Topic 2 Raising Capital edited for A181 CF UG

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Topic 2 : Raising Capital
Lecture Objectives
•
To explain the sources of external financing: venture capital, IPO, SEO and
bonds.
• To discuss the announcement and dilution effects of new equity issues.
• To discuss the rationale and mechanics of a right offerings.
Readings or websites to visit
www.techinasia.com
News on venture capital in the technology sector in Asia
Henderson, Jegadeesh, and Weisbach (2006) World Markets for Raising New
Capital , Journal of Financial Economics (vol 82) pp 63–101
BWFF 3013 Corporate Finance
1-0
20.1
20.2
20.3
20.4
20.5
20.6
20.7
20.8
20.9
20.10
20.11
Chapter Outline
Early-Stage Financing: Venture Capital &Crowdfunding
The Public Issue
Alternative Issue Methods
The Cash Offer
The Announcement of New Equity and the Value of the Firm
The Cost of New Issues
Rights
The Rights Puzzle
Dilution
Shelf Registration
Issuing Long-Term Debt
1-1
Venture Capitalists (VCs)
•
Financial intermediaries that are typically set up as
limited partnerships
•
Play an active role in overseeing, advising, and
monitoring companies in which they invest
•
Generally do not want to own the investment
forever
1-2
Crowdfunding
• Alternative method of raising equity finance.
• Entrepreneur or business can attract “crowd” of
investors.
• Each of whom takes a small stake by contributing
towards an online fundraising target.
• Eg of crowdfunding organization in Malaysia are
Pitch Platform Sdn Bhd and Alix Global Sdn Bhd
https://www.tutor2u.net/business/reference/crowdfunding
BWFF 3013 Corporate Finance
1-3
Stages of Financing
1.
2.
3.
4.
5.
6.
Seed-Money Stage
Start-Up
First-Round Financing
Second-Round Financing
Third-Round Financing
Fourth-Round Financing
1-4
20.2 The Public Issue
• The Basic Procedure In The U.S.
• Management gets the approval of the Board.
• The firm prepares and files a registration statement
with the SEC.
• The SEC studies the registration statement during
the waiting period.
• The firm prepares and files an amended registration
statement with the SEC.
• If everything is satisfactory with the SEC, a price
is set and a full-fledged selling effort gets
underway.
1-5
The Process of a Public Offering
Steps in Public Offering
Time
Several months
1. Pre-underwriting conferences
20-day waiting period
2. Registration statements
Usually on the 20th day
3. Pricing the issue
After the 20th day
4. Public offering and sale
30 days after offering
5. Market stabilization
1-6
An Example of a Tombstone
1-7
20.3 Alternative Issue Methods
• There are two kinds of public issues:
• The general cash offer
• The rights offer
• Almost all debt is sold in general cash offerings.
1-8
Table 20.1 - I
1-9
Table 20.1 - II
1-10
20.4 The Cash Offer
• There are three methods for issuing securities for
cash:
• Firm Commitment
• Best Efforts
• Dutch Auction
• There are two methods for selecting an underwriter
• Competitive
• Negotiated
1-11
Firm Commitment Underwriting
• The issuing firm sells the entire issue to the
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
1-12
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.
• The offer may be pulled if there is not
enough interest at the offer price. The
company does not get the capital, and they
have still incurred substantial flotation costs.
• This type of underwriting is not as common
1-13
Dutch Auction Underwriting
• Underwriter accepts a series of bids that include number of
shares and price per share.
• The price that everyone pays is the highest price that will result
in all shares being sold.
• There is an incentive to bid high to make sure you get in on the
auction but knowing that you will probably pay a lower price
than you bid.
• The Treasury has used Dutch auctions for years.
• Google was the first large Dutch auction IPO.
1-14
Investment Banks
• Also called underwriters
• Perform critical functions:
• Help determine type of security, method of
sale, and offering price
• Sell the securities
• Typically using a syndicate to limit risk
• For compensation – the spread
• Stabilize IPO prices in the aftermarket
1-15
IPO Underpricing
• May be difficult to price an IPO because there is not
a current market price available.
• Private companies tend to have more asymmetric
information than companies that are already publicly
traded.
• Underwriters want to ensure that, on average, their
clients earn a good return on IPOs.
• Underpricing causes the issuer to “leave money on
the table.”
1-16
IPO Underpricing In Asia And Various Countries
1-17
20.5 The Announcement of New
Equity and the Value of the Firm
• The market value of existing equity drops on the announcement
of a new issue of common stock.
• Reasons include
• Managerial Information
Since the managers are the insiders, perhaps they are
selling new stock because they think it is overpriced.
• Debt Capacity
If the market infers that the managers are issuing new
equity to reduce their debt-equity ratio due to the specter
of financial distress, the stock price will fall.
• Issue Costs
1-18
20.6 The Cost of New Issues
1.
2.
3.
4.
5.
6.
Gross spread, or underwriting discount
Other direct expenses
Indirect expenses
Abnormal returns
Underpricing
Green Shoe Option
1-19
The Costs of Equity Public Offerings
Proceeds
Direct Costs
Underpricing
(in millions)
SEOs
IPOs
IPOs
2 - 9.99
35.11%
25.22%
20.42%
10 - 19.99
13.86%
14.69%
10.33%
20 - 39.99
9.54%
14.03%
17.03%
40 - 59.99
13.96%
9.77%
28.26%
60 - 79.99
6.85%
8.94%
28.36%
80 - 99.99
6.72%
8.55%
32.92%
100 - 199.99
5.23%
7.96%
21.55%
200 - 499.99
4.94%
6.84%
6.19%
500 and up
3.37%
5.50%
6.64%`
1-20
20.7 Rights
• If a preemptive right is contained in the firm’s
articles of incorporation, the firm must offer any
new issue of common stock first to existing
shareholders.
• This allows shareholders to maintain their
percentage ownership if they so desire.
1-21
Mechanics of Rights Offerings
• The management of the firm must decide:
• The exercise price (the price existing shareholders must pay
for new shares).
• How many rights will be required to purchase one new
share of stock.
• These rights have value:
• Shareholders can either exercise their rights or sell their
rights.
1-22
Rights Offering Example
• Popular Delusions, Inc. is proposing a rights
offering. There are 200,000 shares outstanding
trading at $25 each. There will be 10,000 new shares
issued at a $20 subscription price.
• What is the new market value of the firm?
• What is the ex-rights price?
• What is the value of a right?
1-23
What is the new market value of the firm?
$25
$20
$5,200,000  200,000 shares 
 10,000 shares 
share
shares
There are 200,000
outstanding shares at
$25 each.
There will be 10,000 new
shares issued at a $20
subscription price.
1-24
What Is the Ex-Rights Price?
• There are 210,000 outstanding shares of a firm with a
market value of $5,200,000.
• Thus the value of an ex-rights share is:
$5,200,000
= $24.7619
210,000 shares

And, the value of a right is:
$0.2381 = $25 – $24.7619
1-25
Alternative Way to Compute the ExRights Price and Value of a Right
• 10,000 new shares will be issued for 200,000 outstanding shares,
or this is a 1 for 20 rights issue
• Hence we have:
20 shares @ $25
plus
1 share @ $20
= $500
= $20
equals 21 shares with value of
so price of 1 share ex-rights
$520
$520/21 = $24.7619
• Value of 1 right = $25 - $24.7619 = $0.2381
1-26
20.8 The Rights Puzzle
• The vast majority of new issues in the U.S. are underwritten,
even though rights offerings are much cheaper.
• A few explanations:
• Underwriters increase the stock price. There is not much
evidence for this, but it sounds good.
• The underwriter provides a form of insurance to the
issuing firm in a firm-commitment underwriting.
• Underwriters “certify” the price to the market.
• The proceeds from underwriting may be available sooner
than the proceeds from a rights offering.
1-27
20.9 Dilution
• Dilution is a loss in value for existing shareholders:
• Percentage ownership – shares sold to the general public without a
rights offering
• Market value – firm accepts negative NPV projects
• Earnings per share – may decline even with positive NPV projects (at
least in short run)
• Book value– occurs when market-to-book value is less than one
1-28
20.10 Shelf Registration
• Permits a corporation to register an offering that it reasonably
expects to sell within the next two years.
• Not all companies are allowed shelf registration.
• Qualifications include:
• The firm must be rated investment grade.
• They cannot have recently defaulted on debt.
• The market capitalization must be > $150 m.
• No recent SEC violations.
1-29
20.11 Issuing Long-Term Debt
• Public issuance follows the same general process as
stocks
• Direct financing
• Term loans
• Private placements
• Direct financing may have more restrictive covenants
and higher rates, but is less costly to issue and easier
to negotiate.
1-30
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