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Finance 3rd Edition

Cornett, Adair, and Nofsinger

18

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Issuing Capital and

the InvestmentBanking Process



18-2

Introduction

• Firms finance assets with capital• Retained earnings

• Debt

• Equity



18-3

Sources of Capital for New and Small Firms

• Debt• Borrowing from friends and relatives

• Bank loans

• Venture capitalists

• Equity

• Venture capitalists



18-4

Debt Financing

• Bank Loans• New and small firms rely on banks

• Availability of small-business loans was heavily

affected by the 2008 financial crisis



18-5

Bank Loans

• Small Business Loans• Risky for commercial banks

• Banks use small-business scoring models



18-6

Bank Loans

• Mid-market firms• Sales between $5 million and $100 million peryear

• Rely on banks for funding


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Credit Process Flow Chart


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Loan Commitments

• Loan commitment agreements specify• Maximum loan amount

• Interest rate terms

• Length of loan



18-9

Fixed versus Floating Rate Loans

• Interest rates for variable-rate loanschange over the life of the loan

• Floating rate loans are set at a fixed

spread over a prevailing benchmark rate



18-10

Small Business Administration

• Created to help small businesses• Basic loan guarantee program

• For qualified new firms that cannot get

reasonable long-term financing from otherfinancial institutions



18-11

Equity Financing and Expertise

• New and high-risk firms use venture capital(VC) for financing

• Professionally managed

• VC firm takes an equity stake in the firmfinanced

• VC firms are actively involved in the business



18-12

Venture Capital Firms

• Institutional venture capital firm types• Venture capital limited partnerships

• Financial venture capital firms

• Corporate venture capital firms

• Small Business Investment Companies



18-13

Angel Venture Capitalists

• Majority of VC equity investments fromwealthy individuals (angels), not institutions

• Angel VCs want

• High return

• Easy exit



18-14

The Choice to Go Public

• Choice made when firm’s capital needsexceed its ability to raise capital

• Initial public offering (IPO) of firm’s stock

• Equity is publicly traded in stock markets for thefirst time



18-15


• Benefits of being a public firm• Access to a larger pool of equity capital

• Stock market provides a market value for the

firm’s stock



18-16


• Benefits of being a public firm• Firm’s managers can be rewarded with firm’s

stock

• Original owners can diversify their holdings



18-17


• Disadvantages of being a public firm• Costs of an IPO

• Public disclosure of information required — may

be valuable to competitors• Shareholders demand a great deal ofinformation



18-18

Public Firms’ Capital Sources

• Debt Financing• Commercial Paper

• Unsecured, short-term promissory note

• Used to raise short-term cash, often working capital



18-19

Commercial Paper

• Trading process• Can be sold directly to investors or throughbroker dealer

• Firm’s credit rating critical because commercialpaper is unsecured debt



18-20

Long-Term Debt

• Corporate bonds• Minimum denomination on publicly tradedbonds is $1,000

• Most coupon-paying bonds pay interestsemiannually



18-21

Trading Process for Corporate Bonds

• Initial sale made by public offering orprivate placement to institutional investors

• Large firms use large investment banks

• Smaller firms use small regional investmentbanks



18-22


• Investment banks• Firm commitment underwriting

• Entire issue bought by bank at fixed price (discount

from par) and resold at higher price• Issuing firm has price guarantee – investment bank

has risk



18-23

Firm Commitment Underwriting Corporate Bond Issue



18-24


• Competitive sale — highest bid from groupof underwriters wins

• Negotiated sale — issuing firm negotiateswith single investment bank



18-25


• Best efforts underwriting• Underwriter does not buy issue but instead actsas a placing or distribution agent for a fee

• Price risk remains with issuing firm



18-26

Equity Financing

• Majority of both the board of directors andthe firm’s existing stockholders must

approve any new stock issue



18-27

The Trading Process for Corporate Equity

• Primary market• IPO

• Seasoned offering is when the firm already has

publicly-traded shares



18-28

Primary Market Stock Transaction



18-29


• The Securities and Exchange Commission(SEC) must approve any new issues to thepublic



18-30


• Stock issues• Firm commitment underwriting

• Best-efforts basis

• Registration statement

• Full disclosure of firm information, risks,management background and securities to be

issued



18 31


• Prospectus• Red herring prospectus is preliminary version ofthe public offering prospectus

• Official prospectus describes issue• Shelf registration allows multiple stock issues for two

years under one registration

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