Equity Offerings Venture capital IPO IPO features SEO 2018 Konan Chan Konan Chan 2 STAGE CYCLE TYPE OF FUNDING SOURCE OF FUNDING R&D Proof of Concept Funding Company life cycle START- UP Seed Corn EARLY GROWTH First Round Founders, Family and Friends Business Angles ACCELERATIN G GROWTH Second Round SUSTAINING GROWTH Development Capital MATURITY GROWTH Replacement Capital MBO/ Development Capital Venture Capital Public Listing/IPO Private Equity Konan Chan 3 Angel Investors Sources of Fund Individual investors who buy equity in small private firms Venture Capital A limited partnership that specializes in raising money to invest in the private equity of young firms The limited partners provide the capital the general partner runs a venture capital firm Konan Chan 4 What is a VC? A VC is a financial intermediary, meaning that they take investors capital and invest it directly in portfolio companies. A VC will only invest in private companies. This means that once the investments are made, the companies cannot be immediately traded on a public exchange. A VC takes an active role in monitoring and helping the companies in his portfolio. Management Fee ABC Ventures has raised their $100M fund, ABC Ventures I, with management fees computed based on committed capital. These fees are 2 percent per year in the first five years of the fund, then fall by 25 basis points per year in each of the subsequent five years. The fees will be paid quarterly within each year. Given this description, what are the lifetime fees and investment capital for this fund? Konan Chan 5 Konan Chan 6 1
Management Fee 2% per year for 5 years = 10% An average of 1.25% per year for 5 years = 6.25% Total = 16.25% of the committed capital Investment capital= $100M - $16.25M = $83.75M 120.0% 100.0% 80.0% 60.0% 40.0% VC Industry Performance Median Top Quartile 20.0% 0.0% 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 Konan Chan 7-20.0% Source: Venture Economics Konan Chan 8 Most Active U.S. VCs, 2015 Some Famous VC Deals VC Firms / Funds Portfolio Firm Investment Exit Sequoia Capital Cisco Systems $2.5M for 30% in 1987 Kleiner Perkins Caufield & Byers VIII Kleiner Perkins Google Caufield & Byers IX A 凱鵬華盈 Seqouia Capital VIII 紅杉資本 IPO (1990) stake at $68M 27x Amazon.com $8M in 1996 Worth $60M in 1997 IPO, far more later (up to 55x) $12.5M each in 1999 (became 21M shares for KPCB and 24M for Sequoia) Accel Partners IX Facebook $12.7M for 15% in 2005 IPO (2004) @ $85; most went to LPs in 2004 5 at $175 200/share. That is around $4B each, 320x multiple None yet, but 15% of $50B =$7.5B, 590x multiple Konan Chan 9 Konan Chan 10 Venture Capital Funding in US Source: National Venture Capital Association Konan Chan 11 Konan Chan 12 2
VC Investments by Stage VC: US vs. China * Lanfang WANG and Susheng WANG s 2011 * First three quarters only for 2010 Source: National Venture Capital Association, PricewaterhouseCoopers Konan Chan 13 Konan Chan 14 Features of VC Stage financing Actively monitoring Professional investment Why VC? Difficult access to the market capital Business know-how Enhance reputation Costly capital Corporate control Konan Chan 15 Konan Chan 16 IPOs Acquisitions VC Exits 500 400 300 200 100 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 500 400 300 200 100 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Dow Jones Venture One in Wilmer Hale 2010 Venture Capital Report Private Equity Firms VC vs. PE Organized very much like a venture capital firm, but it invests in the equity of existing firms Financing the equity purchase by high leverage in the leveraged buyout (LBO) transactions VC vs. PE: magnitude differs In 2011, VC invested 28.5 billion in 3834 deals with an average investment of 7.7 million per deal In 2007, over 400 billion of LBOs by PE, average deal size over 2 billion Konan Chan 17 Konan Chan 18 3
Global LBO Top US Private Equity Funds Source: Dealogic Konan Chan 19 Konan Chan 20 Investment Banks Top Global IPO Underwriters, 2014 Investment banking lines of business Trading Asset management Corporate finance Investment banks provide advice with structuring seasoned and unseasoned issues actual sale and post-sale services Konan Chan 21 Konan Chan 22 Largest U.S. IPOs Konan Chan 23 Konan Chan 24 4
Equity Offerings Seasoned offering Equity issues by firms that are already traded in the market Unseasoned offering: Initial public offering (IPO) issue of securities that are not traded yet Basic Procedures of IPOs Pre-underwriting conference Due diligence / file registration Preliminary prospectus (red-herring) Roadshow / bookbuilding Pricing Public offering Overallotment option (Green shoe option) Stabilization Konan Chan 25 Konan Chan 26 The Process of A Public Offering Steps in Public Offering 1. Pre-underwriting conferences 2. Registration statements 3. Pricing the issue 4. Public offering and sale 5. Market stabilization Time Several months 20-day waiting period Usually on the 20th day After the 20th day 30 days after offering Pre-Underwriting & Due Diligence Primary pre-issue role: provide advice and help plan offer Firm needing capital selects one or more lead underwriters. (book-runner) Top firm the lead manager, others are comanagers Underwriting syndicate organized early in process Konan Chan 27 Konan Chan 28 An Example of a Tombstone Advertisement Preliminary Prospectus & Roadshow Preliminary Prospectus Red Herring after title page disclaimer (in red ink) Statements are submitted to SEC. Firm makes changes and resubmits. Becomes effective with SEC s final approval. After preliminary filing, issuing firm and investment banker begin a road show. Investment banker does book building during road show providing key pricing info Konan Chan 29 Konan Chan 30 5
Pricing & Public Offering Prior to offerings Initial offer price set as a range; final price set the day before offer. Details lock-up agreement Bulge bracket underwriter s spread (commission) usually 7.0% for IPOs Public offerings Lead underwriter sets each syndicate member s percentage of participation Spread in US IPOs Source: Professor Jay Ritter, University of Florida Konan Chan 31 Konan Chan 32 Overallotment Option & Stabilization Overallotment option Also called Green Shoe option. A call option granted to underwriter(s) to be able to sell up to 15% additional shares than scheduled After-market service Lead underwriter is responsible for price stabilization after offering After offering, lead underwriter serves as principal market maker Research coverage Konan Chan 33 Alternative Issue Methods There are two kinds of public issues: Cash offer: sell to interested investors Rights offer: sell to existing shareholders Equity is sold by both cash and rights offers Over 90% of new issues are underwritten, even though rights offerings are much cheaper Almost all debt is sold in cash offerings Konan Chan 34 Underwriters in Cash Offerings Firms can choose an investment bank through Negotiated offer: issuer negotiates with investment bankers Competitive bid: issuer structures the offering and secures bids Underwriters in Cash Offerings Public security issues can be Best effort The bank promises its best efforts to sell securities No guarantees about the success of the offering Firm commitment Underwritten offerings, bank guarantees proceeds Most of US security offerings are in this way Konan Chan 35 Konan Chan 36 6
Rights Offerings Existing shareholders have the rights to buy new shares at a discount or can sell rights to other investors Ex-rights date Date when stock begins trading without rights HSBC Rights Issue (1) HSBC raised 12.5 billion ($18.5 billion) on April 2009 through a rights issue, with the bank's current investors taking up 96.6% of the new shares that were offered. The HSBC rights issue was the largest ever in the U.K. HSBC was seeking more capital to ride out the financial downturn and bolster its war chest for possible acquisitions Konan Chan 37 Konan Chan 38 HSBC Rights Issue (2) HSBC is one of the few global institutions that hasn't sought government aid in financial crisis. HSBC net profit decreased 70% in 2008, because of souring consumer loans in the U.S., write-downs on trading assets and a slowdown in Asia. HSBC plans to trim its dividend and curtail its U.S. consumer-lending operation "This underlines our determination that HSBC should maintain its signature financial strength which has served us so well over HSBC's long history," HSBC Chairman Stephen Green said. HSBC Rights Issue (3) Investors subscribed to the rights issue at a 40% discount to the shares' closing price of 434.50 pence on April 3, where price dropped by 5.34%. The five-for-12 shares offer was underwritten by Goldman Sachs, JPMorgan, HSBC and three other co-bookrunners. Konan Chan 39 Konan Chan 40 Shelf Registration IPO Underpricing SEC introduced rule 415: shelf registration Qualifying issuers file a master registration statement The firm must be rated investment grade The cannot have recently defaulted on debt The market capitalization must be more than $75 million No recent SEC violations. The company can offer securities for sale (off the shelf) over subsequent two years. Popular with larger issuers; very flexible Most qualifying debt issues are shelf registered. Very few equity issues use shelf: IB certification needed Initial returns (the first-day returns) are huge and consistent across world Offering price is lower than the after-market price Leave huge money on the table Konan Chan 41 Konan Chan 42 7
Number of IPOs and Initial Returns US 1980-2015 IPO and Internet Bubble 800 80 700 70 Number of IPOs 600 500 400 300 200 60 50 40 30 20 Average First day Returns 100 10 0 0 Source: Prof. Jay Ritter, University of Florida Konan Chan 43 Source: Prof. Jay Ritter, University of Florida Konan Chan 44 Underpricing of IPOs Worldwide China IPOs, 1990-2010 Source: Prof. Jay Ritter, University of Florida, February 2011 Konan Chan 45 Konan Chan 46 Why Leave Money on the Table? Why Leave Money on the Table? Information acquisition: price partial adjustment Cascades: positive-sloped demand curve Corruption: hidden benefit to issuers managers Lawsuit avoidance Information asymmetry / Signaling Between investors: Winner s curse (adverse selection) Between issuer and investors: Leave a good taste Konan Chan 47 Konan Chan 48 8
Offer Price and Initial Returns Percentage of IPOs relative to file price range: Source: Prof. Jay Ritter, University of Florida IPO Long-Run Underperformance IPOs underperform in 3-5 years after the issuing First-day returns relative to file price range: Source: Prof. Jay Ritter, University of Florida Konan Chan 49 Konan Chan 50 IPO Long-Run Underperformance IPO Long-Run Underperformance Source: Prof. Jay Ritter, University of Florida Konan Chan 51 Konan Chan 52 IPO Long-Run Underperformance Long-Run Patterns Underperformance is more severe for small and young issuers, with high initial returns, in high-volume years No underperformance in low-volume years Long-run underperformance is restricted to companies going public with less than $50 million in annual sales Source: Prof. Jay Ritter, University of Florida Konan Chan 53 Konan Chan 54 9
Why Long-Run Underperformance? Divergence of opinions (Miller, 1977) Windows of opportunity (Loughran and Ritter, 1995) Managerial overoptimism (Heaton, 2002) Earnings management (TWW, 1998) Spread Issuance Costs Other direct expenses legal fees, filing fees, etc. Indirect expenses opportunity costs, i.e., management time spent working on issue Abnormal returns price drop on existing stock Underpricing below market issue price on IPOs Green Shoe option cost of additional shares that the syndicate can purchase after the issue has gone to market Konan Chan 55 Konan Chan 56 Issuance Cost Source: Adapted from I. Lee, S. Lochhead, J. Ritter, and Q. Zhao, The Costs of Raising Capital, Journal of Financial Research 19(1) (1996): 59 74. Konan Chan 57 Private Placements In The U.S. Sale of a security directly to one or a group of accredited investors Institutional investors, insurance companies and pension funds wealthy individuals, venture capitalists Avoid the costly procedures of public issues. One drawback is that shares are hard resold But, rule 144A (1990) has allowed limited trading of PP among qualified institutional investors Konan Chan 58 Corporate Equity Security Offerings Features (Anomalies) of SEOs 17.7% 16.2% 66.1% Private Rule 144A placements Private non-rule 144A placements Public equity offering Negative announcement effects: about 2% Myers and Majluf (JFE, 1984) Agency cost of free cash flows (Jung, Kim, and Stulz, JFE, 1996) Firm with high Tobin s q (market to replacement value), proxy for investment opportunity, have an announcement effect which is insignificantly different from zero Long-run underperformance? Konan Chan 59 Konan Chan 60 10
SEOs Long-Run Underperformance SEOs Long-Run Underperformance Konan Chan 61 Konan Chan 62 Post-SEO Performance Konan Chan 63 11