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  1. 1. Raising Capital © Natalya Brown 2008
  2. 2. 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).
  3. 3. Overview <ul><li>Early Stages: Venture Capital </li></ul><ul><li>Initial Public Offering (IPO) </li></ul><ul><li>The Role of the Underwriter </li></ul><ul><li>Pricing the Issue </li></ul><ul><li>After the IPO: Rights Issue, General Cash Offer and Private Placement of Securities </li></ul>© Natalya Brown 2009
  4. 4. Venture Capital <ul><ul><li>Venture capital is money invested to finance a new firm. </li></ul></ul><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><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>© Natalya Brown 2009
  5. 5. <ul><ul><li>An angel investor is a wealthy individual who invests in early-stage ventures. </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><ul><li>Venture capitalists know that the success of a business depends on the efforts its owner-managers put in. </li></ul></ul></ul><ul><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></ul></ul><ul><ul><ul><li>This transfers risk from venture capitalists to management </li></ul></ul></ul>© Natalya Brown 2009
  6. 6. The Initial Public Offering <ul><ul><li>An initial public offering (IPO) is the first sale of shares to the public. </li></ul></ul><ul><ul><li>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. </li></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>© Natalya Brown 2009
  7. 7. <ul><li>An IPO is called a primary offering when new shares are sold. </li></ul><ul><li>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. </li></ul><ul><li>IPOs commonly consist of both primary and secondary offerings. </li></ul>© Natalya Brown 2009
  8. 8. The Role of the Underwriter <ul><li>Underwriters have three specific roles: </li></ul><ul><ul><li>Underwriters provide advice to the issuing firm, as they help to price and market the issue. </li></ul></ul><ul><ul><li>Buying a new issue from the company </li></ul></ul><ul><ul><li>Reselling issue to investors </li></ul></ul>© Natalya Brown 2009
  9. 9. <ul><ul><li>Firm Commitment: Underwriters buy new shares from the issuer and then resell them to the public at a higher price, thereby making a spread. </li></ul></ul><ul><ul><li>Underwriter’s spread : Difference between public offer price and price paid by underwriter. </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>© Natalya Brown 2009
  10. 10. Prospectus Requirement <ul><li>In Canada, a firm going public must provide potential investors with a prospectus . </li></ul><ul><li>A prospectus is a formal summary that provides information on an issue of securities. </li></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>© Natalya Brown 2009
  11. 11. Pricing the Issue <ul><li>The issuing company and the underwriters must set a price for the new securities they are about to offer. </li></ul><ul><li>This is done using: </li></ul><ul><ul><li>Discounted cash flow calculations. </li></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><li>Underwriters may arrange a “roadshow” </li></ul></ul>© Natalya Brown 2009
  12. 12. Underpricing <ul><li>The issuing company wants to get the highest possible price for its shares. </li></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><li>As a result, underwriters typically try to underprice the IPO. </li></ul><ul><li>Usually measured by calculating the percentage difference between the offer price of the share and its closing price after the first day of trading. </li></ul>© Natalya Brown 2009
  13. 13. Degree of Underpricing © Natalya Brown 2009
  14. 14. Cost of IPO <ul><li>Flotation costs – cost of a new issue </li></ul><ul><li>Direct costs </li></ul><ul><ul><li>Preparation of registration statement and prospectus </li></ul></ul><ul><ul><li>Legal and administrative fees </li></ul></ul><ul><ul><li>Underwriter’s fees </li></ul></ul><ul><ul><li>Underwriting Spread </li></ul></ul><ul><li>Indirect costs </li></ul><ul><ul><li>Underpricing of the issue </li></ul></ul>© Natalya Brown 2009
  15. 15. Exercise 1 <ul><li>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. </li></ul><ul><li>Page One and its shareholders will pay $6 million in legal and administrative fees. </li></ul><ul><li>By the end of the first day’s trading Page One’s stock price rises to $60. </li></ul>© Natalya Brown 2009
  16. 16. <ul><li>The underwriter’s spread = $44 - $40 = $4 </li></ul><ul><li>Underpricing = $60 - $44 = $16 </li></ul><ul><li>Cost of Page One’s IPO: </li></ul><ul><ul><li>Underwriting Spread: 16 million x $4 = $64 million </li></ul></ul><ul><ul><li>Legal, administrative and other = $6 million </li></ul></ul><ul><ul><li>Total Direct Expenses = $70 million </li></ul></ul><ul><ul><li>Cost of underpricing: 16 million x $16 = $256 million </li></ul></ul><ul><ul><li>Total cost of IPO = $326 million </li></ul></ul>© Natalya Brown 2009
  17. 17. Listing on the Stock Market <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><li>Stock exchanges are organized facilities with a centralized physical location. </li></ul></ul><ul><ul><li>OTC markets exist in cyber-space and consist of a network of dealers who trade with each other electronically. </li></ul></ul>© Natalya Brown 2009
  18. 18. Winner’s Curse <ul><li>When an issue is underpriced, the high demand for it means that investors will only be able to get a small share of it. </li></ul><ul><li>However when an issue is overpriced, demand is low enough that investors are able to get a large proportion of it. </li></ul><ul><li>Your ability to purchase an allotment of shares may signal that the stock is overpriced. </li></ul>© Natalya Brown 2009
  19. 19. After the IPO <ul><li>Seasoned Offering: Sale of securities by a firm that is already publicly traded. </li></ul><ul><li>Rights Issue: an issue of securities which is offered only to existing shareholders. </li></ul><ul><li>General Cash Offer: Sale of securities open to all investors by an already public company. </li></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><li>Private Placement : Sale of securities to a limited number of investors without a public offering. </li></ul>© Natalya Brown 2009
  20. 20. Rights Issue <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><li>By directly offering new shares to its shareholders, a company saves on issuing and underwriting expenses. </li></ul><ul><li>A rights issue allows shareholders to retain their proportional shareholding and thus their voting position on the company’s major business decisions. </li></ul>© Natalya Brown 2009
  21. 21. Value of a Right © Natalya Brown 2009
  22. 22. Exercise 2 <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><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 = (135 + 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>© Natalya Brown 2009
  23. 23. Private Placements <ul><li>A private placement is the sale of securities to a limited number of investors without a public offering. </li></ul><ul><li>Private placements avoid many of the costs associated with a public offering and are less expensive to arrange. </li></ul>© Natalya Brown 2009
  24. 24. <ul><li>Advantages: </li></ul><ul><ul><li>The issue can be custom tailored. </li></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><li>Disadvantage: </li></ul><ul><ul><li>Investors cannot easily resell the security. </li></ul></ul>© Natalya Brown 2009
  25. 25. LECTURE 3: CAPITAL STRUCTURE POLICY <ul><li>Next </li></ul>© Natalya Brown 2009