Raising Capital

1
Chapter 16

• Raising Capital

2
Key Concepts and Skills

• Understand the venture capital market and its
  role in financing new business
• Understand how securities are sold to the public
• Understand IPOs and costs of going public

3
Venture Capital

• Private financing for businesses in exchange for
  stock
• Some hands on guidance is usually involved
• Goal
• Take the company public and benefit from the
  capital raised in the IPO
• VC firms are formed by a group of investors that
  pool capital and have partners decide which
  companies will receive financing

4
Venture Capital

• Financing in stages
• First stage
• Prototypes and plans
• Second stage
• Begin production
• Financing in latter stages is contingent upon
  performance

• Access is very limited
• VCs reject many proposals
• Relies heavily upon networking
• VCs demand 40 or more of the equity in the
  company

5
Choosing a VC

• Management style
• Financial strength
• Obtain and check references
• Contacts
• Exit strategy

If a start-up succeeds, the big payoff usually
comes when the company is acquired or goes public.
6
Selling Securities to the Public

• Management needs approval from the Board
• Firm must register with the SEC
• SEC examines registration during a waiting period
• Red herring is distributed to potential
  investors
• If the SEC suggests changes, the waiting period
  restarts
• Price is determined on the effective date of
  registration
• Securities can not be sold during the waiting
  period

7
Tombstone

• Issued during and after the waiting period
• Includes
• Name of the issuer
• Info about the issue
• Underwriters involved

8
Alternative Issue Methods

• General cash offer
• Securities are offered to the public
• IPOs
• Unseasoned new issue
• SEOs
• Issue for a company with securities that have
  been previously issued

• Rights offer
• Securities are initially offered to existing
  owners
• Rare in the U.S.

9
Underwriters

• Services provided by underwriters
• Formulate method used to issue securities
• Price the securities
• Sell the securities
• Syndicate
• Group of underwriters share the risk associated
  with selling the new issue
• Spread
• Difference between the underwriters buying price
  and the offering price

10
Types of Underwriting

• Firm Commitment
• entire issue is sold to the underwriters who then
  sell it to the public
• Underwriter makes money on the spread and bears
  the risk of not being able to sell the issue for
  above its cost

• Best Efforts
• Underwriter is legally bound to sell securities
  at an agreed upon price
• Company bears the risk of not selling the issue
• Offer may be pulled due to lack of interest

11
Green Shoes and Lockups

• Green Shoe provision
• Benefit to underwriter, cost to issuer
• Gives the underwriter the option to purchase
  additional shares at the offering price

• Lockup Agreements
• Specifies how long an insider must wait after the
  IPO before they can sell stock
• VC companies are likely to experience a loss in
  value on the expiration day

12
IPO Underpricing

• It can be difficult to price IPOs because no
  current market price is available
• Helps new shareholders earn higher returns
• Asymmetric information
• Risky new firms need lower prices to attract
  investors
• Causes issuer to leave money on the table

13
IPO Underpricing

• Stone Cold Steve Austin vs. Martha Stewart
• October 19, 1999
• WWF and Martha Stewart both went public
• Martha Stewart Omnimedia ?98
• WWF ?48

The market valued both IPOs above the offering
price. But Martha won the battle!
14
Whos Winning Now?

• Whos winning now?

15
SEOs and Price

• Stock prices tend to decline when new equity is
  issued
• Why?
• Signaling and managerial information
• Signaling and debt usage
• Issue costs
• Management should understand the signals being
  sent and try to reduce the effect when possible

16
Issuance Costs

• Spread
• Difference between offer price and price the
  issuer receives
• Other direct expenses
• Filing fees, legal fees, taxes
• Indirect expenses
• Time spent working on the new issue
• Abnormal returns
• Existing stock price drops
• Underpricing
• Losses from selling stock below the true value
• Green Shoe option
• Underwriters buying at the offer price

17
Rights Offerings

• Issue of common stock offered to existing
  shareholders
• Allows current shareholders to avoid dilution
• Rights are given to shareholders
• Specified number of shares at a specified price
  within a specified time range

18
Dilution

• Loss in value for existing shareholders
• Percentage ownership shares sold to the public
  without a rights offering
• Market value firm accepts negative NPV projects
• Book value and EPS occurs when market to book
  value is less than one

19
The Value of a Right

• Price specified in a rights offering is generally
  less than the current market price
• 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

20
Rights Offering Example

• Suppose a company wants to raise 10 million.
  The subscription price is 20 and the current
  stock price is 25. The firm has 5,000,000
  shares outstanding
• How many shares have to be issued?
• Number of new shares Funds to be raised
  10M/20
• subscription price
• 500,000

21
Example

• How many rights will it take to purchase one
  share?
• rights needed Old shares 5,000,000/500,000
• New shares
• 10 rights needed to buy one share of stock
• What is the value of a right?
• Old price new price 25 - 20
• value of the right 5

22
More on Rights Offerings

• Stockholders can exercise their right or sell
  them
• Rights offerings are generally cheaper than cash
  offerings, but are much less common
• Standby underwriting Underwriter agrees to buy
  any shares that are not purchased through the
  rights offering

23
Long-Term Debt

• Bonds public issue of LT debt
• Private issues
• Examples
• Term loans
• Private placements
• Easier to renegotiate and cheaper than public
  issues

24
Shelf Registration

• Corporations register a large issue with the SEC
  and sell it in small portions
• Reduces flotation costs of registration
• Allows more flexibility to raise money quickly
• Requirements
• Good credit
• Investment grade, no defaulted debt in last three
  years
• Market value of firm 150 million
• No violations of the Securities Act of 1934 in
  the last three years

25
Quick Quiz

• What is venture capital and what types of firms
  receive it?
• What is IPO underpricing?
• What is a rights offering?
• What is a shelf registration?