Chapter 14

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Chapter 14

  1. 1. Chapter 14 Venture Capital, IPOs and Seasoned Offerings Prepared by Shahriar Hasan Thompson Rivers University
  2. 2. Chapter Outline <ul><li>Venture Capital </li></ul><ul><li>The Initial Public Offering </li></ul><ul><li>The Underwriters </li></ul><ul><li>Listing on the Stock Market </li></ul><ul><li>Rights Issues and General Cash Offers by Public Companies </li></ul><ul><li>The Private Placement </li></ul>
  3. 3. 14.1 Venture Capital <ul><li>Venture capital is money invested to finance a new firm. </li></ul><ul><li>● Venture capitalists are investors who are prepared to back an untried company in return for a share of the profits. </li></ul><ul><li>● An angel investor is a wealthy individual who invests in early-stage ventures. </li></ul><ul><li>● Venture capitalists know that the success of a business depends on the efforts its owner-managers put in. </li></ul><ul><li>● Typically, restrictions are placed on the management and venture capitalists advance the funding to the firm in stages, rather than all upfront. </li></ul>
  4. 4. 14.2 The Initial Public Offering (IPO) <ul><li>Terminology </li></ul><ul><li>Initial Public Offering (IPO ): First offering of stock to the general public. </li></ul><ul><li>Prospectus : Formal summary that provides information on an issue of securities. </li></ul><ul><li>Underwriter : Firm that buys an issue of securities from a company and resells it to the public. </li></ul><ul><li>Spread : Difference between public offer price and price paid by underwriter. </li></ul><ul><li>Underpricing : Issuing securities at an offering price set below the true value of the security. </li></ul>
  5. 5. The Initial Public Offering <ul><li>Prospectus Requirement </li></ul><ul><ul><li>In Canada, a firm going public must provide potential investors with a prospectus . </li></ul></ul><ul><ul><li>A prospectus is a formal summary that provides information on an issue of securities. </li></ul></ul><ul><ul><li>One of the key functions of a prospectus is to warn investors about the risks involved in investment in the firm. </li></ul></ul><ul><li>Flotation Costs : The costs incurred when a firm issues new securities to the public. </li></ul><ul><li>It includes commissions, legal, accounting and other administrative costs. </li></ul>
  6. 6. The Initial Public Offering <ul><li>Pricing the Issue </li></ul><ul><ul><li>The issuing company and the underwriters must set a price for the new securities they are about to offer. </li></ul></ul><ul><ul><li>This is done using: </li></ul></ul><ul><ul><ul><li>Discounted cash flow calculations. </li></ul></ul></ul><ul><ul><ul><li>An analysis of the price-earnings ratios of the shares of the firm’s principal competitors. </li></ul></ul></ul><ul><ul><li>The issuing company wants to get the highest possible price for its shares. </li></ul></ul><ul><ul><li>The underwriter is more cautious since they might be left with unsold securities if the issue is perceived to be expensive. </li></ul></ul><ul><ul><li>As a result, underwriters typically try to underprice the IPO </li></ul></ul>
  7. 7. The Initial Public Offering <ul><li>Top 10 IPO issues of Canada in 2007. </li></ul>
  8. 8. 14.3 The Underwriters <ul><ul><li>Underwriters provide advice to the issuing firm. </li></ul></ul><ul><ul><ul><li>They help price and market the new issue. </li></ul></ul></ul><ul><ul><li>For large issues, a group of underwriters called a syndicate is formed with the principal underwriter being called the lead manager . </li></ul></ul><ul><ul><li>Underwriters buy new shares from the issuer and then resell them to the public at a higher price, thereby making a spread. This is called a firm commitment . </li></ul></ul><ul><ul><li>In risky cases, an underwriter may prefer a best efforts deal. </li></ul></ul><ul><ul><ul><li>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. </li></ul></ul></ul>
  9. 9. The Underwriters <ul><li>Canada’s top underwriters for equity and debt in 2007. </li></ul>
  10. 10. 14.4 Listing on the Stock Market <ul><ul><li>When a firm decides on an IPO of its shares, it must also decide where its newly issued shares should be traded . </li></ul></ul><ul><ul><ul><li>Stock exchanges are organized facilities with a centralized physical location. For example, TSX, NYSE and so on. </li></ul></ul></ul><ul><ul><ul><li>OTC markets exist in cyber-space and consist of a network of dealers who trade with each other electronically. NASDAQ is an example. </li></ul></ul></ul>
  11. 11. 14.5 Rights Issues and General Cash Offers by Public Companies. <ul><li>Terminology </li></ul><ul><ul><li>Seasoned Offering : Sale of securities by a firm that is already publicly traded. </li></ul></ul><ul><ul><li>Rights Issues : Issue of securities offered only to current shareholders. </li></ul></ul><ul><ul><li>Oversubscription Privilege : Given to shareholders in a rights issue enabling them to purchase any unsold shares at the subscription price. </li></ul></ul><ul><ul><li>Standby Underwriting Agreement : The underwriter stands ready to purchase any unsold shares. </li></ul></ul>
  12. 12. Rights Issues and General Cash Offers by Public Companies. <ul><ul><li>Shelf Registration : A procedure that allows firms to file one registration statement for several issues of the same security. </li></ul></ul><ul><ul><li>Private Placement : Sale of securities to a limited number of investors without a public offering. </li></ul></ul><ul><ul><li>General Cash Offer : Sale of securities open to all investors by an already public company. </li></ul></ul>
  13. 13. Rights Issues and General Cash Offers by Public Companies. <ul><li>Raising Funds After the IPO </li></ul><ul><ul><li>Public companies can issue securities by making a general cash offer to investors at large or by making a rights issue. </li></ul></ul><ul><ul><li>A rights issue is an issue of securities which is offered only to existing shareholders. </li></ul></ul><ul><ul><li>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. </li></ul></ul>
  14. 14. Rights Issues and General Cash Offers by Public Companies. <ul><li>Example </li></ul><ul><ul><li>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? </li></ul></ul><ul><li>Current Market Value = 9 mil  $15 = $135 mil </li></ul><ul><li>Total Shares = 9 mil + 3 mil = 12 mil </li></ul><ul><li>Amount of new funds = 3 mil  $12 = $36 mil </li></ul><ul><li>New Share Price = (136 + 36) / 12 = $14.25 per share </li></ul><ul><li>Value of a Right = Rights-on price – Ex-rights price </li></ul><ul><li>= 15 - 14.25 = $0.75 </li></ul>
  15. 15. 14.6 The Private Placement <ul><ul><li>A private placement is the sale of securities to a limited number of investors without a public offering. </li></ul></ul><ul><ul><li>Private placements avoid many of the costs associated with a public offering and are less expensive to arrange. </li></ul></ul><ul><ul><li>Advantages: </li></ul></ul><ul><ul><ul><li>The issue can be custom tailored. </li></ul></ul></ul><ul><ul><ul><li>It is much easier to change the terms of the contract when only a few investors are involved. </li></ul></ul></ul><ul><ul><li>Disadvantage: </li></ul></ul><ul><ul><ul><li>Investors cannot easily resell the security. </li></ul></ul></ul>
  16. 16. Summary of Chapter 14 <ul><ul><li>Venture capitalists specialize in providing new equity capital to help firms grow from start-up until they are ready to “go public”. </li></ul></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>An IPO is the first sale of shares to the public. </li></ul></ul><ul><ul><ul><li>This sale is usually managed by an underwriting firm, which purchases the issue for resale to investors. </li></ul></ul></ul><ul><ul><ul><li>Underwriters also provide procedural and financial advice to the issuing firm. </li></ul></ul></ul>
  17. 17. Summary of Chapter 14 <ul><ul><li>An IPO is the first sale of shares to the public. </li></ul></ul><ul><ul><ul><li>This sale is usually managed by an underwriting firm, which purchases the issue for resale to investors. </li></ul></ul></ul><ul><ul><ul><li>Underwriters also provide procedural and financial advice to the issuing firm. </li></ul></ul></ul><ul><ul><li>The costs of an issue can be significant: </li></ul></ul><ul><ul><ul><li>Direct costs include the preparation of a prospectus, legal and administrative fees and the underwriter’s fees. </li></ul></ul></ul><ul><ul><ul><li>The indirect cost is the under-pricing of the issue. </li></ul></ul></ul><ul><ul><li>A firm can use a rights issue to sell its shares to existing shareholders. </li></ul></ul><ul><ul><li>It can use a general cash offer to sell its shares to the public. </li></ul></ul><ul><ul><li>Or, the firm can use a private placement and sell its securities to a small group of institutional investors. </li></ul></ul>

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