Lecture 3 Equity Finance
University of Reading AC203 Notes
Page 1: Week 3 Attendance
Attendance details for Semester 1 of AC203 course.
Page 2: Lecture 3 - Long-term Finance I - Equity
Introduction to long-term finance focusing on equity financing.
Page 3: Required Reading Resources
E. McLaney (2017) Business Finance, 11th Ed.
Chapter 8: Sources of Long-term Finance
D. Watson and A. Head (2010) Corporate Finance: Principles and Practice
Chapter 4: Long-term Finance: Equity Finance
G. Arnold (2013) Corporate Financial Management, 5th Ed.
Chapter 17: Valuing shares
Page 4: Patterns of Corporate Financing
Funding Sources: Firms can raise funds through:
External financing (debt or equity)
Reinvesting profits instead of distributing them to shareholders.
Page 5: Equity vs. Debt
Comparison of Key Features:
Income:
Equity: Dividends (paid from profit)
Debt: Interest (fixed obligation)
Tax Status:
Dividends are taxed as personal income.
Interest is tax-deductible for corporations.
Control:
Ordinary shares provide voting rights.
Debt control is dictated by loan agreements.
Default Consequences:
Firms cannot be forced into bankruptcy for unpaid dividends.
Non-payment of debt results in bankruptcy.
Bottom Line: Tax structure favors debt, yet the equity structure provides greater default protection.
Page 6: Ordinary Shares Characteristics
Nature of Ordinary Shares:
No maturity date; claims on income and assets.
Shareholders cannot dilute their holdings.
Losses are limited to the amount invested.
Voting rights are attached.
Page 7: Ordinary Shares: Claims
Claim on Income:
Ordinary shareholders receive income post bondholders and preferred stockholders.
Two forms of return: cash dividends or reinvestment of earnings.
Residual Income: Potential for unlimited returns, but risks of receiving little or nothing.
Claim on Assets:
In liquidation, ordinary shareholders have residual claims.
However, bankrupt firms usually lack sufficient assets to cover these claims.
Page 8: Dual Class Shares
Definition: Dual-class shares allow founders control through multiple voting rights.
Example: Facebook's Class A (1 vote) vs. Class B (10 votes), allowing Zuckerberg control with only 15% economic interest.
Page 9: Share Classes and Voting
Share Structure for University of Reading Shares:
Class A: 1 vote per share
Class B: 10 votes per share
Breakdown of total votes and equity share percentages.
Page 10: Public Issues
Types of Offerings:
Initial Public Offering (IPO)
Seasoned Equity Offering (SEO)
Page 11: Benefits of IPOs
Advantages of going public include:
Cheaper financing access.
Creation of a publicly traded asset.
Liquid shares for acquisitions.
Diversification for initial owners.
Enhanced firm monitoring.
Increased public awareness.
Page 12: Downsides of IPOs
Costs: Going public can incur high costs.
Ownership Issues: Separates ownership from control.
Disclosure Risks: Sharing strategic info may advantage competitors.
Public Pressure: Increased scrutiny from shareholders and public.
Page 13: IPO Processes
Overview of the IPO process:
Prospectus creation
Pre-underwriting conferences
Public offerings and market stabilization.
Page 14: Methods of Issuing Shares for Cash
Share Issuance Methods:
Firm Commitment, Best Efforts, Dutch Auction.
Underwriter Selection:
Competitive vs. Negotiated.
Page 15: Firm Commitment Underwriting
Description: All shares sold to underwriters who resell to the public.
Underwriter takes on the risk of unsold shares.
Page 16: Best Efforts Underwriting
Underwriter attempts to sell shares but the company bears the risk of insufficient sales.
Offers may be withdrawn if not enough interest is shown.
Page 17: Dutch Auction Underwriting
Mechanism: Accepting bids for shares where all pay the highest accepted price.
Incentive for high bids while potentially realizing lower prices.
Google used this method for IPO.
Page 18: Private Placements
Avoid costly IPO registration procedures but tradeability for these shares may be limited.
Page 19: Anomalies in IPOs
Common issues include: underpricing and long-term underperformance.
Comparison to established firms in the same industry.
Page 20: IPO Underpricing Reasons
Difficulty in pricing due to lack of market price.
Asymmetrical information in private vs. public companies.
Underwriters' desire for client success, leading to "money left on the table" for issuers.
Page 21: U.S. IPO Statistics
Overview of U.S. IPO trends from 1980-2017, including offerings and average first-day returns.
Page 22: International IPO Returns
First Day Returns Across Countries:
Statistics presented for various countries highlighting performance rates.
Page 23: Money Left on the Table in U.S. IPOs
Average first-day return from July 2009 to June 2019 noted to be 16%.
Total “money left on the table” for VC-backed IPOs highlighted.
Page 24: ANT IPO Incident
Overview of ANT's attempt to launch the largest IPO, which was rejected by HK authorities.
Page 25: UK IPO Trends in 2023
Significant declines in listings and proceeds noted.
Highlighted largest IPO of CAB Payments in 2023 amounting to £291.5 million.
Page 26: Equity Issuance to Existing Shareholders
Outline of processes for issuing new shares, including shareholder approvals and previous share price considerations.
Page 27: Rights Issues
Description of rights issues as a means for existing shareholders to purchase additional shares at a discount.
Sale of rights by shareholders allowed.
Page 28: Advantages of Rights Offerings
Key benefits include cost-effectiveness and preservation of voting rights.
Page 29: Theoretical Ex-Rights Price (TERP)
Explanation of TERP calculations with formula.
Page 30: Value of Rights
Defined as the difference between TERP and rights issue price, illustrated by examples.
Page 31: Example of Rights Issue
Royal Bank of Scotland's rights issue explained with financial figures.
Page 32: Rights Issue Calculations
Further calculations regarding shares needed and rights ratios.
Page 33: Shareholder Example for Rights Issues
Scenario detailing how shareholders can use rights to increase holdings without financial loss.
Page 34: Shareholder Outcomes
Outcome analysis for shareholders exercising or selling rights.
Page 35: Bonus Issues
Explanation of bonus issues converting reserves into added share capital.
Page 36: Preference Shares
Characteristics: Priority in dividends, no voting rights, fixed dividends, etc.
Advantages/Disadvantages: Discussed in detail.
Page 37: Share Valuation Fundamentals
Introduction to fundamental theory of valuation detailing future cash flow present value.
Page 38: Dividend Payment Types
Differentiation between zero growth and growth in dividends for share pricing.
Page 39: Gordon's Growth Model
Explanation of the model for stocks with constant dividend growth.
Page 40: Share Valuation Examples
Calculations for zero growth and constant growth models with illustrative examples.
Page 41: Further Example of Constant Growth Model
Detailed calculation of stock price based on expected future dividends.
Page 42: Quiz Example
Quiz content regarding share premium and shareholder rights.
Page 43: Additional Quiz Content
Quiz question on stock valuation models.
Page 44: Quiz on Common Stock
Questions about the nature of common stock.