Common Stocks

• Authorized Share Capital: maximum number of shares that can be issued.

• Issued Shares: Total shares that have been issued.

• Treasury stocks: shares that have been purchased by the company and held in its treasury.

• Outstanding shares: shares that are held by investors.

Preferred Stock.

• Preferred Stock: takes priority over common stock in dividends, but has no voting rights.

• Floating-rate preferred: pays dividends tied to short-term interest rates.

Corporate Debt

• Bonds rated based on default risks.

• “Bond Ratings” are issued on debt instruments to help investors assess the default risk of a firm.

Convertible Securities

• Warrant- Right to buy shares a fixed price at a fixed date. (similar to call options).

• Question: which is more valuable:warrant or call option?

• Convertible Bond - bond that the holder may exchange for another security such as common stock. This is both a bond and a warrant.

Choices of Finance.

• Internal or External.

• External: Debt or Equity.

• Statistic of Debt/Equity ratio.

• Question: Is a high ratio bad?

Start-up

• See book by Jerry Kaplan.

• Stages– Angel investors.– Venture Capital– IPO

Angel Investors.

• Rich friend or relative.

• Some people will help for finder’s fee.

• Should be compensated for the risk.

• Need to value the firm. For instance, could sell of 10% for 100k.

• Usually set up as a partnership.

Venture Capital

• Money invested to finance a new firm

• Since success of a new firm is highly dependent on the effort of the managers, restrictions are placed on management by the venture capital company and funds are usually dispersed in stages, after a certain level of success is achieved

• Usually demand a few board seats as well.

Venture Capital

First Stage Market Value Balance Sheet ($mil)

Assets Liabilities and Equity

Cash from new equity 0.5 New equity from venture capital 0.5

Other assets 0.5 Your original equity 0.5

Value 1.0 Value 1.0

Venture Capital

Second Stage Market Value Balance Sheet ($mil)

Assets Liabilities and Equity

Cash from new equity 1.0 New equity from 2nd stage 1.0

Other assets 2.0 Equity from 1st stage 1.0

Your original equity 1.0

Value 3.0 Value 3.0

Incubators

• Idea started by Bill Gross: idealabs.• Have all startups in same buildings.• Advantages:

– Easy monitoring.– Shared fixed-costs. (connection/accounting/law)– Faster preparation.

• Now individual firms provide separate services. Not so diversified.

IPO

Initial Public Offering (IPO) - First offering of stock to the general public.

Underwriter - Firm that buys an issue of securities from a company and resells it to the public.

Spread - Difference between public offer price and price paid by underwriter.

Prospectus - Formal summary that provides information on an issue of securities.

Underpricing - Issuing securities at an offering price set below the true value of the security.

IPO

• Time to IPO was decreasing. Now… Not so many.

• IPOs are underpriced. Possible explanation is the winners curse. – While new issues have high return, you get a

smaller fraction of them if the return is high. – On average you get normal returns.

Initial OfferingAverage Expenses on 1767 IPOs from 1990-1994

Value of Issues

($mil)

Direct

Costs (%)

Avg First Day

Return (%)

Total

Costs (%)

2 - 9.99 16.96 16.36

10 - 19.99 11.63 9.65

20 - 39.99 9.7 12.48

40 - 59.99 8.72 13.65

60 - 79.99 8.2 11.31

80 - 99.99 7.91 8.91

100 - 199.99 7.06 7.16

200 - 499.99 6.53 5.70

500 and up 5.72 7.53

All Issues 11.00 12.05

25 16

18 15

18 18

17 95

16 35

14 14

12 78

11 10

10 36

18 69

.

.

.

.

.

.

.

.

.

.

The Underwriters

820,1$ers UnderwritAll

61Jenrette LufkinDonaldson

71 ManhattanChase

83StearnsBear

89MorganJP

127ostonCS/First B

147 BrothersLehman

192Sachs Goldman

203Witter anStanley De Morgan

225 BrothersSaloman

$304 LynchMerrill

issues) total of ($bil

1998 in rsUnderwrite U.S. Top

General Cash Offers

Seasoned Offering - Sale of securities by a firm that is already publicly traded.

General Cash Offer - Sale of securities open to all investors by an already public company.

Shelf Registration - A procedure that allows firms to file one registration statement for several issues of the same security.

Private Placement - Sale of securities to a limited number of investors without a public offering.

Rights Issue

Rights Issue - Issue of securities offered only to current stockholders.

Example - YRU Corp currently has 9 million shares outstanding. The market price is $15/sh. YRU decides to raise additional funds via a 1 for 3 rights offer at $12 per share. If we assume 100% subscription, what is the value of each right?

Rights Issue

Current Market Value = 9 mil x $15 = $135 mil Total Shares = 9 mil + 3 mil = 12 mil Amount of new funds = 3 mil x $12 = $36 mil

New Share Price = (135 + 36) / 12 = $14.25/sh Value of a Right = 15 - 14.25 = $0.75

Example - YRU Corp currently has 9 million shares outstanding. The market price is $15/sh. YRU decides to raise additional funds via a 1 for 3 rights offer at $12 per share. If we assume 100% subscription, what is the value of each right?