McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
How Corporations Raise Venture
Capital and Issue Securities
Young firms often require venture capital to
finance growth.
The issuance of securities is a complex process that
the successful financier must comprehend.
15-2
Company Growth
Venture Capital provides entrepreneurs with
financing to grow their firms.
Firms issue securities to further finance their
growth.
15-3
Obtaining Venture Capital
 Steps to obtaining venture funding:
1.
Prepare a business plan.
2.
Receive first-stage financing.
3.
Receive subsequent staged financing.
15-4
Venture Capital Ownership:
Example
Suppose a Venture Capital firm offers to purchase 1
million of your firm’s shares for $1 each, which will give
them 50% ownership in the firm. What value are they
placing on your firm?
$1, 000, 000
Value of the Firm =
 $2, 000, 000
.50
15-5
Types of Venture Investors
 Angel Investors
• Investors who finance companies in their earliest stages of growth
 Corporate Venturers
• Corporations that offer venture assistance to finance young,
promising companies.
 Private Equity Investing
• Investors who offer funds to finance firms that do not trade on
public stock exchanges such as the NYSE or NASDAQ.
15-6
Venture Capital Management
Venture Capitalist are not passive investors.
What do they provide beyond financing?
15-7
The Initial Public Offering
When a firm requires more capital than private investors can
provide, it can choose to go public through an Initial Public
Offering, or IPO.

Primary Offering
– when new shares are sold to raise additional cash
for the company

Secondary Offering
– when the company’s founders and venture
capitalists cash in on some of their gains by selling
shares.
Does a secondary offering provide additional capital to the firm?
15-8
Benefits of Going Public
 Ability to raise new capital
 Stock price provides performance measure
 Information more widely available
15-9
Benefits of Going Public
 Diversified sources of finance
 Reduced borrowing costs
15-10
Arranging Public Issues
Steps to issue a new public security:
SEC Registration
1.
•
Prospectus—a formal summary that provides
information on an issue of securities
2.
Select Underwriter / Undertake Roadshow
3.
Set final issue price for public
15-11
IPO Flowchart
1
Underwriter
2
Firm
Investors
3
4
1.
2.
3.
4.
5.
5
Underwriter provides advice to firm
Underwriter pays firm for a number of shares
Firm provides shares to underwriter to be resold
Underwriter offers shares to investors
Investors purchase shares from underwriter
15-12
Underwriter Spread
Spread - the difference between the public offer
price and the price paid by underwriter
Assume the issuing company incurs $1 million in expenses to sell 3
million shares at $40 each to an underwriter; the underwriter sells
the shares at $43 each. What is the spread for this deal?
15-13
Underwriting Arrangements
Firm Commitment:
Underwriters buy the securities from the firm and then
resell them to the public.
Best Efforts Commitment:
Underwriters agree to sell as much of the issue as possible
but do not guarantee the sale of the entire issue.
15-14
Underwriting Arrangements:
Capital To Firm
How much will a firm receive in net funding from a firm commitment
underwriting of 250,000 shares priced to the public at $40 if a 10%
underwriting spread has been added to the price paid by the underwriter?
Additionally, the firm pays $600,000 in legal fees.
15-15
Underpricing of an IPO
Underpricing: Issuing securities at an offering price set below
the true value of the security.
Example: Assume the issuer incurs $1 million in other expenses to sell 3
million shares at $40 each to an underwriter and the underwriter sells the shares
at $43 each. By the end of the first day’s trading, the issuing company’s stock
price had risen to $70. What is the total cost of underpricing?
Cost of Underpricing:
15-16
Flotation Costs
Flotation Costs: The costs incurred when a firm
issues new securities to the public.
What are some of the specific costs incurred when a firm
issues new securities?
15-17
Types of Offerings
After the IPO, successful firms may issue additional
equity or debt.
 Seasoned Offering

Rights Issue
Issue of securities offered only to current stockholders.

General Cash Offer
Sale of securities open to all investors by an already-public
company.
15-18
Rights Issue: Example
An investor exercises his right to buy one additional share at
$20 for every five shares held. How much should each share be
worth after the rights issue if they previously sold for $50 each?
Pre-Rights Issue:
Post-Rights Issue:
+
15-19
General Cash Offer and
Shelf Registration
Shelf Registration: A procedure that allows firms to file one
registration statement for several issues of the same security.
1.
2.
3.
4.
Benefits of Shelf Registration:
Security issuance without excessive costs
Security issuance on very short notice
Timed issuance to capitalize on favorable market
conditions
Additional underwriter competition
15-20
Private Placements
In order to avoid registering with the SEC, a
company can issue a security privately.
Private Placement: The sale of securities to a limited
number of investors without a public offering
15-21
Private Placements-Advantages

Do not have to register with SEC

Private placements cost less than public issues

Contracts can be customized for each investor
15-22
Private PlacementsDisadvantages

Difficult for investors to resell security

Lenders often require higher return to compensate
for higher risk.
• Private placements typically yield .5% higher than
public issues
15-23