berk chapter 23: raising equity capital
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- 1. Chapter 23 RaisingEquity Capital
2. Chapter Outline
- 23.1 Equity Financing for Private Companies
- 23.2 The Initial Public Offering
- 23.3 The Seasoned Equity Offering
3. Learning Objectives
- Describe four ways in which a private company can raise outside capital.
- Discuss the effects of a company founder selling stock to an outsider.
- Identify the two main exit strategies used by equity investors in private companies.
- Define an initial public offering, and discuss their advantages and disadvantages.
- Distinguish between primary and secondary offerings in an IPO.
- Describe typical methods by which stock may be sold during an IPO; discuss risks for parties involved ineach method.
4. Learning Objectives (cont'd)
- Evaluate the role of the underwriter in an IPO.
- Describe the IPO process, including the methods underwriters use to value a company before its IPO.
- Identify ways in which underwriters can mitigate risk during an IPO.
- List and discuss four puzzles associated with IPOs.
- Define a seasoned equity offering, describe two ways in which they are brought to market, and identify the stock price reaction to the announcement of a seasoned equity offering.
5. 23.1 Equity Financingfor Private Companies
- The initial capital that is required to start a business is usually provided by the entrepreneur and their immediate family.
- Often, a private company must seek outside sources that can provide additional capital for growth.
- It is important to understand how the infusion of outside capital will affect the control of the company.
6. Sources of Funding
- Angel Investors
- Individual Investors who buy equity in smallprivate firms
- Finding angels is typically difficult.
7. Sources of Funding (cont'd)
- Venture Capital Firm
- A limited partnership that specializes in raising money to invest in the private equity of young firms
- Venture Capitalists
- One of the general partners who work for and run a venture capital firm
8. Sources of Funding (cont'd)
- Venture capital firms offer limited partners advantages over investing directly in start-ups themselves as angel investors.
- Limited partners are more diversified.
- They also benefit from the expertise of thegeneral partners.
9. Sources of Funding (cont'd)
- The advantages come at a cost.
- General partners usually charge substantial fees.
- Most firms charge 20% of any positive return they make.
- They also generally charge an annual management fee of about 2% of the funds committed capital.
10. Table 23.1Most Active U.S. Venture Capital Firms in 2007 (by number of deals completed) 11. Figure 23.1Venture Capital Funding in the United States Source: PricewaterhouseCoopers MoneyTree Report (https://www.pwcmoneytree.com) 12. Sources of Funding (cont'd)
- Private Equity Firms
- Organized very much like a venture capital firm, but it invests in the equity of existing privately held firms rather than start-up companies.
- Private equity firms initiate their investment by finding a publicly traded firm and purchasing the outstanding equity, thereby taking the company private in a transaction called aleveraged buyout (LBO) . In most cases, the private equity firms use debt as well as equity to finance the purchase.
13. Figure 23.2Total U.S. LBO Volume and Number of Deals Source: Standard & Poors Leveraged Buyout Review (Volume data not available for the single deal in Q1 09) 14. Table 23.2Top 10 Private Equity Funds in 2009 15. Sources of Funding (cont'd)
- Institutional Investors
- Institutional investors such as pension funds, insurance companies, endowments, and foundations are active investors in private companies
- Institutional investors may invest directly in private firms or they may invest indirectly by becoming limited partners in venture capital firms.
16. Sources of Funding (cont'd)
- Corporate Investor
- A corporation that invests in private companies
- Also known as Corporate Partner, Strategic Partner, and Strategic Investor
- While most other types of investors in private firms are primarily interested in the financial returns of their investments, corporate investors might invest for corporate strategic objectives, in addition to the financial returns.
17. Outside Investors
- Preferred Stock
- Preferred stock issued by mature companies usually has a preferential dividend and seniority in any liquidation and sometimes special voting rights.
- Preferred stock issued by young companies has seniority in any liquidation but typically does not pay regular cash dividends and often contains a right to convert to common stock.
18. Outside Investors (cont'd)
- Convertible Preferred Stock
- Preferred stock that gives the owner an option to convert it into common stock on some future date
19. Outside Investors (cont'd)
- RealNetworks, which was founded by Robert Glaser in 1993, was initially funded with an investment of approximately $1 million by Glaser.
- As of April 1995, Glasers $1 million initial investment in RealNetworks represented 13,713,439 shares of Series A preferred stock, implying an initial purchase price of about $0.07 per share.
20. Outside Investors (cont'd)
- RealNetworks needed additional capitaland management decided to raise this money by selling equity in the form of convertible preferred stock.
- The companys first round of outside equity funding was Series B preferred stock. RealNetworks sold 2,686,567 shares of Series B preferred stock at $0.67 per share in April 1995. After this funding round the distribution of ownership was: ( next slide )
21. Outside Investors (cont'd) 22. Outside Investors (cont'd)
- The Series B preferred shares were new shares of stock being sold by RealNetworks. At the price the new shares were sold for, Glasers shares were worth $9.2 million and represented 83.6% of the outstanding shares.
23. Outside Investors (cont'd)
- Pre-Money Valuation
- At the issuance of new equity, the value of thefirms prior shares outstanding at the price in the funding round
- $9.2 million in the RealNetworks example
- Post-Money Valuation
- At the issue of new equity, the value of the whole firm (old plus new shares) at the price the new equity sold at
- $11.0 million in the RealNetworks example
24. Outside Investors (cont'd)
- Over the next few years, RealNetworks raised three more rounds of outside equity in addition to the Series B funding round.
25. Exiting an Investmentin a Private Company
- Exit Strategy
- It details how investors will eventually realize the return from their investment.
- In July 1997, the post-money valuation of existing preferred stock was $8.99 per share.
- However, because RealNetworks was still a private company, investors could not liquidate their investment by selling their stock in the public stock markets.
26. Textbook Example 23.1 27. Textbook Example 23.1 (cont'd) 28. Alternative Example 23.1
- You founded your own firm two years ago.
- You initially contributed $50,000 of your money and in return received 1,000,000 shares of stock.
- Since then, you have sold an additional 750,000 shares to angel investors.
- You are now considering raising even more capital from a venture capitalist.
29. Alternative Example 23.1
- The venture capitalist would invest $2 million and would receive 2,000,000 newly issued shares.
30. Alternative Example 23.1
- What is the post-money valuation?
- Assuming that this is the venture capitalists first investment in your company, what percentage of the firm will he end up owning?