⌛ D362 - Corporate Finance

Complete to the end of 15.3 "Initial Public Offering" in Fundamentals of Corporate Finance.

Financial management

Encompasses how the business plans and addresses its financing needs.

Choices businesses have to make

Are determined by the math behind finance rather than theory or subjective viewpoints regarding financing methods and business structure.

Business structure

A key choice that firms must make when setting up a company. Common forms include:

• Sole proprietorship

• Partnership

• Corporation (C corp)

• Hybrids (LLCs, S corps, etc.)

Corporations

The business structure virtually all large publicly traded companies fall under.

LLCs/Sole Proprietorships

The business structure privately owned firms usually fall under.

B corporation

A for-profit legal entity that has obtained certification from the nonprofit B Lab and has set performance standards to achieve. Opts out of shareholder primacy, thereby moving the company from value creation (for the shareholder above all else) to stakeholder governance.

Benefit corporation

A legal status administered by the Secretary of State (or similar role operating within the state province, or country), that does not have set performance standards to achieve. Opts out of shareholder primacy, thereby moving the company from value creation (for the shareholder above all else) to stakeholder governance.

Conglomerate

One company owns a controlling stake in smaller companies, which operate separately and independently.

Joint venture

A form of corporate alliance in which parts of a company are joined with another company to achieve specific, limited objectives.

• Typically lasts at least five years

• Management team is representative of two or more parent companies

Mergers

Occur when two organizations combine as a single operating entity, joining forces to execute a uniform strategy and mission. The four primary types are:

• Vertical

• Horizontal

• Congeneric

• Conglomerate

Corporate governance regulations

Exist to align the interests of shareholders and those of firm managers.

Sarbanes-Oxley Act of 2002 (SOX)

Imposes specific requirements on publicly traded companies to ensure greater oversight of firms and accountability for managers.

Securities and Exchange Commission

Provides regulatory guidance and oversight to private and public organizations issuing securities.

General partnership

Two or more owners who have joined together legally to manage a business and share its profits.

• Advantages: The ability to make the business independent from the owners makes it easier to raise capital and less costly for partners to sell their interests at an attractive price

• Disadvantages: More costly to form than sole proprietorships due to need for a partnership agreement, all partners have unlimited liability

Limited partnership

Two or more owners who have joined together legally to manage a business and share its profits.

• Avoids unlimited liability for some partners since limited partners can generally only lose the amount of money that they have invested in the business

C-corporation

A legal entity formed and authorized under a state charter; in a legal sense, it is a “person” distinct from its owners.

• Advantages: Shares can be sold to raise capital, owners (shareholders) have limited liability

• Disadvantages: More costly to start than a partnership, subject to double taxation (taxed at corporate level, then personal level when stockholders receive dividends)

S-corporation

A form of corporation that can be used by private businesses that meet certain requirements.

• Advantages: All profits earned pass directly to the stockholders, just as they pass to a sole proprietor or the partners of a partnership.

• Disadvantages: Can only have one class of stock and cannot have more than one hundred stockholders or any stockholders that are corporations or nonresident alien investors.

Public markets

Markets regulated by the Securities and Exchange Commission (SEC) in which securities such as stocks and bonds are publicly traded (NYSE, NASDAQ)

Privately/closely held corporations

Corporations whose stock is not traded in the public markets

Limited liability partnership (LLP)

• Liability: Partners are typically not responsible for any other partner’s malpractice

• Taxation: Like their regular counterparts, income to the partners is taxed as personal income

Limited liability company (LLC)

Also provide limited liability to the people who make the business decisions while enabling all investors to retain the flow-through tax advantages of a limited partnership

Conglomerate

A form of business organization whereby a corporation, usually operating on a global scale, owns multiple smaller organizations that operate independently of the affiliated firms

Lateral integration merger

A form of horizontal merger, whereby two companies that operate in the same market and offer the same or similar products and services decide to come together and form one entity. Differs slightly from the horizontal merger, as the companies are not competitors

Backward integration merger (backward vertical integration)

A company purchases another company which is a raw materials or parts supplier within the company's supply chain

Forward integration merger (forward vertical integration)

A company purchases an organization that is further along its supply chain, such as a wholesale distributor or retailer

Congeneric merger

Joins two or more companies that operate in the same or related industries and share overlapping customers or technology, but offer different, complementary products

Risk manager

Responsible for monitoring and managing the firm's risk exposure in financial and commodity markets and the firm's relationships with insurance providers

Controller

Maintains the firm’s financial and cost accounting systems, prepares taxes, works closely with the firm’s external auditors, and prepares the firm’s financial statements

Bootstrapping

The process by which many entrepreneurs raise seed money and obtain other resources necessary to start their businesses.

• Common sources of seed money: Income from a job, personal savings, selling assets such as cars and boats, borrowing against the family home, loans from family members and friends, loans obtained through credit cards

• Lasts no more than one or two years

Venture capitalists

Individuals or firms that invest by purchasing equity in new businesses and often provide entrepreneurs with business advice.

Angels (angel investors)

Wealthy individuals who invest their own money in new ventures.

Venture capital vs. traditional investors

The high degree of risk involved, the types of productive assets, and information asymmetry problems.

VC risk-reduction tactics

Funding ventures in three to seven stages, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize.

Syndication

Occurs when the originating venture capitalist sells a percentage of a deal to other venture capitalists, increasing diversification of their portfolio, and being reinforced by the willingness of other venture capitalists to share in the investment.

VC exit strategy

Timing (when), the method, and what price is acceptable.

Seasoned public offering

The sale of securities to the public by a firm that already has publicly traded securities outstanding

Initial public offering (IPO)

A company’s first sale of common stock in the public market.

• Advantages: Raises more equity capital, allows low-cost follow-on offerings, can fund growth without losing control, provides an active secondary stock market, and helps attract and motivate top management

• Disadvantages: High costs, significant legal/accounting expenses, public financial disclosures may hurt competitiveness, and quarterly earnings pressure can encourage short-term thinking in managers

Investment bankers

Experts in bringing new securities to market, and provide three basic services to do so:

1. Origination

2. Underwriting

3. Distribution

Origination

Phase that an investment banker helps management determine whether the firm is ready for an IPO. Requires determining if the management team and the firm's historical financial performance are strong enough to merit consideration by sophisticated traders.

• Preliminary prospectus: Initial registration statement filed with the SEC in preparation to issue securities to the public; contains detailed information about the issuer and proposed issue.

Underwriting

The process where investment banks act as financial intermediaries to help a private company issue stock and go public. Can be done two ways:

• Firm-commitment

• Best-effort

Firm-commitment underwriting

Underwriter purchases securities for a specified price and resells them. Underwriter's spread (IB's compensation) is the difference between the IB's purchase price and the offer price.

Best-effort underwriting

Underwriter does not agree to purchase the securities at a particular price but promises only to make its “best effort” to sell as much of the issue as possible above a certain price.

Distribution

A pricing call is held to determine the final offer price, and the firm's management decides whether it's acceptable. If they do, management will register the securities with the SEC and they can then be sold to investors.