Chapter 4: Long Term Finance – Equity Finance
Slides available at: http://bit.ly/equityfinance
Equity Finance – a way of raising capital (money) by selling shares of a company to investors.
Ordinary Shareholder Rights
• Attend general meetings of the company
• Vote on…
– the appointment of directors of the company
– the appointment, pay and removal of auditors
– Important company matters (repurchase of shares, using shares for a takeover bid
• To Receive…
– The annual accounts of the company and auditor reports
– A share of any dividend agreed to be distributed
• To participate in a new issue of shares in the company (pre-emptive right)
Equity Finance: Risk & Return
• „Ordinary Shareholders are the ultimate bearers of the risk associated with business activities.“
• Proceeds of liquidation paid in this order:
1. Secured Creditors (Ex: Banks)
2. Unsecured Creditors (Suppliers)
3. Preference Shareholders (Company Owners)
4. Ordinary Shareholders (Shareholders)
• Highest Risk = Highest Reward
1. Ordinary Shareholders expect the highest return on investment
The Stock Exchange
• Ordinary Shares are traded on Stock Exchange
• To be listed on the stock exchange, a company needs:
– Sponsor – usually a merchant bank
• Published prospectus, manages listing process & liases with Stock Exchange
– Broker – advises on issue price & markets new issuance to investors
Initial Public Offering (IPO)
• Issuing shares in order to obtain a listing on the stock exchange.
• Methods of Issuing Shares:
– Placing – issued at a fixed price to Institutions. Cheap + low risk.
– Public Offer – issued at a fixed price to the public. Typically underwritten (guaranteed)
– Introduction – exchange listing is granted to existing ordinary shares that already have a wide
ownership. No new selling involed (no new finance).
Listing Regulations
• Must publish a prospectus with forecast & other relative information
• Audited published accounts for at least 3 years prior
• At least 25% of shares must be in public hands when trading begins
• The Company must be able to conduct business without controlling shareholders
• Minimum market capitalization of ₤700,000
Advantages of Being “Listed”
• Raise finance through coming to market
– To pay back Venture Capitalists
– To realize own initial investment
– To raise funds for the company
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Access to finance
– More likely to attract institutional investment
– Credibility and reputation enhanced by listing
Uses of Shares
– For financing a takeover
• Via issuing new shares to raise more capital
• Or offering target company shareholders shares
Disadvantages of Being “Listed”
• High Cost of Becoming Listed
• High Cost of maintaining listing
– Increased financial disclosure
• Shareholder expectations
– Possibility of takeover via „market for corporate control“
• If Shareholder expectations arent met:
– Shareholders more willing to sell shares to takeover Co.
• More Transparency = Bidders find Acquisition Targets easier
Rights Issues
• To Issue New Shares
– Must first offer them to existing shareholders
• „Rights Issue“ (less costly for company)
• Shares offered at a discount (15%-20%)
– Rights can be traded!
• The Value of Rights & Rights Trading can be calculated.
– See the book
Scrip Issues + Share Splits
• Scrip Issues & Share Splits
– Increase Number of Shares without raising additional finance
• Scrip Issues
– Conversion of existing capital reserves or retained earnings into additional shares
– Distributed pro-rata to existing shareholders
• Share Split
– Reduction of Share Price
– 2:1 or 3:1
– Moving into „more favorable“ price category
Scrip Dividends + Share Repurchase
• Scrip Dividends
– Share issue instead of cash dividend issue
• Share Repurchase
– Carefully regulated to protect shareholders
– Number of shares fall = Higher EPS
Preference Shares
• Higher in the Creditor Hierarchy
– Less Risky than Ordinary Shares
– No voting rights
• May have Variable Dividend Rate
• Advantages
– Do not carry voting rights, thereby not diluting ownership and control
– Preserve Debt Capacity, since they are unsecured
• Disadvantages
– Higher Cost for Companies than debentures