Firm Financial Decisions: Financing Decisions

  • Many Australian businesses are sole proprietorships/partnerships, limiting their access to outside equity. Incorporation allows access to capital through angel investors, venture capital firms, institutional investors, and corporate investors.

Sources of Funding

  • Angel Investors: Provide initial equity.

  • Venture Capital Firms: Invest in young firms, often demanding control.

  • Institutional Investors: Invest directly or via venture capital firms.

  • Corporate Investors: Invest for strategic reasons and returns.

Securities and Valuation

  • Companies issue preferred shares. Preference shares in young firms are convertible into ordinary shares, offering senior claims on assets.

Lecture Example 1

  • VC invests $6 million\$6 \text{ million} for 3 million shares in a company. Calculations determine post-money valuation, VC ownership, founder ownership, and value of founder's shares.

Securities Valuation Trade-Off

  • Equity funding requires giving up ownership. Higher share price means less ownership given up.

Exiting an Investment

  • Via acquisition or public offering.

Taking Your Firm Public: The Initial Public Offering

  • IPO is selling shares to the public for the first time.

Advantages and Disadvantages of Going Public

  • Advantages: Greater liquidity, better access to capital, easier to attract talent.

  • Disadvantages: Dispersed equity holders, costly compliance.

Primary and Secondary Offerings

  • Primary offering: New shares for capital. Secondary offering: Existing shares sold by shareholders.

  • Underwriters (lead underwriter and syndicate) manage issuance.

Regulatory Requirements

  • Lodgement of a prospectus with ASIC and ASX. Listing application with ASX.

Valuation

  • Underwriters estimate cash flows, examine comparable firms, and use valuation multiples like price-earnings and price-revenue ratios.

Valuation Based on Comparable Firms

  • Use market value of existing companies to value new firms, adjusting for scale differences.

Lecture Example 2

  • Paddles Outdoor valuation using price-earnings and price-revenue ratios based on comparable firms.

Pricing the Deal and Managing the Risks

  • Road show and book building determine offer price.

Firm Commitment IPO

  • Underwriter guarantees to sell shares.

Best-efforts Basis

  • Underwriter tries to sell shares without guarantee.

Auction IPO

  • Market determines price.

Puzzling Characteristics of IPOs

  • Underpricing, hot/cold markets, high issuance costs, poor long-run performance.

Underpricing of IPOs

  • Issue price set below market value for positive first-day return.

'Hot' and 'Cold' IPO Markets

  • IPO activity varies over time.

High Cost of Issuing an IPO

  • Underwriter fees are significant.

Poor Post-IPO Long-Run Share Performance

  • Newly listed firms underperform post-IPO.