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Chapter 19Issuing Securities

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Public Offering of Securities

• Traditional underwritingTraditional underwriting

– SEC registration takes several weeksSEC registration takes several weeks

• Shelf registrationShelf registration

– Quicker and more efficient than Quicker and more efficient than traditional security offeringstraditional security offerings

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Traditional Underwriting• Underwriting syndicate is formed to spread risk Underwriting syndicate is formed to spread risk

and obtain better distributionand obtain better distribution– Underwriters guarantee payment to the security Underwriters guarantee payment to the security

issuer, regardless of the success of the offeringissuer, regardless of the success of the offering– Lead investment banker works directly with the firm Lead investment banker works directly with the firm

in determining the essential features of the issuein determining the essential features of the issue

• Compensation to investment bankersCompensation to investment bankers– Gross underwriting profitGross underwriting profit– Selling concessionSelling concession

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Best Efforts Offering

• Investment bankers agree only to sell as Investment bankers agree only to sell as many securities as they can at an many securities as they can at an established priceestablished price

– Have no responsibility for securities that Have no responsibility for securities that are unsoldare unsold

– Bear no riskBear no risk

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Making a Market

• Important to investors of IPOsImportant to investors of IPOs

• Underwriter maintains a position in the Underwriter maintains a position in the stockstock

• Underwriter maintains a secondary market Underwriter maintains a secondary market for the stockfor the stock

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Shelf Registrations

• Shortcut registration process under Rule 415Shortcut registration process under Rule 415

• Company files a form with the SEC Company files a form with the SEC describing itself, its financing needs, and the describing itself, its financing needs, and the securities it is likely to issue over the next 2 securities it is likely to issue over the next 2 yearsyears

• Flexibility to time issues to market Flexibility to time issues to market conditions, and the issues need not be largeconditions, and the issues need not be large

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Flotation Costs

• Cost for a large common stock issue, using a Cost for a large common stock issue, using a traditional underwriting, might run 3 to 4 traditional underwriting, might run 3 to 4 percent of the gross proceedspercent of the gross proceeds

• For smaller issues, it will run upward to 8 For smaller issues, it will run upward to 8 percentpercent

• With a shelf registration, costs run about 2 With a shelf registration, costs run about 2 percentpercent

– Legal and administration costs are lower Legal and administration costs are lower

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Government Regulations

• Securities Act of 1933 dealt with the sale of Securities Act of 1933 dealt with the sale of new securities and required the full new securities and required the full disclosure of information to investorsdisclosure of information to investors

• Securities Exchange Act of 1934 dealt with Securities Exchange Act of 1934 dealt with the regulation of securities already the regulation of securities already outstanding and created the SEC to enforce outstanding and created the SEC to enforce the two actsthe two acts

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Registration Process• Purpose is to protect the investor through proper Purpose is to protect the investor through proper

disclosure of financial and legal information disclosure of financial and legal information about the issuing corporationabout the issuing corporation

• Exemption if security is sold to a limited number Exemption if security is sold to a limited number of financially sophisticated investors (private of financially sophisticated investors (private placement)placement)

• Corporation must file a copy of the prospectusCorporation must file a copy of the prospectus– Summary of the essential information in the Summary of the essential information in the

registration statementregistration statement– Must be available to prospective investors and Must be available to prospective investors and

others who request itothers who request it

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Info in Registration Statement

• Nature and history of the companyNature and history of the company

• Use of the proceeds Use of the proceeds

• Financial statementsFinancial statements

• Management and directors and their security Management and directors and their security holdingsholdings

• Competitive conditions and risksCompetitive conditions and risks

• Legal opinionsLegal opinions

• Description of the securityDescription of the security

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SEC Review• See that all the required information is See that all the required information is

presented and that it is not misleading presented and that it is not misleading • Only concerned with the presentation of Only concerned with the presentation of

complete and accurate information on all complete and accurate information on all material facts regarding the securitymaterial facts regarding the security

• Not concerned with the investment valueNot concerned with the investment value• Minimum period required is 20 daysMinimum period required is 20 days• Usual time lapse is around 40 daysUsual time lapse is around 40 days

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Streamlining Registration Procedures

• Less scrutiny by SECLess scrutiny by SEC• Larger companies(> $250 million market Larger companies(> $250 million market

capitalization) no longer will be required to go capitalization) no longer will be required to go through the lengthy review processthrough the lengthy review process

• Companies of all sizes will face fewer restrictions Companies of all sizes will face fewer restrictions in how they market and communicate with in how they market and communicate with potential investorspotential investors

• Provide more timely and accurate information to Provide more timely and accurate information to investorsinvestors

• Underwriters will be required to undertake more Underwriters will be required to undertake more due diligence in ferreting out fraud and deceptiondue diligence in ferreting out fraud and deception

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SEC Regulations in the Secondary Market

• Activities of the security exchangesActivities of the security exchanges

• Over-the-counter marketOver-the-counter market

• Investment bankers and brokersInvestment bankers and brokers

• National Association of Security DealersNational Association of Security Dealers

• Investment companiesInvestment companies

• Requires monthly reports on insider stock Requires monthly reports on insider stock transactionstransactions

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Selling Common Stock Through a Rights Issue

• Preemptive rightPreemptive right– Existing common stockholders have the right to Existing common stockholders have the right to

preserve their proportionate ownership in the preserve their proportionate ownership in the corporationcorporation

• Offering through rightsOffering through rights– Rights issues are to existing shareholders, with a Rights issues are to existing shareholders, with a

subscription price below existing share pricesubscription price below existing share price– The holder of rights has three choices: exercise them, The holder of rights has three choices: exercise them,

sell them, or do nothingsell them, or do nothing– Stock sells rights-on through date of recordStock sells rights-on through date of record– Stock sells ex-rights after date of recordStock sells ex-rights after date of record

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Value of Rights• Function of the present market price of the stock, Function of the present market price of the stock,

the subscription price, and the number of rights the subscription price, and the number of rights required to purchase an additional share of stockrequired to purchase an additional share of stock

• Theoretical market value, stock selling rights-onTheoretical market value, stock selling rights-on• Theoretical value of one share of stock selling Theoretical value of one share of stock selling

ex-rightsex-rights• Theoretical value of a right, stock selling ex-Theoretical value of a right, stock selling ex-

rights rights 1

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SPR

1

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SPR XX

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Success of the Offering

• Setting the subscription priceSetting the subscription price

• Amount of discountAmount of discount

• Size of the capital outlaySize of the capital outlay

• Mix of existing stockholdersMix of existing stockholders

• Balance between institutional and Balance between institutional and individual investorsindividual investors

• Current trend and tone of the stock marketCurrent trend and tone of the stock market

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Standby Underwriting• Standby arrangements guarantee to the issuer that the Standby arrangements guarantee to the issuer that the

funds will be raisedfunds will be raised• Underwriter charges a fee that varies with the risk Underwriter charges a fee that varies with the risk

involved in the offeringinvolved in the offering– Flat feeFlat fee– Additional fee for each unsold share of stockAdditional fee for each unsold share of stock

• Underwriter sells a put option to the firm and its Underwriter sells a put option to the firm and its shareholdersshareholders

• Standby fees are significant and increase with the Standby fees are significant and increase with the volatility of the stockvolatility of the stock

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Oversubscriptions

• Awarded on a pro rata basis relative to the Awarded on a pro rata basis relative to the number of unsold sharesnumber of unsold shares

• Increases the chances that the issue will be Increases the chances that the issue will be entirely soldentirely sold

• Still possible to fall shortStill possible to fall short

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Rights Issue Versus Offering

Rights IssueRights Issue• Principal sales tool is Principal sales tool is

the discount from the the discount from the current market pricecurrent market price

• Lower flotation costLower flotation cost• Stock sold at lower Stock sold at lower

priceprice• More dilutionMore dilution• Less distributionLess distribution

Public OfferingPublic Offering• Major selling tool is the Major selling tool is the

investment banking investment banking organizationorganization

• Higher flotation costHigher flotation cost• Stock sold at higher Stock sold at higher

priceprice• Less dilutionLess dilution• Wider distribution Wider distribution

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Green Shoe Provision

• Option to purchase additional securities at Option to purchase additional securities at the offering pricethe offering price

• Lasts several weeks after the offeringLasts several weeks after the offering

• Benefits the holderBenefits the holder

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Financing a Fledgling• Founders and angels get the idea formulated, initially Founders and angels get the idea formulated, initially

survey the potential market, and develop a business survey the potential market, and develop a business planplan

• Venture capitalists provide early stage financing to Venture capitalists provide early stage financing to new enterprisesnew enterprises

• Stages of VC financingStages of VC financing– Seed moneySeed money– Start-upStart-up– First-roundFirst-round– Second-roundSecond-round– Third-roundThird-round– BridgeBridge

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Financing Structure

• Preferred stock with equity linkPreferred stock with equity link

• Letter stockLetter stock

• Staged financingStaged financing

– Pre-offer market pricePre-offer market price

• SyndicateSyndicate

• Venture capital portfolioVenture capital portfolio

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Initial Public Offerings• Conform to SEC requirementsConform to SEC requirements

– Board of directorsBoard of directors– Disclosing sensitive informationDisclosing sensitive information– Employ certain accounting conventionsEmploy certain accounting conventions– Incurring expenses as a public companyIncurring expenses as a public company– Investor fixation on quarterly earningsInvestor fixation on quarterly earnings

• Underpricing of IPOUnderpricing of IPO– Typically have a “pop” in price on the first day of tradingTypically have a “pop” in price on the first day of trading– Lure uninformed investors into the marketLure uninformed investors into the market– Price of admission to the public marketPrice of admission to the public market

• Long-run underperformance attributable to IPOs that Long-run underperformance attributable to IPOs that are not venture capitalist-backedare not venture capitalist-backed

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Information Effects of Announcing a Security Issue

• Negative stock price reaction (or abnormal return) Negative stock price reaction (or abnormal return) to a common stock or convertible security issueto a common stock or convertible security issue

• Expectations of future cash flowsExpectations of future cash flows• Asymmetric information between investor and Asymmetric information between investor and

management is the foundation for an information management is the foundation for an information effecteffect– Managers are more likely to issue debt when they Managers are more likely to issue debt when they

believe the common stock is underpriced in the market believe the common stock is underpriced in the market and to issue common stock when it is believed to be and to issue common stock when it is believed to be overpricedoverpriced

• Seasoned equity offerings (non-IPOs) Seasoned equity offerings (non-IPOs) underperform nonissuing public corporations on underperform nonissuing public corporations on averageaverage