lecture 5 how corporations raise venture capital and issue securities
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Lecture 5 How Corporations Raise Venture Capital and Issue Securities. Young firms often require venture capital to finance growth. The issuance of securities is a complex process that the successful financier must comprehend. Company Growth. - PowerPoint PPT PresentationTRANSCRIPT
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Lecture 5How Corporations Raise Venture
Capital and Issue Securities
Young firms often require venture capital to finance growth.
The issuance of securities is a complex process that the successful financier must comprehend.
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Company Growth
Venture Capital provides entrepreneurs with financing to grow their firms.
Firms issue securities to further finance their growth.
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Obtaining Venture Capital Steps to obtaining venture funding:
1. Prepare a business plan.
• Business Plan – A description of a firm’s products, market, production methods, and resources needed for success.
• Staged Financing – Venture capital is rarely disbursed in one large lump sum payment, but instead is paid to the firm in stages. Each stage is usually just enough to guide the firm towards its next major checkpoint.
1. Receive first-stage financing.
2. Receive subsequent staged financing.
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Venture Capital Ownership: Example
Suppose a Venture Capital firm offers to purchase 1 million of your firm’s shares for $1 each, which will give them 50% ownership in the firm. What value are they placing on your firm?
$1,000,000Value of the Firm = $2,000,000.50
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Types of Venture Investors
Angel Investors• Investors who finance companies in their earliest stages of
growth
Corporate Venturers• Corporations that offer venture assistance to finance young,
promising companies.
Private Equity Investing• Investors who offer funds to finance firms that do not trade on
public stock exchanges such as the NYSE or NASDAQ.
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Venture Capital Management
Venture Capitalist are not passive investors.
What do they provide beyond financing?
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The Initial Public OfferingWhen a firm requires more capital than private investors can provide, it can choose to go public through an Initial Public
Offering, or IPO.
Primary Offering– when new shares are sold to raise additional cash for
the company Secondary Offering
– when the company’s founders and venture capitalists cash in on some of their gains by selling shares.
Does a secondary offering provide additional capital to the firm?
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Benefits of Going Public Ability to raise new capital
Stock price provides performance measure
Information more widely available
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Benefits of Going Public
Diversified sources of finance
Reduced borrowing costs
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Arranging Public IssuesSteps to issue a new public security:
1. SEC Registration
• Prospectus—a formal summary that provides information on an issue of securities
2. Select Underwriter / Undertake Roadshow
3. Set final issue price for public
•The roadshow attempts to gauge the interest that potential investors would have in purchasing the new securities.
•If enough public interest, the underwriters issue shares to the public. Typically underwriters underprice shares upon issue.
• Underpricing – Issuing securities at an offering price set below the true value of the security.
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IPO Flowchart
InvestorsFirmUnderwriter
1
2
4
3
51. Underwriter provides advice to firm2. Underwriter pays firm for a number of shares3. Firm provides shares to underwriter to be resold4. Underwriter offers shares to investors5. Investors purchase shares from underwriter
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Underwriter Spread
Assume the issuing company incurs $1 million in expenses to sell 3 million shares at $40 each to an underwriter; the underwriter sells
the shares at $43 each. What is the spread for this deal?
Spread - the difference between the public offer price and the price paid by underwriter
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Underwriting Arrangements
Firm Commitment:Underwriters buy the securities from the firm and then resell them to the public.
Best Efforts Commitment:Underwriters agree to sell as much of the issue as possible but do not guarantee the
sale of the entire issue.
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Underwriting Arrangements: Capital To Firm
How much will a firm receive in net funding from a firm commitment underwriting of 250,000 shares priced to the public at $40 if a 10%
underwriting spread has been added to the price paid by the underwriter? Additionally, the firm pays $600,000 in legal fees.
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Underpricing of an IPO
Example: Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day’s trading, the issuing company’s stock price had risen to $70. What is the total cost of underpricing?
Cost of Underpricing:
Underpricing: Issuing securities at an offering price set below the true value of the security.
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Flotation Costs
Flotation Costs: The costs incurred when a firm issues new securities to the public.
What are some of the specific costs incurred when a firm issues new securities?
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Types of OfferingsAfter the IPO, successful firms may issue additional equity or debt.
Seasoned Offering:– Sale of securities by a firm that is already publicly traded.
Rights IssueIssue of securities offered only to current stockholders.
General Cash OfferSale of securities open to all investors by an already-public company.
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Rights Issue: ExampleAn investor exercises his right to buy one additional share at $20 for every five shares held. How much should each share be worth after the rights issue if they previously sold for $50 each?
Pre-Rights Issue:
Post-Rights Issue:+
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General Cash Offer and Shelf Registration
Benefits of Shelf Registration:1. Security issuance without excessive costs2. Security issuance on very short notice3. Timed issuance to capitalize on favorable market
conditions4. Additional underwriter competition
Shelf Registration: A procedure that allows firms to file one registration statement for several issues of the same security.
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Private PlacementsIn order to avoid registering with the SEC, a
company can issue a security privately.
Private Placement: The sale of securities to a limited number of investors without a public offering
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Private Placements-Advantages
Do not have to register with SEC
Private placements cost less than public issues
Contracts can be customized for each investor
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Private Placements-Disadvantages
Difficult for investors to resell security
Lenders often require higher return to compensate for higher risk.
• Private placements typically yield .5% higher than public issues