Raising Capital Lecture Review

Raising Capital

• Raising External Capital

  • Firms need to raise external financing during their lifetime.

  • Two main forms: debt financing and equity financing.

Early-Stage Financing

• Types of Investors:

  • Angel Investors: Individuals investing personal funds, focusing on early-stage deals.

  • Venture Capital Firms (VCs): Specialize in pooling funds from various sources to invest in high-risk ventures.

Venture Capital**

• Stages of Investment:

  • Financing is often provided in stages (mitigates risk for VCs):

  • Seed or Angel Round: Initial investment for firms with products in beta stage.

  • Series A: Salaries, market research, and product finalization—less than 10% of firms progress from Seed to Series A.

  • Series B: Products already in the market but require capital for expansion.

  • Series C, D, etc.: Funding for acquisitions, more product development, or preparation for public offering.

• Growth Equity: A recent approach allowing more extended private holding periods.

Crowdfunding & Regulation

• Crowdfunding: Raising small amounts from many people, typically via the internet.

• JOBS Act: Allows companies to raise equity through crowdfunding. Initial limit raised to $50 million in securities within a year.

Initial Coin Offerings (ICOs)

• ICOs: Raising funds by selling tokens, often linked to digital platforms, especially in blockchain technology.

Issuing Securities to the Public

• SEC Regulations:

  • Securities Act of 1933: Federal regulations for interstate securities.

  • Securities Exchange Act of 1934: Regulates already outstanding securities.

• Public Issues Procedure:

  1. Board Approval: Initial management board must approve.

  2. Prepare Registration Statement: Must disclose material information.

  3. SEC Review: SEC examines registration statements; firms can distribute a preliminary prospectus during this waiting period.

  4. Effective Date: Determines final price and sells securities.

• Types of Offers:

  • General Cash Offer: Securities offered publicly.

  • Rights Offering: Existing shareholders are offered shares first.

  • IPO: First public equity issue of a company.

  • SEO: Follow-on offering for already public companies.

Underwriting

• Underwriters: Act as intermediaries for issuing securities; compensate through gross spread—difference between buying price and offering price.

• Types of Underwriting:

  • Firm Commitment: Underwriter buys the entire issue, assumes risk of unsold shares.

  • Best Efforts: Sells as much as possible, returning unsold shares to the issuer.

  • Dutch Auction: Sets price based on competitive bids.

Aftermarket & IPO Pricing

• Aftermarket Period: Time after initial sale; underwriters may stabilize prices by purchasing shares if prices drop.

• Green Shoe Provision: Allows underwriters to buy more shares to cover excess demand.

• Lockup Agreements: Protect insiders from selling shares immediately post-IPO.

• Underpricing: Occurs to create positive returns for new investors, yet can lead to loss for existing shareholders.

  • Example: Beyond Meat’s IPO experienced significant first-day price increases.

Costs of Issuing Securities

• Flotation Costs: Associated costs when floating a new issue.

• Percentage Costs: Direct costs typically around 10% for IPOs, 7% for SEOs.

• Indirect Costs: Includes underpricing effects and potential drops in existing stock prices after announcements of new issues.

Rights Offerings & Dilution

• Rights Offering: Common stock issued to existing shareholders, helping to prevent dilution.

• Dilution Definitions:

  • Loss in Value: Negative impacts due to new shares affecting ownership percentage.

  • Market Value vs. Book Value Dilution: Accounting dilution vs. real decreases in firm value due to unproductive projects.

Early-Stage Financing

Firms often need external financing throughout their lifecycle, with a focus on:

• Types of Investors:

  • Angel Investors: Individual investors who provide personal funds, primarily targeting early-stage projects.

  • Venture Capital Firms (VCs): Organizations that pool funds from different sources to invest in high-risk ventures, often focusing on potential growth companies.

• Stages of Investment:
  Financing for startups typically follows a structured progression:

  • Seed or Angel Round: The initial investment for firms at the product beta stage.

  • Series A: Funds allocated for salaries, market research, and product finalization; only about 10% of firms advance from Seed to Series A.

  • Series B: Financing for companies with market-ready products needing capital for further expansion.

  • Series C, D, etc.: Funding aimed at acquisitions, further product development, or preparation for an initial public offering (IPO).

  • Growth Equity: A newer strategy allowing longer periods of private ownership before public offerings.

Understanding VC Funding:

• Obtaining VC funding is competitive, usually requiring a unique value proposition or innovation in the market. The cost often includes equity dilution and can involve high expectations for rapid growth.

Equity Crowdfunding:

• Description: Involves raising capital from many investors in small increments, typically via online platforms.

• Regulation CF: Under the JOBS Act, it allows companies to raise equity up to $50 million in a 12-month period from unaccredited investors, subject to certain guidelines.

Initial Coin Offerings (ICOs):

• A fundraising method where new tokens are sold to investors, usually tied to a digital project or platform, especially in blockchain technology.

Issuing Securities to the Public:

• Process Overview:

  1. Board Approval: Initial approval from the management board is required.

  2. Prepare Registration Statement: Disclosure of material information is essential.

  3. SEC Review: The SEC reviews the registration statements, allowing preliminary prospectus distribution during this stage.

  4. Effective Date: This sets the final price and allows the sale of securities.

• Key Terms:

  • Registration Statement: Document filed with the SEC including details about the securities being offered.

  • Regulation A: Provides an exemption for public offerings under certain conditions.

  • Prospectus: Information document provided to potential investors.

  • Red Herring: A preliminary prospectus that doesn’t contain final pricing information.

  • Tombstone: An announcement of the offering that includes essential details about the securities.

Alternative Issue Methods:

• General Cash Offer: Public offering of securities.

• Rights Offering: Existing shareholders have the first opportunity to buy new shares.

• Initial Public Offering (IPO): The first issuance of stocks to the public.

• Seasoned Equity Offering (SEO): Subsequent offerings after the IPO.

Underwriters:

• Duties: Act as intermediaries in the issuance process.

• Types of Underwriting:

  • Firm Commitment: The underwriter purchases the entire issue, assuming unsold share risks.

  • Best Efforts: Sells the maximum possible but returns any unsold shares.

  • Dutch Auction: Sets the final price based on competitive bids.

Additional Terms:**

• Underwriting Syndicate: A group of investment banks engaged in underwriting.

• Gross Spread: The difference between the purchase price and the offering price paid to underwriters.

• Aftermarket: Secondary market where securities are traded post-IPO.

• Green Shoe Provision: Allows underwriters to buy more shares if demand exceeds expectations.

• Lockup Agreements: Prevent insiders from selling shares immediately after an IPO.

• Quiet Period: Duration where company executives cannot discuss the upcoming offering publicly.

Pricing and Underpricing:

• Underpricing: Creating initial positive returns for investors; it can be harmful to existing shareholders.

• Historical Evidence: Underpricing often leads to significant first-day price increases, benefiting new investors but may indicate a value compromise for existing ones.

Costs of Issuing Securities:

• Flotation Costs: The total cost incurred when launching a new issue, including direct costs (around 10% for IPOs, 7% for SEOs) and indirect costs, including potential impacts from underpricing.

Rights Offerings & Dilution:

• Rights Offering: A way to issue common stock to existing shareholders, helping mitigate dilution.

• Dilution: The reducing effect on existing shareholders’ ownership due to additional shares being issued, which can lead to both market value and book value dilution, influencing investor perceptions and company performance.