Chapter 19. Raising Capital. Private financing for new, high-risk businesses in exchange for stock Individual investors Venture capital firms

Transcription

1 Chapter 19 Raising Capital Private financing for new, high-risk businesses in exchange for stock Individual investors Venture capital firms Usually involves active participation by venture capitalists (VCs) Ultimate goal: Take company public The VCs will benefit from the capital raised in the initial public offering (IPO) Venture Capital is Expensive 1-1

2 Funding provided in several stages Contingent upon specified goals at each stage First stage Ground-floor money or Seed money This money funds prototypes and the manufacturing plan Second stage Mezzanine financing (mix of debt & equity) Debt is high-interest-rate debt that has an option for eventual conversion to equity This money funds manufacturing, marketing, and distribution 1. Management obtains permission from the Board of Directors 2. Firm files a registration statement with the Securities & Exchange Commission 3. The SEC examines the registration during a 20-day waiting period 4. Securities may not be sold during this waiting period 1-2

3 5. A preliminary prospectus, called a red herring, is distributed during the waiting period If any problems emerge, the company amends the registration and the waiting period starts over 6. Price/share is determined on the effective date of the registration and the selling effort begins Investment banks in the syndicate are divided into brackets Firms are listed alphabetically within each bracket Pecking order Higher bracket = greater prestige Underwriting success is built on reputation 1-3

4 Public Issue Registration with SEC required General cash offer = offered to general public Rights offer = offered only to current shareholders IPO = Initial Public Offering SEO = Seasoned Equity Offering Private Issue Sold to fewer than 35 investors SEC registration not required Underwriting services: Formulate method to issue securities Price the securities Sell the securities Stabilize the stock s price in the aftermarket (done by the lead underwriter) 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 & what the syndicate then sells the security for in the market 1-4

5 Issuer sells entire issue to underwriting syndicate Syndicate resells issue to the public Underwriter makes money on the spread between the price paid to the issuer and the price received from investors when the stock is sold Syndicate bears the risk of not being able to sell the entire issue for more than the cost Most common type of underwriting in the United States Underwriter makes best effort to sell the securities at an agreed-upon offering price Issuing company bears the risk of the issue not being sold Offer may be pulled if not enough interest exists/emerges at the offer price The company does not get the capital and it has still incurred substantial flotation costs Less common in recent years 1-5

6 Buyers: Each bids a price and number of shares Seller: Works down through the list of bidders Determine the highest price at which it can sell the desired number of shares All successful bidders pay the same price per share Encourages aggressive bidding The company wants to sell 1,500 shares of stock. The firm will sell 1,500 shares at $15/share, and Bidders A, B, C, and D will get shares all at $15/share. D only gets 350 of the 450 shares that it bid on 1-6

7 Not legally required but common Restricts insiders from selling IPO shares for a specified time period Common lockup period = 180 days Stock price tends to drop when the lockup period expires due to market anticipation of additional shares hitting the Street IPO pricing is very difficult No current market price available Dutch Auctions designed to eliminate first day IPO price pop Underpricing causes the issuer to leave money on the table Degree of underpricing varies over time 1-7

8 Underwriters want offerings to sell out Reputation for successful IPOs is critical Underpricing = insurance for underwriters Oversubscription & allotment Smaller, riskier IPOs underprice to attract investors Most Common Motivations for IPO: Create Public Shares for Use in Acquisitions Establish Market Value of the Firm Enhance Reputation of Firm Diversify Ownership and Owner Wealth Most Common Reasons for Underpricing: Compensate Investors for IPO Risk Increase Post-Issue Trading Volume Curry Favor with Institutional Investors Increase Publicity on Opening Day 1-8

9 Stock prices tend to decline when new equity is issued Managerial Information: If management believes equity is overvalued, they would choose to issue stock shares. Usually benefits current shareholders but new shareholders anticipate the superior information and bid down the price of the stock over time. Debt usage: Issuing stock may indicate firm has too much debt and can not issue more debt Issue costs Issue costs for equity direct and indirect - are significantly more than for debt Total direct costs 10.4% Direct costs are very large, especially for issues less than $10 million (where these costs are as high as 25.2%) Underpricing cost 19.3% Average spread = 7.0% Patterns: Substantial economies of scale Costs of selling debt < issuing equity IPO costs > SEO costs Straight bonds < Convertible bonds 1-9

10 Bonds Public issue of long-term debt Private issues Term loans Direct business loans from commercial banks, insurance companies, etc. Maturities from 1 to 5 years Repayable during the life of the loan Private placements Similar to term loans with longer maturity Easier to renegotiate than public issues Lower costs than public issues No SEC registration SEC Rule 415 Permits firm to register a large issue with the SEC and sell it in small portions Reduces flotation costs Allows company more flexibility to raise money quickly 1-10