FIN 4510 Chapter 15: Raising Capital

Venture Capital (VC)

Is financing for new, often high-risk ventures

• “Angels” are usually individuals who invest their own money, but they tend to focus on smaller deals.

• Venture capital firms specialize in pooling funds from various sources and investing them.

• Underlying sources of funds include individuals, pension funds, insurance companies, large corporations, and university endowments

Private Equity

Often used to label the rapidly growing area of equity financing for non-public companies, generally in the later stages before going public.

Venture Capital Stages

To limit their risk, venture capitalists generally provide financing in stages, and venture capital firms often specialize in different stages:

• A seed, or angel, round is the initial investment

• Early-stage venture capital is classified as Series A or Series B

• Late-stage rounds are classified as Series C, Series D, and so on

Growth equity has become more common as a form of venture capital in the later stage of company’s growth.

Price of Venture Capital

• Typically, the venture capitalist will demand 40% or more of the equity in the company

• Venture capitalists frequently hold voting preferred stock and typically demand several seats on the company’s board of directors, possibly appointing one or more members of senior management

• Venture capitalists tend to be specialized, investing in particular industries

Crowdfunding

The practice of raising small amounts of capital from a large number of people, typically via the internet.

Jumpstart Our Business Startups (JOBS) Act of 2012

A provision allows companies to raise money by selling equity through crowdfunding.

Initial Coin Offering (ICO)

A company can raise funds by selling tokens, which often grant the holder the right to use the company’s services in the future/

Procedures for Selling Securities to the Public

• Management must obtain approval from board of directors

• Firm must prepare a registration statement, a statement filled with the SEC that discloses all material information concerning the corporation making a public offering

• SEC examines registration statement during a waiting period, during which time the firm may distribute copies of a preliminary prospectus, a legal document describing details of the issuing corporation and the proposed offering to potential investors

• Firm cannot sell securities during the waiting period, but oral offers can be made

• On effective date of registration statement, a price is determined and a full-fledged selling effort gets underway

Initial Public Offering (IPO)

A company’s first equity issue made available to the public; also called an unseasoned new issue. (All IPOs are cash offers)

Seasoned Equity Offering (SEO)

A new equity issue of securities by a company that has previously issued securities to the public.

For equity sales, there are two types of public issues:

• A general cash offer, is an issue of securities offered for sale to the general public on a cash basis

• A rights offer (that is, rights offering) is a public issue of securities in which securities are first offered to existing shareholders

Alternative Issue Methods

When a company decides to issue a new security, it can sell it as public issue or a private issue

• In a public issue, firm is required to register the issue with the SEC

• If the issue is to be sold to fewer than 35 investors, the sale can be carried out privately, and a registration statement is not required

Firm Commitment Cash Offer

The company negotiates an agreement with an investment banker to underwrite and distribute the new shares. A specified number of shares are bought by underwriters and sold at a higher price.

Best Efforts Cash Offer

The company has investment bankers sell as many of the new shares as possible at the agreed-upon price. There is no guarantee concerning how much cash will be raised.

Dutch Auction Cash Offer

The company has investment bankers auction shares to determined the highest offer price obtainable for a given number of shares to be sold.

Direct Rights Offer

The company offers the new stock directly to its existing shareholders.

Standby Rights Offer

Like the direct rights offer, this contains a privileged subscription arrangement with existing shareholders. The net proceeds are guaranteed by the underwriters.

Shelf Cash Offer

Qualifying companies can authorize all shares they expect to sell over a two-year period and sell them when needed.

Competitive Firm Cash Offer

The company can elect to award the underwriting contract through a public auction instead of through negotiation.

Direct Placement

Securities are sold directly to the purchaser, who, at least until recently, generally could not resell securities for at least two years.

Underwriters

Investment firms that act as intermediaries between a company selling securities and the public, which may entail the following services:

• Formulating the method used to issue the securities

• Pricing the new securities

• Selling the new securities

Gross Spread

Difference between the underwriter’s buying price and the offering price, representing compensation to underwriter.

Syndicate

Group of underwriters formed to share the risk and help sell an issue.

Basic types of underwriting are involved in a cash offer:

• Firm commitment

• Best efforts

• Dutch auction

Firm Commitment

In firm commitment underwriting, the underwriter buys the entire issue, assuming full financial responsibility for any unsold shares.

Road Show

Underwriter and company management will do presentation in multiple cities, pitching the stock

Book Building

Process of soliciting information about buyers and the prices and quantities they would demand is known as book building

Green Shoe Provision

Gives the members of the underwriting group the option to purchase additional shares from the issuer at the offering price.

Lockup Agreements

Specify how long insiders must wait after IPO before they can sell stock. (180 days)

Direct Listing

A firm arranges for its stock to be listed on an exchange without marketing and other help from an underwriter.

Quiet Period

Once a firm begins to seriously contemplate an IPO, the SEC requires that a firm and its managing underwriters observe a “quiet period”

• During this time, all communication with the public must be limited to ordinary announcements and other purely factual matters

• Quiet period ends 40 calendar days after IPO

Aftermarket

The period after a new issue is initially sold to the public.

• During this time, members of the underwriting syndicate generally do not sell securities for less than offering price

Winner’s Curse

Implies the average investor “wins” and gets the entire allocation because those who knew better avoided the issue.

Gross Spread

The gross spread consists of direct fees paid by the issuer to the underwriting syndicate - the difference between the price the issuer receives and the offer price.

Other Direct Expenses

These are direct costs, incurred by the issuer, that are not part of the compensation to underwriters. These cots include filling fees, legal fees, and taxes - all reported on the prospectus.

Indirect Expenses

These costs are not reported on the prospectus and include the costs of management time spent working on the new issue.

Abnormal Returns

In a seasoned issue of stock, the price of the existing stock drops on average by 3 percent on the announcement of the issue.

Underpricing

For initial public offerings, losses arise from selling the stock below the true value.

Rights Offering

An issue of common stock offered to existing stockholders.

• Each shareholder is issued rights to buy a specified number of new shares from the firm at a specified price within a specified time, after which the rights are said to expire.

• Terms of the are evidenced by certificates known as share warrants or rights.

• Rights are often traded on securities exchanges or over the counter

Ex Rights

The ex-right is the beginning of the period when stock is sold without a recently declared right, normally two trading days before the holder-of record date.

The holder of record date is the date on which existing shareholders on company records are designed as the recipients of stock rights, also the date of record.

Standby Underwriting

Is where the underwriter agrees to purchase the unsubscribed portion of the issue.

• Rights offers are usually arranged using standby underwriting.

• The underwriter usually gets a standby fee and additional amounts based on the securities purchased.

• Protects the firm against undersubscription

Oversubscription Privilege

Allows shareholders to purchase unsubscribed shares in a rights offering at the subscription price.

Dilution

Loss in existing shareholders’ value in terms of ownership, market value, book value, or EPS

Basic forms of direct private long-term finacning

• Term loans are direct business loans of typically one to five years

• Private placements are loans (usually long-term) provided directly by a limited number of investors