Lecture notes, lectures 10 - raising capital PDF

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Raising Capital...

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10/4/2015

LectureTopic:RaisingCapital Agenda EquityCapital:

ChoosingBondMaturity

Earlystagefinancing

ChoosingBondAmount

IPOprocess,prosandcons

BondRefunding

IPOunderpricing MarketreactiontoSEOs AsymmetricInformationProblem Goingprivate,prosandcons

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EarlyStageFinancing:VentureCapital(VC) Anentrepreneuratanearlystagemayseekfinancingfroma venturecapitalist (orabusinessangel). Venturecapitalreferstofundsthatfinanceyoung(ornew)high‐risk ventures. Thismarketisdominatedbyventurecapitalistsorventurecapital firms(VC). Majorplayersinthismarketarewealthyinvestors,VCsand institutionalinvestors(managedfunds).Accesstoventurecapital canbeverydifficult. SomeVCsspecializeininvestingindifferentstagesoffirm development(ie.1st stage,2nd stage,etc).E.g.,“incubation orseed money”,“mezzanine‐levelfinancing”,etc... FINS3625S2Yr2015 2

EarlyStageFinancingandGoingPublic Intheeventofliquidation,VCsrankjustaheadofotherequity holders Moststart‐upsfailandVCslosemostoftheirinvestments. Butsomeventuresmakeitbig,verybig(e.g.SunMicrosystemsco‐ founderAndreasBechtolsheim asofOct2,2015made45,500% returnon$100,000investmentinGooglein1998). VCscan“cashout”iftheyrealizeenoughfinancialgainsorifthey thinkfutureprospectofthebusinessisdim. Ifsuccessful,thefirmlikelywillgrowtobecomepubliclytraded,at whichpointVCsmaychoosetocashout(secondaryoffering). FINS3625S2Yr2015

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BasicStepsinInitialPublicOfferings Steps in an Initial Public Offering (IPO):

A) Obtain the approval from the Board of Directors.

B) Prepare and lodge a prospectus with the Australian Securities & Investments Commission (ASIC). In the US: Security Exchange Commission (SEC). These agencies enforce securities laws and regulate the securities markets.

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BasicStepsinInitialPublicOfferings Steps in an Initial Public Offering (IPO) Cont’d:

C) The prospectus contains: • • • • •

financial information, history of the company, qualifications of the directors and the management, auditors, underwriters, consultants involved in the issue description of the proposed financing, amount, and uses of financing

The sole purpose of the prospectus is to inform and educate prospective investors of the company (not to endorse). FINS3625S2Yr2015

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BasicStepsinInitialPublicOfferings Steps in an Initial Public Offering (IPO) Cont’d: D) If it’s a public offering, must also lodge a prospectus with Australia Securities Exchange (ASX). In the US: with the exchange.

E) Revise and resubmit the prospectus until final approval from ASIC and the exchange. During the registration period, the management and underwriter can go on road shows and engage in book building.

F) Selling efforts get under way once the final prospectus is approved by the ASIC and the exchange. FINS3625S2Yr2015

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ProsofGoingPublic Pros: ‐ Currentstockholderscandiversify(BillGatesonMicrosoft’sIPO day.Hasbeenoffloadingeversince). ‐ Increasesliquidity(originalinvestors/founderscansellmoreeasily) ‐ Easiertoraisenewcapitalinthefuture(noneedtolookfor investors) ‐ Establishesmarketfirmvalue ‐ Facilitatesuseofstockstoincentivizeemployees/management ‐ Increasescustomerrecognition. FINS3625S2Yr2015

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ConsofGoingPublic Cons: ‐ Repeatedfilings ‐ Havetoabidetosecuritiesandcorporatelaws(e.g.Sarbanes‐Oxley Act) ‐ Greaterscrutinyofcorporateinsiders(complicatesspecial“deals” withinsiders) ‐ Marketvaluemaynotreflecttrueintrinsicvalue ‐ Threatoftakeovers ‐ Investor’srelation:managinginvestorrelations isverytime‐ consuming(rumorisDellwentprivatetopreventbeingberatedby investors/analysts).

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RoleoftheUnderwriters At least one underwriter is involved in an IPO. syndicates) perform the following services:

Underwriters (or

• Formulate the method used to issue the securities i.e. private placement (Goldman Sacs), public offering (e.g. UPS), private auction (e.g. Google) • Help with the marketing and the pricing of the new securities i.e. Road show, book building, intrinsic valuation, etc. • Help sell the new securities i.e. offer access to the distribution channel through brokerage firms (investment banks and brokerage firms tend to be affiliated with larger `umbrella’ financial institutions) The spread is the most significant source of compensation for the underwriters. The spread is the difference between the offer price and the price paid for the shares. FINS3625S2Yr2015

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WhyareIPOsunderpriced?

ThreepossibleexplanationsforIPOunderpricing: 1)Investors’compensationforrisk: Onaverage,investorsmustbecompensatedforinvestinginhighly speculativeissues 2)Underwritersunderpricetosellout – ReputationalreasonsforsuccessfulIPOs – Underpricing=lowerrisksfortheunderwriters

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WhyareIPOsunderpriced? 3)TheWinner’sCurse: IPOsareundervaluedtocompensateinvestorsforexposuretothe Winner’sCurseProblem. Winner’sCurseProblem: InformedinvestorswarmwinningIPOsand shunmoneylosingIPOs.RaisesthechancesthatbadIPOswillgoto uninformedinvestors,meaningtheaverageinvestorwilltendtolose moneyintheIPOmarket.

UnderpricinghelpsmitigatetheWinner’sCurseProblem. FINS3625S2Yr2015

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Winner’sCurseProblem:Example LastyearthereweretwoIPOs. JohnknowingabouttheIPO underpricingphenomenonplacedpurchaseordersfor1,000shares foreachoftheIPOs. Hereceived100sharesofthefirstIPOand1000sharesofthe secondIPO. ThefirstIPOwasundervaluedby$1whilethesecondIPOwas overvaluedby$3.WhatwasJohn’sdollarreturnontheseIPOs? Conclude. GainfromIPOs=100x$1+1000x(‐$3)=‐$2,900 JohnwasexposedtotheWinner’sCurseProblem. FINS1613S2Yr2015

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MarketReactiontoSEOAnnouncements EmpiricalEvidence: Pricesdroponaverageby1‐3%uponequity raisingannouncement.Butpresumablyfirmsissuestockstofinance+ NPVprojects!Whatisgoingon? Possiblereasons:AllbasedonAsymmetricInformationProblem (a) Issuingequitysignalsthestockpricewillfallinthefuture.Signals thatinternalforecastsaredim. (b) Markettiming:managerstendtoissueequityattimeswhenstocks are‘overvalued’ (c) Peckingorder: Ifinternalforecastsarerosy,thenthefirmshould notissuestocks.Profitablefirmsshouldhavethefollowingpecking order:Equityshortterm>>>longterm>>>equity(Peckingorder) Internalforecastsofdegradingfinancialstrengthfavorslong‐term debtfinancing: cash...