CHAPTER 15

Raising Capital

Introduction

Definition of capital: borrowed sums or equity with

which the firm's assets are acquired and its operations

are funded.

When does a firm need capital?

New or start up companies

Finance expansion

Rapid growth

Opening new market lines

Mergers and acquisitions

How can a firm raise money??

1. Equity: the value of an ownership interest in property

or interest in a corporation in the form of common

stock or preferred stocks

2. Debt: An amount owed to a person or organization for

funds borrowed. Debt can be represented by a loan note,

bond, mortgage or other form stating repayment terms

and interest

requirements.

Introduction

Can new start-up firms rely on bank loans for capital?

Venture capital: general term for financing startup,

early stage, and "turn around" type businesses

Sources of VC

New business will be risky

What does Venture capitalist do to avoid this risk?

Why might Venture capitalist be willing to take this

risk?

Capital for new firms

Capital for existing firms

How can a company finance its investments?1. Selling securities to the public

A. PublicB. Private

2. General cash offer3. Rights offer4. Initial public offering (IPO)5. Seasoned equity offering (SEO)

Refer to table 15.1

Underwriters

Definition: investment firms that act as

intermediaries between a company selling

securities and the investing capital

Services provided by underwriters

Formulate method used to issue securities

Price the securities

Sell the securities

Price stabilization by lead underwriter

Syndicate – group of investment bankers that

market the securities and share the risk associated

with selling the issue

Spread – difference between what the syndicate

pays the company and what the security sells for

initially in the market

Underwriters

Types of underwriter

1. Firm Commitment Underwriting

Issuer sells entire issue to underwriting syndicate

The syndicate then resells the issue to the public

The underwriter makes money on the spread

between the price paid to the issuer and the price

received from investors when the stock is sold

The syndicate bears the risk of not being able to

sell the entire issue for more than the cost

2. Best efforts underwriting

Underwriter must make their “best effort” to sell

the securities at an agreed-upon offering price

The company bears the risk of the issue not being

sold

Not as common as it used to be

Types of underwriter

3. Dutch auction underwriting:

Underwriter accepts a series of bids that include

number of shares and price per share

Google was the first large Dutch auction IPO

Types of underwriter

IPOs & under pricing

Initial Public Offering – IPO

May be difficult to price an IPO because there isn’t

a current market price available

Under pricing causes the issuer to “leave money on

the table”

Why does under pricing exist?

To attract investors for young firms

To act as an Insurance for the investment bank

A way that a bank can reward investors for reveling

what they think the stock worth and the numbers

of shares they would like to buy

The costs of issuing securities

1. Gross spread

2. Other direct expenses

3. Indirect expenses

4. Abnormal returns

5. Under pricing

Rights

Definition: an issue of common stock offered to

existing stockholders

“Rights” are given to the shareholders

Specify number of shares that can be purchased

Specify purchase price

Specify time frame

Why do companies offer Rights? (Advantages)

Rights may be traded OTC or on an exchange

The mechanics of a rights offering

Number of rights needed to purchase a share

Rights

The value of a right

Example:

National Power current share price is 20$, there is 1,000,000

shares outstanding. Suppose they want to raise 5,000,000$ in

new equity using a right offering (1 right for each 1 share)

with a subscription price of 10$. Calculate the following:

1. Number of new shares to be issued

2. Number of rights needed to buy a new share

3. The value of the right

4. Show in calculations the effects of the rights offering on

shareholders

Effects on share holders

The case of buying a new share using rights

The case of selling rights

Results

The price specified in a rights offering is generally

less than the current market price

The 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

The value of a right

Suppose a company wants to raise $10 million. The

subscription price is $20 and the current stock

price is $25. The firm currently has 5,000,000

shares outstanding.

How many shares have to be issued?

How many rights will it take to purchase one share?

What is the value of a right?

Rights Offering Example

Dilution

Dilution is a loss in value for existing shareholders

that occurs through the issuance of additional stocks

Dilution kinds:

1. Percentage ownership – shares sold to the general

public without a rights offering

2. Market value – firm accepts negative NPV projects

3. Book value and EPS – occurs when market-to-book

value is less than one

Types of Long-term Debt

1. Public issue of long-term debt are usually in the form of

bonds

2. Private issues

Long-Term loans usually bank loans or could be from private firm

which has a history with the company

Easier to renegotiate than public issues

If bonds were issued to private investors costs would be lower than

public issues

MORE THAN 50% OF ALL DEBT ARE ISSUED PRIVATELY

Interest rates are higher in private issues when compared to public

issues

Issuing Long-term Debt

Ex 1 Page 505

Big Time, Inc., is proposing a rights offering. Presently

there are 500,000 shares outstanding at 81$ each. There

will be 60,000 new shares offered at 70$ each.

A. What is the new market value of the firm

B. How many rights are associated with one of the new

shares?

C. What is the value of a right?

D. Why might a company have a rights offering rather than

a general cash offer?