Lecture Essentials of corporate finance (2/e) – Chapter 15: Raising capital

This chapter include objectives: Understand the venture capital market and its role in financing new businesses, understand how securities are sold to the public and the role of investment bankers, understand initial public offerings and the costs of going public.

Raising capital

Chapter 15

Key concepts and skills

• Understand the venture capital market and its role in financing new

businesses

• Understand how securities are sold to

the public and the role of investment

bankers

• Understand initial public offerings and

the costs of going public

Chapter outline

• The financing life cycle of a firm:

Early-stage financing and venture capital

• Selling securities to the public: The basic procedure

• Alternative issue methods

• Underwriters

• IPOs and underpricing

• New equity sales and the value of the firm

• The cost of issuing securities

• Issuing long-term debt

Venture capital

• Private financing for relatively new businesses

in exchange for shares in the firm

– Individual investors

– Venture capital firms

• Usually involves active participation by VC

• Ultimate goal to take company public; the VC will benefit from the capital raised in the IPO

• Many VC firms are formed from a group of

investors that pool capital and then have

partners in the firm decide which companies

will receive financing

• Some large corporations have a VC division

Venture capital stage

financing

• Funding provided in several stages

• Contingent upon specified goals at

each stage

• First stage

– ‘Ground floor’ financing or ‘seed money’

– Fund prototype and manufacturing plan

• Second stage

– ‘Mezzanine’ financing

– Begin manufacturing, marketing and

distribution

Choosing a venture

capitalist

• Look for financial strength.

• Choose a VC that has a management

style that is compatible with your own.

• Obtain and check references.

• What contacts does the VC have?

• What is the exit strategy?

Selling securities to the public:

The basic procedure

• Management must obtain permission from the

Board of Directors.

• Appoint an underwriter

• Firm must file a prospectus with ASIC or NZSC.

• ASIC or NZSC examines the prospectus and

• The price is usually determined on the effective

date of the registration

Issue methods

• Public issue—Initial public offering (IPO)

– General cash offer = offered to general public – Usually open for six to eight weeks

– Only cash offers

• Private issue—Rights issue

– Opportunity for existing share holders to buy more shares

– A new issue by a company with shares issued already

– Existing shareholders can sell their

entitlement if issue is renounceable

Total equity raised and bank lending

1999–2008 (A$ in billions)

Table 15.1

The methods of issuing new securities

Table 15.2

• Services provided by underwriters:

– Formulate method used to issue securities – Price securities

– Sell securities

• Syndicate—group of investment

bankers (underwriters) that market

securities and share the risk associated with selling the issue

• The underwriter bears the risk of not

being able to sell the entire issue to the public.

• Most common type of underwriting in

Best efforts underwriting

• Underwriter must make their ‘best effort’ to sell the securities at an agreed-upon offer price.

• The company bears the risk of the issue

not being sold.

• The offer may be pulled if there is not

enough interest at the offer price and the

company does not get the capital while

still incurring substantial flotation costs.

• Not as common as it used to be.

IPO underpricing

• Initial public offering – IPO.

• May be difficult to price an IPO because

there is not a current market price

available.

• Additional asymmetric information

associated with companies going public.

• Underwriters want to ensure that their

clients earn a good return on IPOs on

average.

Average first-day returns

Figure 15.1

Average first-day returns by month for ASX initial public

offerings: February 1993–December 2009

Number of offerings by month

Figure 15.2

Number of offerings by month for ASX-listed initial public

offerings: February 1993–December 2009

IPO underpricing reasons

• Underwriters want offerings to sell out

– Reputation for successful IPOs is critical

– Underpricing = insurance for underwriters

– Oversubscription and allotment

– ‘Winner’s curse’

• Smaller, riskier IPOs underprice to

attract investors.

New equity issues and price

• Private placement

– An exclusive issue of new securities to an investor or group

of investors who may or may not be current investors in the firm.

• Share prices tend to decline when new equity is issued

• Possible explanations for this phenomenon:

– Signalling and managerial information

– Signalling and debt usage

The cost of issuing

securities

Types of long-term debt

• Bonds/Debentures—public issue of long-term debt

• Similar to term loans with longer maturity

– Easier to renegotiate than public issues

• What type of underwriting is the most

common in Australia and how does it

work?

• What is IPO underpricing and why might it persist?

• What are some of the costs associated

with issuing securities?

• What are some of the characteristics of

Chapter 15

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