Raising capital. Raising money is not the same as making money

Transcription

1 Raising capital Raising money is not the same as making money

2 Types of Financial Instruments Used by All SMEs in Canada Formal financing Percent of total Commercial line of credit 21.65% Commercial credit cards 20.78% Commercial loans 19.05% Leasing 12.99% Government loans and grants 9.09% Factoring and micro-credit 11.26% Venture capital 5.19% Total % Informal financing Percent of total Personal savings of owners 15.70% Retained earnings 14.88% Trade credit to suppliers 14.33% Owner's personal credit cards 13.77% Owner's personal line of credit 12.40% Personal bank loans to owners 9.09% Loans from friends and relatives 6.61% Loans from employees 4.96% Loans from unrelated individuals (angel investors) 4.13% Other sources 4.13% Total %

3 Suppliers of business financing Source: Statistics Canada Domestic banks 54.00% 54.00% 54.00% 52.00% 52.00% 53.00% Other banks 11.00% 11.00% 12.00% 13.00% 13.00% 16.00% 9.00% 10.00% 10.00% 10.00% 10.00% 10.00% 12.00% 11.00% 11.00% 12.00% 13.00% 11.00% 3.00% 2.00% 2.00% 2.00% 2.00% 2.00% 11.00% 12.00% 11.00% 11.00% 10.00% 8.00% % % % % % % Credit unions, caisses populaires Finance companies Portfolio managers, venture capital companies and financial funds Insurance companies Total

4 Venture capital investment in the US Source: PricewaterhouseCoopers/National Venture Capital Association, MoneyTree Report, Data: Thomson Reuters Year Number of deals Amount invested ,839 $7,995,782, ,571 $11,265,113, ,155 $14,870,890, ,647 $21,079,265, ,502 $54,048,043, ,900 $104,767,767, ,484 $40,577,326, ,102 $22,009,668, ,944 $19,776,882, ,093 $22,468,158, ,155 $23,173,465, ,675 $26,740,603, ,952 $30,885,861, ,808 $28,298,040, ,146 $19,901,000, ,646 $23,360,000, ,001 $29,710,000, ,858 $27,323,000, ,995 $29,365,000,000

5 Venture capital investment in the US by stage Source: PricewaterhouseCoopers/National Venture Capital Association, MoneyTree Report, Data: Thomson Reuters Stage Startup/Seed $1,177,319,200 $1,267,968,200 $1,509,963,800 $825,000,000 $943,000,000 Early Stage $4,172,001,400 $5,486,760,800 $5,339,272,800 $8,312,000,000 $9,759,000,000 Expansion $11,521,031,400 $11,677,215,200 $10,604,468,700 $9,445,000,000 $9,838,000,000 Later Stage $9,870,251,400 $12,453,916,900 $10,844,335,300 $8,742,000,000 $8,825,000,000 Grand Total $26,740,603,400 $30,885,861,100 $28,298,040,600 $27,323,000,000 $29,365,000,000 Stage Number of deals Number of deals Number of deals Number of deals Number of deals Startup/Seed Early Stage 940 1,036 1,013 1,738 2,003 Expansion 1,366 1,259 1, Later Stage 1,014 1,207 1, Grand Total 3,675 3,952 3,808 3,858 3,995

6 Bond vs. Bank Loans Loans & Syndicated Loans: Amortized to spread out the risk of default Typically senior to all other debt obligations Can be traded when securitized (see the infamous CDOs) Bonds: Designed to be traded in secondary markets Default risk is borne by a multitude of individual and institutional investors Not amortized

7 Terminology Bond indenture: A contract detailing the obligations of the issuer and the rights of the bondholders Bond covenant: A provision in the bond indenture that constrains the issuer. Ex: the issuer has to maintain a certain cash coverage ratio, or is not allowed to increase dividends, etc. Bond trustee: (usually a bank) handles the indenture and has fiduciary duties on behalf of bondholders. The trustee becomes actively involved in governance and administration matters if the issuer goes bankrupt. Sinking fund provision: It reduces credit risk because it specifies that the issuer must retire a predetermined amount on a periodical basis.

8 Several types of bonds Mortgage bonds have liens on specified real assets. Collateral trust bonds are guaranteed with common stock, notes, bonds and other financial assets. Debentures are not secured by specific assets, but rather by the good name of the issuer. Subordinated debentures rank lower than secured debt, debenture bonds, and some general creditors. Guaranteed bonds are guaranteed by another entity, such as a financial institution or government agency. Convertible bonds grant the bondholder the right to convert his bond into common stock. Debt with warrants allow warrant-holders to buy common stock at a set price - "sweeteners" or "equity kickers." Putable bonds can be sold back to the issuer at par Zero-coupon or deep discount bonds pay no coupon Floating-rate securities pay variable interest, following market trends Callable bonds can be redeemed by the issuer prior to maturity at a predetermined price, usually at a premium Junk-bonds are nowadays euphemistically called "high-yield bonds."...see "fallen angels" Payment-in-kind bonds (PIK) allow the issuer to chose between paying cash or issue another (junk) bond to the bondholder Etc.

9 Fixed-income risk Default risk Interest rate risk

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11 Issuance in the U.S. Bond Markets ($ Billions) Source: Securities Industries and Financial Markets Association, U.S. Department of Treasury, Federal Agencies, Thomson Financial, Inside MBS & ABS, Bloomberg. Municipal Treasury1 Mortgage-Related Corporate debt Other Securities AssetBacked Total 1996 $185 $612 $493 $344 $278 $168 $2, $221 $540 $604 $466 $323 $223 $2, $287 $438 $1,144 $611 $596 $287 $3, $228 $365 $1,025 $629 $548 $287 $3, $201 $312 $684 $588 $447 $337 $2, $288 $381 $1,671 $776 $941 $383 $4, $358 $572 $2,249 $637 $1,042 $469 $5, $383 $745 $3,071 $776 $1,268 $600 $6, $360 $853 $1,779 $781 $0 $870 $4, $408 $746 $1,967 $753 $669 $1,172 $5, $387 $789 $1,988 $1,059 $747 $1,253 $6, $429 $752 $2,050 $1,128 $942 $902 $6,203

12 Corporate bond issues in the US: Source: Securities Industries and Financial Markets Association, U.S. Department of Treasury, Federal Agencies, Thomson Financial, Inside MBS & ABS, Bloomberg. Investment Grade High Yield Total , ,128.3

13 Why do firms go public Cashing out Entrepreneurs and venture capitalists who invest in small growth firms use public offerings as an exit strategy. The capital locked in the firm at the onset is finally returned to its initial liquid form after it has (hopefully) generated an adequate return. Price discovery Once the shares become more frequently traded in the secondary market, the equity of the firm finally gets a price tag. One discovers how much investors are willing to pay for residual rights over the cash flow and control of the firm. Access to capital The issuance of public shares paves the way for subsequent equity financing. Publicly held firms also receive more favorable lending terms from banks and other financial institutions. This is so because they are now intensely scrutinized and eventually acquire a performance track record. Visibility and prestige This is self-explanatory and explains to some extent why IPOs usually involve selling only a small portion of a firm's outstanding stock. Liquidity for shareholders Shareholders can exit much easier when shares are traded in the secondary market. This has far reaching implications for corporate governance, because it is now cheaper to divest than to challenge the competence of the management.

14 Trade-offs Cost of disclosure Agency costs

15 How to get listed Filling a prospectus Direct listing Reverse takeover Graduation Etc.

16 Cost of being listed Stock Exchange fees They range between $10,000 and CDN$250,000, as determined by the market value of the company. Securities commission fees Securities commissions charge administrative fees for prospectus filing, for additional filings, additional brokerage fees, etc. Sponsorship fees The sponsorship fee is a third-party cost, payable for a due diligence study ensuring that listing requirements are met. Investment dealer fees Investment dealers charge a corporate finance fee, and a negotiable sales commission, called spread, ranging from 3%-10% of the value of the securities. This sales commission will be paid out of the offering proceeds. Professional fees Audit costs range between $12,000 and $150,000, although may be higher if a company has foreign operations. Costs of maintaining a public company Additional legal, investor relation, and accounting costs and fees related to additional reporting requirements and complying with corporate governance standards.

17 The underwriting of securities Underwriting syndicate investment banks that combine to spread the risk of a securities issue Lead underwriter Role of underwriters: Advise the issuer on the terms and the timing of the offering; Buy or take in consignment securities from the issuer; Distribute or sell the issue to the public. Types of underwriting: Best-efforts Firm commitment (bought deal)

18 Primary vs. Secondary Markets Primary markets: Investors who buy newly issued securities at subscription prices Secondary markets: Investors who buy and sell already issued securities at market prices

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25 Total Number Of IPO Pricings in the US Source: /global-ipoc-index.xhtml Fourth Quarter 2007 Total Number Total Value Average Value Fourth Quarter 2008 Third Quarter 2008 Third Quarter 2013 Fourth Quarter $13.3 billion $0.1 billion $0.9 billion $10.6 billion $23.4 billion $187.6 million $126.0 million $183.3 million $190.1 million $354.3 million

26 Summary statistics of US IPOs: Source: Thomson Financial Securities, and James R. Booth, Lena C. Booth "Agreeing to Disagree: Why IPOs are Underpriced?," Working paper Year N Average Proceeds ($m) Average Offer Price Proportion VC-Backed Proportion of Firms with Loss Proportion of Tech Firms Proportion for Repay Debt Purpose Average Underpricing (%) ($) $36.82 $ % % $52.12 $ % $40.12 $ % $52.12 $ % $52.58 $ % $48.07 $ % $42.71 $ % $62.63 $ % $57.12 $ % $61.84 $ % $ $ % $ $ % $ $ % 4,322 $71.42 $ % All

27 Four IPOs: Shares subscribed and purchased on a pro-rata basis Shares offered Shares subscribed by Joe Offering price Total shares subscribed Pro rata factor Shares actually purchased by Joe IPO One Inc. 10, $ , IPO Two Inc. 10, $ , IPO Three Inc. 10, $9.00 2, IPO Four Inc. 10, $9.00 6,

28 Initial investment Joe's expected initial investment = 400($9) = $3,600 Joe's initial investment = 40($9) + 100($9) + 100($9) + 100($9) = $3,060

29 Four IPOs: Subsequent price performance Subsequent IPO price Individual IPO return IPO One Inc. $ % IPO Two Inc. $ % IPO Three Inc. $ % IPO Four Inc. $ %

30 Returns: the Winner's Curse Joe's expected return Expected portfolio value 100($18) + 100($12) + 100($5) + 100($6) = $4,100 Expected return ($4,100/$3,600)-1 = 13.9% Joe's actual return Actual portfolio value 40($18) + 100($12) + 100($5) + 100($6) = $3,020 Actual return ($3,020/$3,060)-1 = - 1.3%

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32 Dutch Auction IPO: Bids for 4,000,000 shares to be issued at $16/share or less Bids Bid range Running total Alloted shares Winning price Proceeds Bidder A 1,000,000 $ ,000,000 1,000,000 $13,000, Bidder B 1,000,000 $ ,000,000 1,000,000 $13,000, Bidder C 1,000,000 $ ,000,000 1,000,000 $13,000, Bidder D 1,000,000 $ ,000,000 1,000,000 Bidder E 1,000,000 $ $0.00 Bidder F 1,000,000 $ $0.00 Bidder G 1,000,000 $ $0.00 Total 7,000,000 Bid-to-cover 1.75 $13.00 $13.00 $13,000, $52,000,000.00

33 Dutch Auction IPOs Faster Relatively cheaper Less underpricing More fairness More resistance form traditional investment bankers

34 SEO Seasoned Equity Offerings

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37 Rights issues AKA Preemptive rights Initially used to avoid dilution of ownership Stand-by agreements Relatively faster than standard SEO issues

38 Rights issues: Timeline Announcement date <Cum-rights date> <Ex-rights date> Holder-of-record Expiration date Cum date: The last day when shares trade with rights (cum rights) Ex date: First day when shares trades without rights (ex-rights) Holder-of-record: The day the corporation determines who was the holder of record at close on the cum date Expiration date: The last day to exercise the rights

39 Rights Offerings Initial number of shares: 5,000,000 Number of new shares planned: 1,000,000 Number of rights to be issued: 5,000,000 Subscription price: $13 for one new share Number of rights needed for one new share (N): 5,000,000/1,000,000 = 5 One new share = $ rights

40 The Valuation of Rights On the cum-date P(on) = $14.67 How much should P(ex) be at the open on the next morning, on the ex-rights date? On the ex-rights date, the stock price gets diluted because new shares are about to be issued at below-market price P(ex) = [(Initial shares)(price)+(new shares)(subscription price)]/( Initial shares + New shares) P(diluted) = P(ex-rights) = (5,000,000*$ ,000,000*$13)/(6,000,000) = $14.40 Value of one right, R = P(on) P(ex) = $ $14.40 = $0.27, caeteris paribus

41 No arbitrage condition Buy 5 rights -$1.40 Buy one new share at the subscription price: -$13 Sell share in the market: $ Profit: $0

42 The shareholder who exercises his/her rights and buys new shares (no ownership dilution): Has 5 shares before the ex-rights date and $13 in cash 5($14.67) + $13 = $86.37 Exercises 5 rights and buys one new share -$13 Has 6 shares on the ex-rights date 6($14.40 )= $86.37

43 The shareholder who sells his/her rights (ownership dilution) Has 5 shares before the ex-rights date 5($14.67) = $73.37 Sells 5 rights in the market $1.40 Has 5 shares on the ex-rights date + cash 5($14.40) + $1.40 = $73.37

44 More on rights valuation N*R + S = P(ex) that is: R = (Pex S)/N where: R = value of one right P(ex) = stock price after the ex-rights date S = subscription price N = number of rights needed to buy one new share Since P(ex) = P(on) R Then, R = (Pon S)/(N+1)

45 Rights are call options More precisely, R = max [0, (Pex S)/N] = max [0, (Pon S)/(N+1)]

46 Rights vs. Warrants Rights Warrants What Call options on stock Call options on stock Use To issue equity Attached to other (fixed-income) securities (sweeteners) Maturity Short: Several weeks Long: Several years Where Traded in the market Traded in the market Pricing In-the-money (S < P) Out-of-the-money (S > P)

47 The over-allotment option (Greenshoe option) A Greenshoe option gives the right to the underwriter to buy from the issuer an additional number of shares under the same terms as the rest. This allows the underwriter to over-subscribe the issue (similar to airlines overbooking their flights) practically, the underwriter sells short an additional number of shares

48 Greenshoe option Volume of shares to be issued 1,000,000 Offering price per share $20.00 Over-allotment (short position) 10.00% Spread 4.58% Expected gross proceeds = 1,100,000($20) $22,000, Regular proceeds to the issuer = 1,000,000($20)( ) $19,083,969.47

49 Proceeds to the issuer (the corporation) 1,000,000($20)( ) = $19,083, if the trading price falls below the offering price ($20) 1,100,000($20)( ) = $20,992, if the trading price increases above the offering price ($20) and the underwriter exercises the Greenshoe

50 Net margin to the underwriter Net margin = Gross proceeds - Proceeds owed to the issuer Cost of covering the short position Net margin = 1,100,000($20) -1,000,000($20)( ) min[ 100,000($20)( ); 100,000(P)] Net margin = $22,000, $19,083, min[ $1,908,396.9; 100,000(P)]

51 Exemplification If P = $17 (under $20) it is cheaper to buy shares in the market than to exercise the Greenshoe option Gross proceeds = $22,000, Proceeds paid to the issuer = $19,083, Cost of covering the short position = $1,700,000 Net margin to the underwriter = $22,000, $19,083, $1,700,000 = $1,216, If P = $22 (over $20), it is cheaper to exercise the Greenshoe option than to buy shares in the market Gross proceeds = $22,000, Proceeds paid to the issuer = $20,992, Net margin to the underwriter = $22,000, $20,992, = $1,007,633.59

52 Greenshoe option: Simulation of market prices immediately after offering Market price Greenshoe exercised Greenshoe exercised Greenshoe exercised $17.00 $18.00 $19.00 $20.00 $21.00 $22.00 $23.00 Proceeds $22,000, $22,000, $22,000, $22,000, $22,000, $22,000, $22,000, Cost of purchasing allotted shares from the issuer -$19,083, $19,083, $19,083, $19,083, $19,083, $19,083, $19,083, Cost of covering the short position -$1,700, $1,800, $1,900, $2,000, $1,908, $1,908, $1,908, Net margin to underwriter $1,216, $1,116, $1,016, $916, $$1,007, $1,007, $1,007,633.59

53 Reverse Greenshoe Option A reverse Greenshoe option gives the underwriter the right to sell back to the issuer a certain number of the shares at a set price.

54 Reverse Greenshoe Option Volume of shares to be issued 1,000,000 Offering price per share $20.00 Over-allotment (short position) 10.00% Spread 4.58% Expected gross proceeds = 1,000,000($20) $20,000,000.00

55 Reverse Greenshoe option: Proceeds to the issuer 1,000,000($20)( ) = $19,083, if the stock trades above the offering price ($20) $19,083, $2,000,000 = $17,083, if the stock trades below the offering price ($20)

56 Reverse Greenshoe option: Net margin to the underwriter Gross proceeds from selling the issue - Regular proceeds to the issuer + Proceeds from selling back overalloted shares to the issuer (if price falls) - Cost of purchasing the overalloted shares in the market (if price falls) Net margin to the underwriter Net margin to the underwriter = 1,000,000($20) -1,000,000($20)( ) + max[ 0; 100,000($20 - P)] Net margin to the underwriter = $20,000, $19,083, max[ 0; 100,000($20 - P)]

57 Reverse Greenshoe option: Net margin to the underwriter Gross proceeds from selling the issue - Regular proceeds to the issuer + Proceeds from selling back overalloted shares to the issuer (if price falls) - Cost of purchasing the overalloted shares in the market (if price falls) Net margin to the underwriter Net margin to the underwriter = 1,000,000($20) -1,000,000($20)( ) + max[ 0; 100,000($20 - P)] Net margin to the underwriter = $20,000, $19,083, max[ 0; 100,000($20 - P)]

58 Reverse Greenshoe option: Exemplification If P = $17 (under $20) exercise the Reverse Greenshoe option and sell back 100,000 shares to the issuer at $20 Gross proceeds = $2,000,000 Proceeds paid to the issuer = $19,083, Proceeds realized from selling 100,000 shares (overallotment) back to the issuer = $2,000,000 Cost of buying 100,000 shares (overallotment) in the market = $1,700,000 Net margin to the underwriter = $20,000,000 - $19,083, $2,000,000 -$1,700,000 = $1,216, If P = $22 (over $20) Gross proceeds = $20,000,000 Proceeds to the issuer = $19,083, Net margin to the underwriter = $20,000, $19,083, = $916,030.53

59 Reverse Greenshoe option: Simulation of market prices immediately after offering Reverse Greenshoe exercised Reverse Greenshoe exercised Reverse Greenshoe exercised Market price $17.00 $18.00 $19.00 $20.00 $21.00 $22.00 $23.00 Gross Proceeds $20,000, $20,000, $20,000, $20,000, $20,000, $20,000, $20,000, Underwriter pays the issuer -$19,083, $19,083, $19,083, $19,083, $19,083, $19,083, $19,083, Cost of buying overalloted shares at market -$1,700, $1,800, $1,900, Proceeds from selling overalloted shares back to the issuer $2,000, $2,000, $2,000, Net margin to underwriter $1,216, $1,116, $1,016, $916, $916, $916, $916,030.53

60 Price falls after the issue Higher margin for the underwriter Can lead to a tarnished reputation if frequent

61 Regulation of securities Regulation of disclosure aims at ensuring transparency so that all investors have access to the same information. Disclosure is paramount in building and maintaining trust. Regulation of financial activity consists of rules about what investors can and cannot do; it is aimed at fostering fair competition Regulation of financial Institutions consists of rules about what financial institutions can and cannot do in order to preserve the integrity of the system in the face of systemic risk Regulation of foreign participants is often aimed at limiting foreign ownership