering price of $14.00
founders and other shareholders sold an additional 571,289 of their own shares
the underwriters’ direct charge was $0.98 per share
thus the stock was sold at a price of $14, but MBUU received only $14-$0.98=$13.02 per share
So the total cost for the 7.142 million shares =$0.98(7.142)=$7.0 million, and $559,000 for the shares sold by the founders and other existing shareholders.
Malibu Boats (MBUU) (Cont’d)
Other direct costs (lawyers’ fees, accountants’ fees, pricing, engraving...): ≈ $800,000
Indirect costs:
a 1st-day run-up from offering price $14 to $17.50, so money left on the table ≈ 7.142($17.5-$14)=$25 million
time spent on IPO rather than managing the business
IPO is quite expensive!
Long-Run IPO Underperformance
In the long-run, IPO shares have significantly underperformed to the turn of the 30%-50% below comparable companies over 3-5 years.
Is IPO for everyone?
It is difficult for retail investors to get the chance to buy an IPO at its offering price, especially a “hot” one.
Virtually all sales go to institutional investors and preferred retail customers.
OpenIPO (a modified Dutch auction) may allows shares to be allocated in an impartial way, but it is still difficult for small investors to get in on the first day for hot IPOs.
