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  • Raising Capital © Natalya Brown 2008
  • Raising Capital © Natalya Brown 2009 Early Stages Venture Capital Initial Public Offering* Primary Secondary After the IPO Rights Issue General Cash Offers Private Placement *Note that some large companies continue to prosper as independent private businesses (i.e. the company remains closely held).
  • Overview
    • Early Stages: Venture Capital
    • Initial Public Offering (IPO)
    • The Role of the Underwriter
    • Pricing the Issue
    • After the IPO: Rights Issue, General Cash Offer and Private Placement of Securities
    © Natalya Brown 2009
  • Venture Capital
      • Venture capital is money invested to finance a new firm.
      • Venture capitalists are investors who are prepared to back an untried company in return for a share of the profits.
      • Venture capitalists specialize in providing new equity capital to help firms grow from start-up until they are ready to “go public”.
    © Natalya Brown 2009
      • An angel investor is a wealthy individual who invests in early-stage ventures.
      • Most venture capital financing is done in stages to keep the firm on a short leash and force it to prove, at several crucial points, that it is worthy of additional investment.
        • Venture capitalists know that the success of a business depends on the efforts its owner-managers put in.
        • Typically, restrictions are placed on the management and venture capitalists advance the funding to the firm in stages, rather than all upfront.
        • This transfers risk from venture capitalists to management
    © Natalya Brown 2009
  • The Initial Public Offering
      • An initial public offering (IPO) is the first sale of shares to the public.
      • This sale is usually managed by an underwriting firm or a group of underwriting firms. These are firms that buy an issue of securities from a company and resell it to the public.
      • For large issues, a group of underwriters called a syndicate is formed with the principal underwriter being called the lead manager.
    © Natalya Brown 2009
    • An IPO is called a primary offering when new shares are sold.
    • An IPO is called a secondary offering when the company’s founders and the venture capitalist cash in some of their grains by selling shares.
    • IPOs commonly consist of both primary and secondary offerings.
    © Natalya Brown 2009
  • The Role of the Underwriter
    • Underwriters have three specific roles:
      • Underwriters provide advice to the issuing firm, as they help to price and market the issue.
      • Buying a new issue from the company
      • Reselling issue to investors
    © Natalya Brown 2009
      • Firm Commitment: Underwriters buy new shares from the issuer and then resell them to the public at a higher price, thereby making a spread.
      • Underwriter’s spread : Difference between public offer price and price paid by underwriter.
      • In risky cases, an underwriter may prefer a best efforts deal.
        • Here the underwriter agrees, for a commission, to sell as much of the issue as possible, but does not guarantee to sell the entire issue.
    © Natalya Brown 2009
  • Prospectus Requirement
    • In Canada, a firm going public must provide potential investors with a prospectus .
    • A prospectus is a formal summary that provides information on an issue of securities.
    • One of the key functions of a prospectus is to warn investors about the risks involved in investment in the firm.
    © Natalya Brown 2009
  • Pricing the Issue
    • The issuing company and the underwriters must set a price for the new securities they are about to offer.
    • This is done using:
      • Discounted cash flow calculations.
      • An analysis of the price-earnings ratios of the shares of the firm’s principal competitors.
      • Underwriters may arrange a “roadshow”
    © Natalya Brown 2009
  • Underpricing
    • The issuing company wants to get the highest possible price for its shares.
    • The underwriter is more cautious since they might be left with unsold securities if the issue is perceived to be expensive.
    • As a result, underwriters typically try to underprice the IPO.
    • Usually measured by calculating the percentage difference between the offer price of the share and its closing price after the first day of trading.
    © Natalya Brown 2009
  • Degree of Underpricing © Natalya Brown 2009
  • Cost of IPO
    • Flotation costs – cost of a new issue
    • Direct costs
      • Preparation of registration statement and prospectus
      • Legal and administrative fees
      • Underwriter’s fees
      • Underwriting Spread
    • Indirect costs
      • Underpricing of the issue
    © Natalya Brown 2009
  • Exercise 1
    • Page One Paper Company decides to public with underwriters requiring a total of 16 million shares for $40 each. The underwriters sell them to the public at an offering price of $44.
    • Page One and its shareholders will pay $6 million in legal and administrative fees.
    • By the end of the first day’s trading Page One’s stock price rises to $60.
    © Natalya Brown 2009
    • The underwriter’s spread = $44 - $40 = $4
    • Underpricing = $60 - $44 = $16
    • Cost of Page One’s IPO:
      • Underwriting Spread: 16 million x $4 = $64 million
      • Legal, administrative and other = $6 million
      • Total Direct Expenses = $70 million
      • Cost of underpricing: 16 million x $16 = $256 million
      • Total cost of IPO = $326 million
    © Natalya Brown 2009
  • Listing on the Stock Market
    • When a firm decides on an IPO of its shares, it must also decide where its newly issued shares should be traded .
      • Stock exchanges are organized facilities with a centralized physical location.
      • OTC markets exist in cyber-space and consist of a network of dealers who trade with each other electronically.
    © Natalya Brown 2009
  • Winner’s Curse
    • When an issue is underpriced, the high demand for it means that investors will only be able to get a small share of it.
    • However when an issue is overpriced, demand is low enough that investors are able to get a large proportion of it.
    • Your ability to purchase an allotment of shares may signal that the stock is overpriced.
    © Natalya Brown 2009
  • After the IPO
    • Seasoned Offering: Sale of securities by a firm that is already publicly traded.
    • Rights Issue: an issue of securities which is offered only to existing shareholders.
    • General Cash Offer: Sale of securities open to all investors by an already public company.
    • Shelf Registration: A procedure that allows firms to file one registration statement for several issues of the same security.
    • Private Placement : Sale of securities to a limited number of investors without a public offering.
    © Natalya Brown 2009
  • Rights Issue
    • In a rights issue, the company offers its shareholders the right to buy additional shares at a subscription price, which is significantly below the market value of the shares.
    • By directly offering new shares to its shareholders, a company saves on issuing and underwriting expenses.
    • A rights issue allows shareholders to retain their proportional shareholding and thus their voting position on the company’s major business decisions.
    © Natalya Brown 2009
  • Value of a Right © Natalya Brown 2009
  • Exercise 2
    • ABC Corp currently has 9 million shares outstanding. The market price is $15 per share. ABC decides to raise additional funds via a 1 for 3 rights offer at $12 per share. If we assume 100% subscription, what is the value of each right?
    • Current Market Value = 9 mil  $15 = $135 mil
    • Total Shares = 9 mil + 3 mil = 12 mil
    • Amount of new funds = 3 mil  $12 = $36 mil
    • New Share Price = (135 + 36) / 12 = $14.25 per share
    • Value of a Right = Rights-on price – Ex-rights price
    • = 15 - 14.25 = $0.75
    © Natalya Brown 2009
  • Private Placements
    • A private placement is the sale of securities to a limited number of investors without a public offering.
    • Private placements avoid many of the costs associated with a public offering and are less expensive to arrange.
    © Natalya Brown 2009
    • Advantages:
      • The issue can be custom tailored.
      • It is much easier to change the terms of the contract when only a few investors are involved.
    • Disadvantage:
      • Investors cannot easily resell the security.
    © Natalya Brown 2009
  • LECTURE 3: CAPITAL STRUCTURE POLICY
    • Next
    © Natalya Brown 2009