Class notes meeting 12

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Class notes meeting 12

  1. 1. Raising equity capital (see chapter 23 in Berk and Demarzo “ The Mechanics of Raising Equity Capital”)
  2. 2. Equity Financing for Private Companies <ul><li>Sources of Funding (Institutional Investors) </li></ul><ul><ul><li>Angel Investors </li></ul></ul><ul><ul><li>Venture Capital Firms </li></ul></ul><ul><ul><li>Private Equity </li></ul></ul><ul><ul><li>Corporate Investors </li></ul></ul>
  3. 3. Venture Capital Funding in the United States Panel (a) indicates the total number of venture capital deals by year. Panel (b) shows the total dollar amount of venture capital investment. Source: Venture Economics.
  4. 4. Angel investors <ul><li>An angel investor is an affluent individual who provides capital for a business start-up </li></ul><ul><li>Angels provide capital (few hundred thousand to few millions) and expertize </li></ul><ul><li>A small but increasing number of angel investors organize themselves into angel groups or angel networks to share research and pool their capital </li></ul><ul><li>Angel investments bear extremely high risk, and thus require a very high return on investment, sometimes 10 or more their original investment within 5 years </li></ul><ul><li>Defined exit strategy, such as plans for an initial public offerings or a sale </li></ul>
  5. 5. Venture capital <ul><li>Investment in start-ups with high growth opportunities </li></ul><ul><li>Organized as investment partnerships, with VC as general partners and the investors as limited partners </li></ul><ul><li>The bring capital (millions to ten of millions), technical and managerial expertise: </li></ul><ul><li>Actively involved in the management of the company </li></ul><ul><li>First venture capital founded in 1946 </li></ul><ul><li>Exit strategy; IPO or sale, usually after 3-7 years </li></ul><ul><li>For performance and more information see the National Venture Capital Association web site </li></ul>
  6. 6. Private equity <ul><li>Investment partnerships with a structure similar to venture capital </li></ul><ul><li>Leveraged buyout: refers to a strategy of making equity investments as part of a transaction in which a company, business unit or business assets is acquired from the current shareholders typically with the use of financial leverage. The companies involved in these transactions are typically more mature and generate operating cash flows. </li></ul><ul><li>Growth capital: refers to equity investments, most often minority investments, in more mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change of control of the business. </li></ul>
  7. 7. Example 23.1 Funding and Ownership
  8. 8. Alternative Example 23.1 <ul><li>Problem </li></ul><ul><ul><li>What is the post-money valuation? </li></ul></ul><ul><ul><li>Assuming that this is the venture capitalist’s first investment in your company, what percentage of the firm will he end up owning? </li></ul></ul><ul><ul><li>What percentage will you own? </li></ul></ul><ul><ul><li>What is the value of your shares? </li></ul></ul>
  9. 9. Example 23.1 Funding and Ownership
  10. 10. Advantages and Disadvantages of Going Public <ul><li>IPO (Initial Public Offering): the process of selling stock to the public for the first time </li></ul><ul><li>Advantages: </li></ul><ul><li> - Greater liquidity </li></ul><ul><ul><ul><li>Private equity investors get the ability to diversify. </li></ul></ul></ul><ul><ul><li>Better access to capital </li></ul></ul><ul><ul><ul><li>Public companies typically have access to much larger amounts of capital through the public markets. </li></ul></ul></ul><ul><li>Disadvantages: </li></ul><ul><ul><li>The equity holders become more widely dispersed. </li></ul></ul><ul><ul><ul><li>This makes it difficult to monitor management. </li></ul></ul></ul><ul><ul><li>The firm must satisfy all of the requirements of public companies. </li></ul></ul><ul><ul><ul><li>SEC filings, Sarbanes-Oxley, etc. </li></ul></ul></ul>
  11. 11. Types of Offerings <ul><li>Primary and Secondary Offerings </li></ul><ul><ul><li>Primary Offering </li></ul></ul><ul><ul><ul><li>New shares available in a public offering that raise new capital </li></ul></ul></ul><ul><ul><li>Secondary Offering </li></ul></ul><ul><ul><ul><li>Shares sold by existing shareholders in an equity offering </li></ul></ul></ul>
  12. 12. <ul><li>Best-Efforts basis </li></ul><ul><ul><ul><li>For smaller IPOs, a situation in which the underwriter does not guarantee that the stock will be sold, but instead tries to sell the sock for the best possible price </li></ul></ul></ul><ul><ul><ul><ul><li>Often such deals have an all-or-none clause: either all of the shares are sold on the IPO or the deal is called off </li></ul></ul></ul></ul><ul><li>Firm Commitment </li></ul><ul><ul><ul><li>An agreement between an underwriter and an issuing firm in which the underwriter guarantees that it will sell all of the stock at the offer price </li></ul></ul></ul><ul><li>Auction IPOs </li></ul><ul><ul><ul><li>Rather than setting a price itself and then allocating shares to buyers, the underwriter in an auction IPO takes bids from investors and then sets the price that clears the market. </li></ul></ul></ul>
  13. 13. <ul><li>Underwriters and the Syndicate </li></ul><ul><ul><li>Lead Underwriter: The primary investment banking firm responsible for managing a security issuance </li></ul></ul><ul><ul><li>Syndicate: A group of underwriters who jointly underwrite and distribute a security issuance </li></ul></ul><ul><li>SEC Filings </li></ul><ul><ul><li>Registration Statement: A legal document that provides financial and other information about a company to investors prior to a security issuance </li></ul></ul><ul><ul><li>Preliminary Prospectus (Red Herring):Part of the registration statement prepared by a company prior to an IPO that is circulated to investors before the stock is offered </li></ul></ul>
  14. 14. The Cover Page of RealNetworks’ IPO Prospectus
  15. 15. <ul><li>Valuation of the IPO </li></ul><ul><ul><li>There are two ways to value a company. </li></ul></ul><ul><ul><ul><li>Compute the present value of the estimated future cash flows. </li></ul></ul></ul><ul><ul><ul><li>Estimate the value by examining comparables (recent IPOs). </li></ul></ul></ul>
  16. 16. Example 23.3
  17. 17. Example 23.3 (cont'd)
  18. 18. <ul><li>Pricing the Deal and Managing Risk </li></ul><ul><ul><li>Spread </li></ul></ul><ul><ul><ul><li>The fee a company pays to its underwriters that is a percentage of the issue price of a share of stock </li></ul></ul></ul><ul><ul><ul><ul><li>For RealNetworks, the final offer price was $12.50 per share and the company paid the underwriters a spread of $0.875 per share, exactly 7% of the issue price. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Since this was a firm commitment deal, the underwriters bought the stock from RealNetworks for $11.625 per share and then resold it to their customers for $12.50 per share. </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>$12.50 – $0.875 = $11.625 </li></ul></ul></ul></ul></ul>
  19. 19. IPO Puzzle <ul><li>Underpricing </li></ul><ul><ul><li>Generally, underwriters set the issue price so that the average first-day return is positive. </li></ul></ul><ul><ul><ul><li>As mentioned previously, research has found that 75% of first-day returns are positive. </li></ul></ul></ul><ul><ul><ul><li>The average first day return in the United States is 18.3% </li></ul></ul></ul><ul><ul><ul><li>The underwriters benefit from the underpricing as it allows them to manage their risk. </li></ul></ul></ul><ul><ul><ul><li>The pre-IPO shareholders bear the cost of underpricing. In effect, these owners are selling stock in their firm for less than they could get in the aftermarket. </li></ul></ul></ul>
  20. 20. International Comparison of First Day IPO Returns
  21. 21. Long-Run Underperformance <ul><li>Although shares of IPOs generally perform very well immediately following the public offering, it has been shown that newly listed firms subsequently appear to perform relatively poorly over the following three to five years after their IPOs. </li></ul>
  22. 22. Learning Objectives <ul><li>Discuss what is and the role of Angel capital </li></ul><ul><li>Discuss what is and the role of Venture capital </li></ul><ul><li>Discuss what is and the role of Private Equity </li></ul><ul><li>Discuss the best efforts, firm commitment and auction mechanisms to go public </li></ul><ul><li>Define an initial public offering, and discuss their advantages and disadvantages. </li></ul><ul><li>Discuss the IPO first day performance and longer term performance </li></ul><ul><li>Terminology: slides 11, 13, 18 </li></ul>

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