Chapter 15 - Venture Capital, IPOs and Seasoned Offerings

What is an IPO?

An IPO (Initial Public Offering) is a firm’s first offering of stock to the general public, and the firm is said to go public.

What are the two types of stock markets?

• Organized exchanges: Have centralized locations for trading.

• Over-the-counter market: A network of security dealers who trade over the phone and through electronic networks.

What are the listing requirements for a firm to sell stock publicly?

The firm must meet minimum requirements for net assets, earnings, cash flow, adequate working capital, and an appropriate capital structure.

What must a firm do before selling stock to the public?

The firm must satisfy provincial securities laws and regulations and may have to register the stock with an appropriate securities commission.

What is a Preliminary Prospectus?

A preliminary prospectus is a formal summary that provides information on an issue of securities and is distributed to the OSC and potential investors. It may be called a "red herring" due to a warning in bold red letters.

What are the advantages of going public?

–Greater access to new capital.

–Publicly traded firms must meet OSC and other disclosure requirements that reduce information risk for potential investors.

–Going public makes it possible for the firm’s principal owners to sell some of their shares and diversify their personal portfolios while retaining control of the company.

What is a disadvantage of being a public firm?

Public firms are subject to stricter disclosure and other potentially costly regulatory requirements.

What is the role of an Underwriter in a new securities issue?

Underwriters act as financial "midwives" by providing procedural and financial advice, buying the new securities, and selling the new securities.

What is the Underwriting Spread?

The underwriting spread is the difference between the underwriter's buying price and the offering price of the securities.

What risk does the Underwriter accept when buying securities?

The underwriter accepts the risk of not being able to sell the securities

What is a Syndicate of Underwriters?

A group of underwriters formed to handle large issues, share risks, and help market the securities.

What is a Firm Commitment?

Underwriters buy securities from the firm and sell them to the public, taking on the risk of unsold securities.

What is Best Efforts Underwriting?

Underwriters try to sell as much as possible but don't guarantee the full sale of securities. Fees are lower.

What happens if the IPO is priced too high?

The issue may be unsuccessful and have to be withdrawn.

What happens if the IPO is priced too low?

Shareholders may experience an opportunity loss when they sell shares for less than they are worth.

What do managers want when setting the IPO price?

Managers want to secure the highest possible price for their stock.

Why do underwriters typically underprice an IPO?

To attract investors and reduce marketing costs. This usually leads to a significant increase in stock price after the issue.

How do you calculate the value of the founder’s shares after an IPO?

total market value minus the value of the shares sold to the public.

What happens when an IPO is oversubscribed?

Investors won’t be able to buy all the shares they want, and underwriters will allocate shares among them.

What happens when an IPO is overpriced?

Few investors will want the stock, and underwriters will be eager to sell it to you.

What is the winner’s curse in IPOs?

The winner’s curse occurs when investors overestimate and overpay for the stock, leading to a large average return on IPOs.

What are flotation costs?

Flotation costs are the costs incurred when a firm issues new securities, including commissions, legal, accounting, and other administrative costs.

What is the underwriting spread in an IPO?

The underwriting spread is the direct fee paid by the issuer to the underwriting syndicate.

What are other direct expenses in an IPO?

These include filing fees, legal fees, taxes, and the costs of management time spent working on the new issue.

What is underpricing in an IPO?

Underpricing occurs when stock is sold below its correct value, resulting in losses for the firm.

What is a seasoned offering?

A seasoned offering is the issuance of additional stock by a company whose stock is already publicly traded.

What is a rights issue in a seasoned offering?

A rights issue is when the stock is offered only to existing shareholders.

What is a general cash offer in a seasoned offering?

general cash offer is when the stock is sold to the general public.

What happens in a rights issue?

Shareholders can buy additional shares at a price below the current market price within a specified time.

How do shareholders participate in a rights issue?

Shareholders get one right for each share of stock they own and can use those rights to buy new shares.

How are rights often traded in a rights issue?

Rights are often traded on securities exchanges or over-the-counter.

What questions must a financial manager answer to execute a rights offering?

1. What price should shareholders pay for new stock?

2. How many rights are needed to buy one new share?

3. What effect will the rights offering have on the stock price?

What is the subscription price in a rights offering?

The subscription price is the price at which existing shareholders can buy new shares of stock.

When will a rational shareholder subscribe to a rights offering?

A rational shareholder will subscribe if the subscription price is below the market price on the offer’s expiration date.

Why is the subscription price set below the market price?

The subscription price is set below the market price to ensure the rights offering will succeed.

How much below the market price is the subscription price typically set?

set 20 to 25% below the prevailing stock price.

How do you calculate the number of new shares in a rights offering?

funds to be raised / subscription price

How do you calculate the number of rights needed to buy one new share?

number of old shares / number of new shares

How do you calculate the stock price after a rights offering?

Stock price after the issue = (2 × current stock price + subscription price) / total new shares.

What is the formula for calculating the ex-rights price?

Ex-rights price = (Subscription price + (Number of rights × Value of a right)).

What is the formula to calculate the value of a right?

Rights-on price of a share - Ex-rights price

What is the holder-of-record date in a rights offering?

The holder-of-record date is when shareholders on the company’s records are entitled to receive stock rights.

When does the stock go ex-rights?

The stock goes ex-rights 4 trading days before the holder-of-record date.

What happens if the stock is sold before the ex-rights date?

If sold before the ex-rights date, the new owner will receive the rights (rights on, with rights).

What happens if the stock is sold on or after the ex-rights date?

If sold on or after the ex-rights date, the buyer will no longer be entitled to the rights.

What is a standby underwriting in a rights offering?

In a standby underwriting, the underwriter commits to purchasing any unsubscribed shares, protecting the firm against under subscription.

What is the role of the underwriters in a standby underwriting?

The underwriters typically receive a standby fee for purchasing any unsubscribed shares in a rights offering.

What is an oversubscription privilege in a rights offering?

An oversubscription privilege allows shareholders to purchase any unsold shares at the subscription price.

What is a general cash offer?

A general cash offer is when firms raise money by issuing securities to the public, following a similar procedure to an IPO.

What is a bought deal in underwriting?

A bought deal is when a large company sells the entire issue to one investment dealer or a group, which then attempts to resell it, assuming the price risk.

What is a market-out clause in underwriting?

A market-out clause allows the underwriter to terminate the underwriting agreement without penalty under extraordinary circumstances or if market conditions are unfavorable for the issue.

Does adding more shares necessarily depress stock prices below their true value?

no

What are the costs of a general cash offer?

The costs include underwriting spread, administrative costs, and underpricing, similar to IPOs. An additional cost is abnormal returns, which arise from the market's reaction to stock issues.

What is venture capital?

• Venture capital is equity capital provided to a promising new business or invested to finance a new firm.

Who are angels in the context of venture capital?

Angels are wealthy individual investors who make small-scale investments in local start-ups and early-stage ventures.

What is a private placement?

A private placement is the sale of securities to a limited number of investors without a public offering.