Key Concepts in Corporate Finance

Key Concepts in Corporate Finance

Private Equity

• Definition: Investments made in private companies, not listed on public exchanges.
• Types of Investors:
  • Angel Investors: Wealthy individuals providing capital for startups.
  • Crowdfunding: Raising small amounts of money from many people, typically via the internet.
  • Venture Capital: Investment firms that provide funding to early-stage companies.
• SAFE Notes: Simple Agreement for Future Equity; a way for startups to raise money.
• Private vs Public Markets: Private markets lack regulatory scrutiny, while public markets are regulated and provide liquidity.

Venture Capital

• Convertible Preferred Shares: Shares that can be converted into common stock.
• Liquidation Preference: Rights of shareholders to get their investment back during liquidation events before common shareholders.
• Anti-Dilution Rights: Protection against equity dilution during subsequent funding rounds.
• Board Membership: Investors may require board seats as part of the agreement.

Public Equity (IPO/SEO)

• Information Asymmetry: Different stakeholders have access to different information.
• Adverse Selection: Potential misrepresentation affecting the selection of investors.
• Moral Hazard: Risk that one party will take risks because they do not bear the full consequences.
• Signalling Theory: Actions taken by informed parties to reveal information to uninformed parties.

IPO Process

• Stages:
  1. Preparatory: Preparing the company for public offering.
  2. Draft: Submitting a draft registration statement to regulatory bodies.
  3. Blackout: Period when company insiders cannot trade shares.
  4. Pathfinder: Educational document for potential investors.
  5. Listing: Shares are available for public trading.
• Role of Investment Banks: Underwriters facilitate the IPO process, set prices, and sell shares.

IPO Issues

• Underpricing: Initial share price is set below market value; investors make quick profits.
• Book-Building: Process of generating, capturing, and analyzing demand from investors.
• Best-Effort vs Firm Commitment vs Auction IPO:
  • Best-Effort: Underwriter does their best to sell all shares, but does not guarantee sales.
  • Firm Commitment: Underwriter buys all shares and resells them.
  • Auction: Shares are sold to the highest bidder.

SPACs (Special Purpose Acquisition Companies)

• Structure: Blank check companies formed for the purpose of acquiring private companies.
• Promote: Incentive for SPAC sponsors that grants them equity during the merger.
• PIPE Deals: Private Investment in Public Equity, often used to secure additional funding.
• SPAC vs Traditional IPO: SPACs offer quicker access to public markets but with different risks and costs.

Rights Issues

• Rights Offer vs Cash Offer: Rights offer gives existing shareholders the chance to buy additional shares at a discount.
• Subscription Price: Price offered to existing shareholders in a rights issue.
• Underwriting: Insurance against shares not being sold.
• Deep Discount Issues: Selling shares below market price to encourage uptake.

Cost of Capital

• CAPM Assumptions: Assumes rational investors and a risk-return trade-off.
• Risk-Free Rate Issues: The baseline return investors can expect without risk.
• WACC (Weighted Average Cost of Capital): Average rate of return expected by all of a company's shareholders.
• Equity vs Project Beta: Different measures of risk for equity investments vs project-specific risks.

Liquidity and Adverse Selection

• Impact on Cost of Capital: Lack of liquidity can increase the cost of capital due to greater risk.

Debt and AIC (All-in-Cost)

• Private vs Public Debt: Private debt often has different costs and risks compared to public debt instruments.
• Yield to Maturity (YTM): Total return anticipated on a bond if it is held until it matures.
• Transaction Cost: Costs incurred in the process of trading debt securities.
• Credit Spread: Difference in yield between a corporate bond and a government bond of similar maturity.

Practical Calculations

• Private Equity / Venture Capital:
  • Post-Money & Pre-Money Valuations; Ownership % After Investment; Price Per Share; Shares Issued for % Ownership, IRR for VC Returns.
• IPO / SEO / Rights Issue:
  • Money Raised in IPO After Underwriting Fee; Underpricing %; Ex-Rights Price and Value of a Right; Dilution on Share Price.
• SPACs:
  • Promote Shares Calculation; Cash Per Share Contributed; Implied Valuation of Merged Company.
• Cost of Capital (WACC):
  • CAPM Return Calculation; WACC Calculation Using Market Values; Project Beta Adjustment.
• Debt Cost:
  • Yield To Maturity, All-In-Cost of Debt, Cost of Debt After Tax.

Formulas to Memorise

• CAPM: R = Rf + eta(Rm - R_f)
• WACC: WACC = (E/V)Re + (D/V)Rd(1 - T_c)
• IRR: IRR = (Ending Value / Investment)^{(1/n)} - 1
• Ex-Rights Price: P_x = \frac{(Old Value + New Funds)}{(Old Shares + New Shares)}
• Value of a Right: Right Value = P_x - Subscription Price
• Debt Cost After Tax: Rd(1 - Tc)
• Post-Money Valuation: Post-Money = \frac{Investment}{Ownership ext{%}}
• Pre-Money Valuation: Pre-Money = Post-Money - Investment
• Ownership%: Ownership ext{%} = \frac{Investment}{Post-Money}
• Shares for Target % Ownership: \frac{New Shares}{(Old Shares + New Shares)} = Target ext{%}
• Beta Unlevered/Levered: \betaU = \frac{\betaL}{(1+(D/E))} \, and \, \betaL = \betaU(1+D/E)

Important Reminders

• The official AG917 formula sheet covers CAPM, WACC, IRR, Rights Issue formulas.
• Master practical calculations and be familiar with rearranging basic math concepts.
• Topics for Section B theory include Information Asymmetry, IPO Puzzles, SPAC vs IPO, Cost of Capital Problems, Rights vs Cash Offers.

Additional Practice Required

• Complete at least 1 full Section A sample paper.
• Write out 2-3 bullet-pointed essays for Section B topics.
• Rapid recall of formulas and their applications is critical.