RAISING CAPITAL
CHAPTER 15
INTRODUCTION
• Definition of capital: borrowed sums or equity with
which the firm's assets are acquired and its operations
are funded.
• When does a firm need capital?
• New or start up companies
• Finance expansion
• Rapid growth
• Opening new market lines
• Mergers and acquisitions
INTRODUCTION
• How can a firm raise money??
• 1. Equity: the value of an ownership interest in
property interest in a corporation in the form of
common stock or preferred stocks
• 2. Debt: An amount owed to a person or
organization for funds borrowed. Debt can be
represented by a loan note, bond, mortgage or
other form stating repayment terms and interest
requirements.
1- THE FINANCING LIFE CYCLE OF A FIRM:
EARLY-STAGE FINANCING AND VENTURE
CAPITAL
• Venture Capital Financing for new, often highrisk venture.
• Private Equity: is often used to label the rapidly
growing areas of equity financing for
nonpublic companies.
CAPITAL FOR NEW FIRMS
• Can new start-up firms rely on bank loans for
capital?
• Venture capital: general term for financing startup,
early stage, and "turn around" type businesses
• Sources of VC
Individual, pension funds, insurance company, large
corporation, university endowment funds.
• New business will be risky
• What does Venture capitalist do to avoid this risk?
• Why might Venture capitalist be willing to take this
risk?
• Venture capital firm often specialize in
different stage. Some specialize in very early
“seed money or ground floor” financing.
• Financing in the late stages might come from
venture capitalist specializing in so-called
mezzanine-level financing (mezzanine level
refers to the level just above the ground floor).
CHOOSING A VENTURE CAPITAL
1.
2.
3.
4.
5.
Financing strength is important.
Style is important.
References are important.
Contacts are important.
Exit strategy is important.
2- SELLING SECURITIES TO THE PUBLIC
1. The first step is to obtain approval from the board of
directors
2. The second step is to prepare a registration
statement and file it with the SEO “Securities and
Exchange Commission”.
3. The SEO examine the registration statement during
a waiting period.
4. The company cannot sell these securities during the
waiting period.
5. On the effective date of the registration statement,
a price is determines.
3- ALTARNATIVE ISSUE METHODS
• When a company decides to issue a new security, it
can sell it as public issue or a private issue.
• In the case of a public issue, the firm is required to
register the issue with the SEC.
• For equity sale, there are two kinds of public issue
1. General cash offer.
2. Rights offer.
• With the cash offer, securities are offered to the
general public .
• With the rights offer, securities are initially offered
only to existing owners.
 The first public equity issue that is made by the
company is referred to as an initial public offering,
IPO, or an unseasoned new issue.
• This issue occurs when a company decides to go
public.
• All initial public offering are cash offers.
• If the firm’s existing shareholder wanted to buy the
shares, the firm wouldn’t have to sell them publicly
in the first place.
A seasoned equity offering (SEO) is new issue a
company with securities that have been previously
issued.
A seasoned equity offering of common stock can
be made by using a cash offer or a rights offer.
4- UNDERWRITERS
 Definition: investment firms that act as intermediaries
between a company selling securities and the investing
public.
 Services provided by underwriters

Formulate method used to issue securities

Price the securities

Sell the securities

Price stabilization by lead underwriter
UNDERWRITERS
 Syndicate – group of investment bankers that
market the securities and share the risk associated
with selling the issue
 Spread – difference between what the syndicate
pays the company and what the security sells for
initially in the market
• The underwriter buys the securities for less than the
offering price and accepts the risk of not being
able to sell them.
• Because underwriting involves risk, underwriters
usually combine to from an underwriting group
called a syndicate to share the risk and to help sell
the issue.
• The difference between the underwriter's buying
price and the offering price is called the Gross
spread, or underwriting discount.
TYPES OF UNDERWRITING
1.
Firm Commitment Underwriting
 Issuer sells entire issue to underwriting syndicate
 The syndicate then resells the issue to the public
 The underwriter makes money on the spread
between the price paid to the issuer and the price
received from investors when the stock is sold
 The syndicate bears the risk of not being able to
sell the entire issue for more than the cost
TYPES OF UNDERWRITER
2.
Best efforts underwriting
 Underwriter must make their “best effort” to sell the
securities at an agreed-upon offering price
 The company bears the risk of the issue not being sold
 Not as common as it used to be
TYPES OF UNDERWRITER
3.
Dutch auction underwriting:

Underwriter accepts a series of bids that include
number of shares and price per share

Google was the first large Dutch auction IPO
If a firm want to sell 400 share and it has the following series of bids:
Bidder
Quantity
Price
A
100 shares
$16
B
100 shares
$14
C
200 shares
$12
D
100 shares
$12
E
200 shares
$10
400\500=0.8
IPOS & UNDER PRICING
 Initial Public Offering – IPO
 May be difficult to price an IPO because there isn’t
a current market price available
 Under pricing causes the issuer to “leave money on
the table”
WHY DOES UNDERWRITING EXIST??
• To attract investors for young firms
• To act as an Insurance for the investment bank
• A way that a bank can reward investors for reveling
what they think the stock worth and the numbers of
shares they would like to buy
THE COST OF ISSUING SECURITIES
1. Gross spread: The gross spread consists of direct
fees paid by the issuer to the underwriting
syndicate- the different between the price the
issuer receive and the offer price.
2. Other direct expenses: these are direct cost,
incurred by the issuer, that are not part of the
compensation underwriters. These cost include
filing fees, legal fees, and tax … etc.
THE COST OF ISSUING SECURITIES
3. Indirect expenses: these cost are not reported on
the prospectus and include the cost of management
time spent working on the new issue.
4. Abnormal return: in seasoned issue of stock, the
price of the existing stock drop on average by 3% on
the announcement of the issue. This drop is called the
abnormal return.
THE COST OF ISSUING SECURITIES
5. Under pricing: For initial public offering, losses arise
from selling the stock below the true value.
6. Green shoe option: It gives the underwriters the right
to buy additional shares at the offer price to cover
overallotment.
RIGHTS
 Definition: an issue of common stock offered to
existing stockholders
 “Rights” are given to the shareholders
 Specify
number of shares that can be purchased
 Specify
purchase price
 Specify
time frame
 Why do companies offer Rights? (Advantages)
 Rights may be traded OTC or on an exchange
RIGHTS
 The mechanics of a rights offering
 Number of rights needed to purchase a share
THE VALUE OF A RIGHT
• Example:
• National Power current share price is 20$, there is 1,000,000
shares outstanding. Suppose they want to raise 5,000,000$ in
new equity using a right offering (1 right for each 1 share) with
a subscription price of 10$. Calculate the following:
1. Number of new shares to be issued
2. Number of rights needed to buy a new share
3. The value of the right
4. Show in calculations the effects of the rights offering on
shareholders
THE VALUE OF A RIGHT
• Results
• The price specified in a rights offering is generally
less than the current market price
• The share price will adjust based on the number of
new shares issued
• The value of the right is the difference between
the old share price and the “new” share price
RIGHTS OFFERING EXAMPLE
• Suppose a company wants to raise $10 million. The
subscription price is $20 and the current stock price
is $25. The firm currently has 5,000,000 shares
outstanding.
• How many shares have to be issued?
• How many rights will it take to purchase one share?
• What is the value of a right?
DILUTION
• Dilution is a loss in value for existing shareholders
that occurs through the issuance of additional
stocks
• Dilution kinds:
1.
Percentage ownership – shares sold to the general
public without a rights offering
2.
Market value – firm accepts negative NPV projects
3.
Book value and EPS – occurs when market-to-book
value is less than one
ISSUING LONG-TERM DEBT
• Types of Long-term Debt
1.
Public issue of long-term debt are usually in the form of
bonds
2.
Private issues
• Long-Term loans usually bank loans or could be from private firm
which has a history with the company
• Easier to renegotiate than public issues
• If bonds were issued to private investors costs would be lower than
public issues
• MORE THAN 50% OF ALL DEBT ARE ISSUED PRIVATELY
• Interest rates are higher in private issues when compared to public
issues
EX 1 PAGE 505
• Big Time, Inc., is proposing a rights offering. Presently there
are 500,000 shares outstanding at 81$ each. There will be
60,000 new shares offered at 70$ each.
A. What is the new market value of the firm
B. How many rights are associated with one of the new
shares?
C. What is the value of a right?
D. Why might a company have a rights offering rather than a
general cash offer?