RAISING CAPITALChapter 15

Definition of capital: borrowed sums or equity withwhich 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: the value of an ownership interest

in property interest in a corporation in the form of common stock or preferred stocks

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.

Introduction

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.

1- The Financing Life Cycle of a Firm:Early-Stage Financing and Venture Capital

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?

Capital for new firms

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).

1. Financing strength is important.2. Style is important.3. References are important. 4. Contacts are important.5. Exit strategy is important.

Choosing a venture capital

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.

2- SELLING SECURITIES TO THE PUBLIC

The second exception is known as the small-issues exemption. Under this basic small-issues exemption, issues of less than $5 million are governed by Regulation A.

Regulation A: is an SEO regulation that exempts public issues of less than $5 million from most registration requirement.

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. The preliminary prospectus is sometime called a red herring.

4. The company cannot sell these securities during the waiting period.5. On the effective date of the registration statement, a price is determines and a full-fledged selling effort gets under way. A final prospectus must accompany the delivery of securities or confirmation of sale, whichever come first.

When a company decides to issue a new security, it can sell it as public issue or a private issue.

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.

3- ALTARNATIVE ISSUE METHODS

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, or an unseasoned new issue.

This issue occurs when a company decides to go public.

All initial public offering are cash offers. If the firm’s existing shareholder wanted to

buy the shares, the firm wouldn’t have to sell them publicly in the first place.

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.

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

4- 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

Underwriters

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.

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 underwriting

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

Types of underwriter

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”

IPOs & under pricing

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

Why Does Underwriting Exist??

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.

THE COST OF ISSUING SECURITIES

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

Rights

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

The value of a right

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?

Rights Offering Example

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

Dilution

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

Issuing Long-term Debt

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?

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