1. Raising Capital:
All firms must obtain capital. To do so a firm must either borrow or
sell the proportion of the firm (equity financing) or both. how a firm
raises capital depends a great deal on size of the firm, its life cycle
stage, and its growth prospects.
To borrow a firm may take loan from a bank. Float bond or
commercial paper.
The Financing Life Cycle of a firm: Early- stage
Financing and Venture Capital
Venture capital generally means financing for new ,often
high-risk ventures. Individual venture capital investors invest their
own money, but they tend to specialize in smaller deals.
Venture capital firms recognize that many or most new firms will
Not fly, but the occasional will fly. The potential profits are
Enormous.
2. The name of famous venture capital firms are Acacia,
Benchmark Capital, Kleiner Perkins, Chase Capital, Draper
Fisher Jurvetson, Sevin Rosen. Soft Bank.
Mainly technology/biotechnology /IT based companies are VC backed
Companies. In addition to providing financing ,venture capitalists often
Actively participate in running the firm sharing their experience.VC
About 21% of the GDP of US comes from VC backed companies’ revenue
Venture capital is incredibly expensive. In a typical deal VC demand 40%
of the equity in the company, or voting preferred stock, some priorities
In the event of liquidation. They may demand some seats in the
Company’s board of directors and often demand to appoint some
senior Management post.
3. Choosing a Venture Capitalists:
Some start-up companies , particularly headed by previously
Experienced successful entrpreneurs,will look beyond money
In choosing a venture capitalist. The key considerations are
1.Financial strength is important:
2. Style is important: involvement in day to day operations,
decision making VS. With monthly report. Depends on
entrepreneurs skills. Large VC are less flexible.
3. Reference is important: Has the VC been successful with
similar firms. How has the VC dealt with the situation when the
project didn't work?
4. 4. Contacts are important: Beside providing financing and
Management they may introduce the entrepreneur with
Potential customer, suppliers and other industry contacts.
5. Exit Strategy is important: Venture capitalists are not long
time investors. How and under what circumstances the VC’s
will “cash out” of the business should be carefully evaluated.
5. Stages of Financing
Venture capital is an important part of private equity market
To limit the risk venture capitalist generally provide financing in
stages. At each stage money is invested to reach the next
Milestone.
(i)Seed money stage: a small amount of financing needed to
Prove a concept or develop a product prototype.Marketing is
Not included in this stage.
(ii)Start up :Financing for firms that started within the past year.
Funds are likely to pay for marketing and product development
Expenditure.
6. (iii)First round financing: Additional money to begin sales and
Manufacturing after a firm has spent its start up funds.
(iv) Second round financing: funds earmarked for working capital
That is currently selling its product but still losing money.
(v)Third round financing: Financing for a company that is at least
At break-even and is contemplating an expansion. This is also
known as mezzanine financing.
(vi) Fourth-round financing: Money provided for firms that are
likely to go public within half a year. This is also known as
bridge financing.
7. Alternative Issue methods:
When a company decides to issue a new security, it can
sell it as a public or private issue. In the case of public
issue the firm is Required to register with the SEC.For
equity sales, there are two kinds of public issues-Initial
public Issue and right offering.
The first public offering that is made by a company is
referred to an Initial public issue or unseasoned new
issue. This issue occurs when a company decides to go
public.
8. With a right offer securities are initially offered to the existing
owners.
A seasoned equity offering or secondary offering is a new issue
of securities by a Company that has previously issued securities
to the public.
Underwriters:
Investment firms that act as intermediaries between a company
selling securities and the investing public. The underwriters
Performs the following services
•Formulating the method used to issue securities
•Pricing the new securities
•Selling the new securities.
9. What is the difference between Investment and Merchant
Banking?
Traditional investment banks only engage in the underwriting of
shares and issuance of shares, whereas merchant banks involve
in international financial activities like real estate financing
While traditional investment banks assist companies in the
acquisition and merges, merchant banks are not.
Normally investment banks focus on share issuance of large
private and public companies, whereas merchant banks look after
small scale companies.
merchant banks offer trade financing to their clients, investment
banks rarely offer this service.
10. Typically underwriters buys the securities for less than the
Offering price and accepts the risk of not being able to sell them.
As underwriters assumes risk ,underwriters usually combine to
form an underwriting syndicate to share the risk and to help
sell the issue.
In a syndicate one or more managers arrange or comanage the
Offering.
The difference between the underwriter’s buying price and
Offering price is called the gross spread. This is the basic
Compensation received by the underwriter.
JP Morgan, Bank of America, Merrill Lynch, Goldman
Sachs, Morgan Stanley, and Credit Suisse are some of
the world renowned investment banks.
11. Types of underwriting agreement
Three basic types of underwriting agreement are involved in a
Cash offer
•Firm commitment
•Best effort
•Dutch Auction
•Firm Commitment Underwriting: In Firm Commitment
Underwriting the issuers sells the entire issue to the underwriter,
Who then attempts to resell it. This just a purchase- resale
Agreement, and the underwriter’s fee is the spread.
If the underwriter cannot sell all of the issue at the agreed
upon price ,it may have to lower the price on the unsold shares
12. •Best effort underwriting: In this method the underwriter is legally
Bound to use the best effort to sell the securities at the agreed
Upon offering price. Beyond this the underwriter does not
Guarantee any amount of money to the issuer.
•Dutch Auction Underwriting: The underwriter does not set a fix
Price for the shares to be sold. Instead ,the underwriters conduct
An auction in which investors bid for shares. the offer price is
Determined based on the submitted bids. A Dutch Auction is also
Known as uniform price auction.
13. An example :
Suppose a company wants to sell 400 shares to the public.
The Company receives five bids as follows:
Bidder Quantity Price
A 100 shares 16
B 100 shares 14
C 200 shares 12
D 100 shares 12
E 200 shares 10
Lockup Agreement: Such agreement specify how long
Insiders must wait after an IPO before they can sell some or
All of their stock.
14. The cost of issuing securities
The cost associated with floating a new issue are generically
Called floatation cost.
The cost are as follows
1.Gross spread– The gross spread consist of direct fees paid
By the issuer to the underwriting syndicate.
2.Other Direct expenses: These include filling fees, legal fees,
And taxes—all reported on the prospectus.
3.Indirect expenses—These costs are not reported on the
Prospectus and include cost of management time spent working
On the new issue.
4. Abnormal return: In a seasoned new issue the price of existing
Stock drops on announcement of the issue. This drop is called
Abnormal return.
15. 5. Underpricing: For IPO losses arise from selling the stock below
The true value.
Right offering:
•It is comparatively cheaper for the issuing firm than
Seasoned secondary offering.
•Secondly, a right offering can be done without using an
Underwriter.
16. National Power Company: Balance sheet
Assets Stock holders equity
Assets 15,000,000 Common Stock 5,000,000
Re.earnings 10,000,000
15,000,000 15,000,000
Income statement
Earning before taxes 3030303
Taxes(34%) 1030303
Net income 2,000,000
Shares outstanding 1,000,000
EPS 2
Market price per share 20
Total market value 20,000,000
17. Value of a right:
National power want to raise 5 million in new equity. And the
Subscription price is set at 10 per share
Number of new shares=Funds to be raised/subscription price
5,000,000/10=5,00,000 shares
Number of rights needed to buy a share of stocks
Old shares /new shares=1,000,000/5,00,000=2 rights
18. The value of right:
Initial position
Number of shares 2
Share price 20
Value of holding 40
After offer
Number of shares 3
Value of holding 50
Share price 16.67
Value of one right 20 -16.67
=3.33
