Finance-WK1

Qualities of ordinary shareholders

• have voting rights

• have subordinated right to a return on capital

• have subordinated right to a return of capital on liquidation

• equity provided is a permanent investment of capital

Listed vs unlisted companies

• listed companies have shares that can be traded on a public stock exchange

• unlisted can’t

• Unlisted firms get funding from private equity

• listed firms can use a private placement, rights issue or dividend reinvestment plan (DRP)

Sources of private equity

• angel finance thats provided by a small number of high wealth people. informal source

• Venture capital is like a financial intermediary who organises and raises funds from investors

  • they are a temporary source of equity since they need their money back to pay back the investors they get funding from.

ANGEL AND VCS are temporary so they exit when the company is sold or company is put into IPO.

They both control some ownership of the company

Reasons for seeking Public equity

• Broaden ownership base

• company has run out of private equity

• increase customer recognition of company

• enhance reputation

• debt is becoming too expensive

• minimise cost of capital

• establishes market value for the firm

• allow VC to cash out (ie. VCs might force company to do IPO so they can cash out)

• increase liquidity

• makes it feasible to use stocks as an employee incentive

Disadvantages of seeking IPO/going public

• one off legal, accounting and investment banking fees

  • 10% of the funds raised are usually fees

  • Underwriters will usually charge a fee through a spread- diff between underwriters buying price and the offering price

• company has to continually disclose more information and are under more scrutiny by ASIC

• it is time consuming to maintain relationships with investors

• dilution of control from existing owners

• special insider deals get harder

IPO process

• Engage an investment banker

  • find investment banker to market the legal document that details IPO (prospectus) and they might also act as the underwriter to ensure all shares are sold.

• The roadshow

  • investment bankers market the float and gauge investor interest to indicate how many shares they’d buy and at what price.

  • this helps pick an appropriate sub price.

  • provide regulators with a price or range or prices.

• Set the share price and list

  • fixed price: price is set by underwriter and can’t be changed according to market conditions

  • book building: investment bankers talk to big companies to figure out a good price for shares.

  • open auction by investors

Reasons for undepricing

• winners curse, investors not being informed

• market feedback hypothesis: sometimes when underwriters talk to investors to understand what price to set for the shares, investors might want to be compensated for providing this information through underpricing the share

• Investment banking conflicts: IBs underprice to benefit themselves and other clients.

• litigation: if underpriced, less chance of getting sued based on prospectus

• signalling: leaving good taste for investors to encourage them to partake in SEO

Long run underperformance reasons

• clientele effect: investor optimism fades as they find out more information

• impresario effect: IBs might try to create impression of overdemand and then they leave which can lead to underperformance

• Window of opportunity

  • underperforming based on market conditions

SEOS types

DRP/rights issue, general offers, placement

Private placement SEO pros and cons

Is issuing shares to investors at a discount to current market price to certain institutional investors

pros:

• quick (few weeks)

• lower issue costs

• don’t generally need prospectus

cons:

• dilutes control of existing shareholders

• shares issued at discount

• can only privately place 15% of shares in a year

Rights issue

• existing shareholders given right to buy more shares at a discount

• most are renounceable ie. they can be sold

  • can allow rights to lapse or pass them on

pros

• preserves voting patterns

• convienent source of funds

cons:

• takes longer 2-3 months

• Can be costs with underwriting the rights issue

• involves admin

• needs prospectus

ex rights date

• irl X might not be price on ex rights date eg. because of changes in market conditions

DRP

• very small rights issue

• instead of taking cash from dividend, company gives option for shareholders to use the cash from dividend to buy shares at a discount

regulation

• capital markets rely on full disclosure of any info that affects valuation

why can theoretical X rights price differ from actual x rights price

• general movement in share price

• transaction costs associated with exercising the right

• theroetical R value ignores the option characteristic of a right

• R understates values of X because it doesn’t consider stock price undertainity (ie. you can buy for that price even if general stock prices change)

Costs of IPOS

direct costs:

• spread

• admin costs (management, lawyers etc)

Indirect costs:

• underpricing

Effects of doing diff things with rights issue

1. exercising the right

no wealth loss, no voting rights loss

2. not exercising right

wealth loss, voting pattern loss

3. can sell the right

voting loss, no wealth loss