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: selling a portion of the firm to investors so the
investor would be the owner of that portion of the firm in
the form of common stock or preferred stock.
 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.
 How a firm raises capital depends on the size of the firm,
the life cycle stage, and the growth prospects of the firm.
1- The Financing Life Cycle of a Firm:
Early-Stage Financing and the Importance of
Venture Capital
 Venture Capital Financing for new, often high-risk
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
 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” The registration statement is
required for all public, interstate issues of securities,
with two exceptions:
a. Loan that mature within nine months.
b. Issue the involve less than $5 million.
3. The SEO examine the registration statement during a
waiting period. During this time, the firm may distribute
copies of a preliminary prospectus.
The prospectus: contain much of the information in the
registration statement, and it is given to potential investors
by the firm.
4. The company cannot sell these securities during the
waiting period.
While and after the waiting period, an advertisement
announcing a public offering is used by underwriters and
called Tombstone.
3- ALTARNATIVE ISSUE METHODS
 When a company decides to issue a new security, it
can sell it as public issue or a private issue (less than
35 investor)
 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.
This issue occurs when a company decides to go
public.
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
capital
 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 batten the underwriter's buying price
and the offering price is called the Gross spread, or
underwriting discount.
 It is the basic compensation received by the
underwriter.
 Sometime, on smaller deals, the underwriter will get
noncash compensation in the form of warrants and
stock in addition to the spread.
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
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?