Raising capitalChapter 15

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Key concepts and skillsUnderstand the venture capital market and its role in financing new businessesUnderstand how securities are sold to the public and the role of investment bankersUnderstand initial public offerings and the costs of going public

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Chapter outlineThe financing life cycle of a firm: Early-stage financing and venture capitalSelling securities to the public: The basic procedureAlternative issue methodsUnderwritersIPOs and underpricingNew equity sales and the value of the firmThe cost of issuing securitiesIssuing long-term debt

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Venture capitalPrivate financing for relatively new businesses in exchange for shares in the firmIndividual investorsVenture capital firmsUsually involves active participation by VCUltimate goal to take company public; the VC will benefit from the capital raised in the IPOMany VC firms are formed from a group of investors that pool capital and then have partners in the firm decide which companies will receive financingSome large corporations have a VC division15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Venture capital stage financingFunding provided in several stagesContingent upon specified goals at each stageFirst stageGround floor financing or seed moneyFund prototype and manufacturing planSecond stageMezzanine financingBegin manufacturing, marketing and distribution

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Choosing a venture capitalistLook for financial strength.Choose a VC that has a management style that is compatible with your own.Obtain and check references.What contacts does the VC have?What is the exit strategy?

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Selling securities to the public: The basic procedureManagement must obtain permission from the Board of Directors.Appoint an underwriter. Firm must file a prospectus with ASIC or NZSC.ASIC or NZSC examines the prospectus and approves it.The period between filing and approval is called the registration period.Securities may not be sold during the registration period.The price is usually determined on the effective date of the registration.

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Issue methodsPublic issueInitial public offering (IPO)General cash offer = offered to general publicUsually open for six to eight weeks Only cash offersPrivate issueRights issueOpportunity for existing share holders to buy more sharesA new issue by a company with shares issued alreadyExisting shareholders can sell their entitlement if issue is renounceable

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Total equity raised and bank lending 19992008 (A$ in billions)Table 15.115-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

The methods of issuing new securitiesTable 15.215-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

UnderwritersServices provided by underwriters:Formulate method used to issue securitiesPrice securitiesSell securitiesSyndicategroup of investment bankers (underwriters) that market securities and share the risk associated with selling the issue

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Standby underwritingAt the end of the issue, the issuer buys any shares not bought by the public.The underwriter charges a fee for this service.The underwriter bears the risk of not being able to sell the entire issue to the public.Most common type of underwriting in Australia.

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Best efforts underwritingUnderwriter must make their best effort to sell the securities at an agreed-upon offer price.The company bears the risk of the issue not being sold.The offer may be pulled if there is not enough interest at the offer price and the company does not get the capital while still incurring substantial flotation costs.Not as common as it used to be.

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

IPO underpricingInitial public offering IPO.May be difficult to price an IPO because there is not a current market price available.Additional asymmetric information associated with companies going public.Underwriters want to ensure that their clients earn a good return on IPOs on average.Underpricing causes the issuer to leave money on the table.

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Average first-day returnsFigure 15.1Average first-day returns by month for ASX initial public offerings: February 1993December 2009

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Number of offerings by monthFigure 15.2Number of offerings by month for ASX-listed initial public offerings: February 1993December 2009

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

IPO underpricing reasonsUnderwriters want offerings to sell outReputation for successful IPOs is criticalUnderpricing = insurance for underwritersOversubscription and allotment Winners curseSmaller, riskier IPOs underprice to attract investors.

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

New equity issues and pricePrivate placementAn exclusive issue of new securities to an investor or group of investors who may or may not be current investors in the firm.Share prices tend to decline when new equity is issuedPossible explanations for this phenomenon:Signalling and managerial informationSignalling and debt usageIssue costsSince the drop in price can be significant and much of the drop may be attributable to negative signals, it is important for management to understand the signals that are being sent and try to reduce the effect when possible.

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

The cost of issuing securities15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Types of long-term debtBonds/Debenturespublic issue of long-term debtPrivate issuesTerm loansDirect business loans from commercial banks, insurance companies, etc.Maturities 15 yearsRepayable during life of the loanPrivate placementsSimilar to term loans with longer maturityEasier to renegotiate than public issuesLower costs than public issues

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Quick quizWhat is venture capital and what types of firms receive it?What are some of the important services provided by underwriters?What type of underwriting is the most common in Australia and how does it work?What is IPO underpricing and why might it persist?What are some of the costs associated with issuing securities?What are some of the characteristics of private placement debt?

15-* Copyright 2011 McGraw-Hill Australia Pty LtdPPTs t/a Essentials of Corporate Finance 2e by Ross et al.Slides prepared by David E. Allen and Abhay K. Singh

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

Chapter 15END15-*

Copyright 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al Slides prepared by David E Allen and Abhay K Singh

***Click on the information icon to go to to search for VC in Australia.

**Financial strengthyou want to have the option to obtain additional financing.Styledo you want a hands-on or hands-off VC?Contactswill the VC provide you with additional business contacts that can help your business succeed?Exit strategyVCs are not long-term investors; what are the provisions for the VC getting out of the business?

The internet is a tremendous source of venture capital information, both for suppliers and demanders of capital. For example, click on the information icon to see the site.

*ProspectusA legal document filed with ASIC or the NZSC that discloses all material information required by the corporations law concerning the firm making a public offering.

Registration periodThe period from lodgement of the prospectus with ASIC or the New Zealand Securities Commission to its approval and registration.

Click on the information icon to go to to search for firms going public.****UnderwritersInvestment firms that act as intermediaries between a company selling securities and the investing public.

*This is a good place to review the difference between primary and secondary market transactions. Technically, the sale to the syndicate is the primary market transaction and the sale to the public is the secondary market transaction.

Note that the cost of the issue includes the price paid to the issuing company plus the expenses of selling the issue.

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