Chapter 15 – Raising Capital
Chapter 15
RAISING CAPITAL
CHAPTER WEB SITES
Section
Web Address
CHAPTER ORGANIZATION
15.1 The Financing Life Cycle of a Firm: Early Stage Financing and Venture Capital
15.5 IPOs and Underpricing
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15.8 Rights
15.9 Dilution
ANNOTATED CHAPTER OUTLINE
15.1. The Financing Life Cycle of a Firm: Early-Stage Financing and Venture
Capital
Real-World Tip: Entrepreneur Magazine has a series of “How to…” articles
Venture capital – financing for new, often high-risk businesses
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Real World Tip: In a Forbes article, Guy Kawaski, business
Real World Tip: Information on venture capital is much more
Real-World Tip: Various groups supply venture capital. An article
Corporations are also getting into the venture capital game,
Real World Tip: PriceWaterhouseCoopers Money Tree Report
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B. Some Venture Capital Realities
Even with the explosion in VC funds, access to venture capital is
C. Choosing a Venture Capitalist
A list of important considerations when choosing a VC is provided
below:
-Financial strength – you want to make sure the VC will be
15.2. Selling Securities to the Public: The Basic Procedure
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Video Note: “Going Public” shows what must be done to take a company public. This is
a common exit strategy for VCs.
15.3. Alternative Issue Methods
-General cash offer – securities offered for sale to the general
15.4. Underwriters
Underwriters are investment firms that act as intermediaries between the
issuer and the public. Some of the services provided by underwriters include:
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Lecture Tip: The underwriter’s spread is defined as the difference between
the offer price and the price at which the underwriter purchases the securities
from the issuing firm. In a study of utility stock issues by Bhagat and Frost,
A. Choosing an Underwriter
Competitive offer basis – taking the underwriter that bids the most
for the securities
Negotiated offer basis – the more common (and expensive) method
Real-World Tip: “Corporate America is turning more fickle in
B. Types of Underwriting
Firm commitment underwriting – the underwriting syndicate
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C. The Aftermarket
Trading period after a new issue is initially sold to the public. The
syndicate, and in particular the lead underwriter, stabilizes the
Lecture Tip: See Aggarwal, 2000, “Stabilization Activities by
Ethics Note: The regulatory process attempts to ensure that
investors receive enough information to make informed decisions;
this is the role of the prospectus. However, this is not always the
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D. The Green Shoe Provision
The Green Shoe provision allows the underwriters to purchase
E. Lockup Agreements
The lockup agreement prevents insiders from selling their shares
F. The Quiet Period
The quiet period is a period of time around the IPO when company
employees and the underwriters must limit communications with
the public to “ordinary announcements and other purely factual
matters.” This is done to prevent too much hype in the hope of
increasing demand for the stock.
Lecture Tip: In October of 2004, the SEC voted to seek public
15.5. IPOs and Underpricing
A. Underpricing: The 1999 – 2000 Experience
The number of IPOs and the average return on IPOs during 1999
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B. Evidence on Underpricing
The underpricing (there is a large increase above the offer price the
Real-World Tip: An article in the Red Herring supplemental issue
“Going Public 2000” discusses the issue of IPO underpricing. The
The author points out that a more accurate measure of “money left
on the table” might be the difference between the offer price and
the opening price. In 1999, five IPOs left over $1 billion on the
table using this measurement. When you consider that the
underwriters generally earn a 7% spread based on the offer price,
they are losing a substantial chunk of money as well.
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The other main argument that the author gives is that the
underwriter does not want to face a lawsuit for overpricing an
C. Why Does Underpricing Exist?
Ethics Note: Traditionally, IPOs have been reserved for the
15.6. New Equity Sales and the Value of the Firm
Stock prices tend to decline when a company announces a
seasoned equity offering. Why? Much of the decline may be due to
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15.7. The Costs of Issuing Securities
A. The Costs of Selling Stock to the Public
Other conclusions:
B. The Costs of Going Public: A Case Study
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Real-World Tip: There is an excellent article in the June 2000
issue of The Journal of Finance by Chen and Ritter, called the
15.8. Rights
Privileged subscription – issue of common stock offered to
A. The Mechanics of a Rights Offering
B. Number of Rights Needed to Purchase a Share
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Subscription Price # of new shares # of rights required
C. The Value of a Right
D. Ex Rights
When a privileged subscription is used, the firm sets a holder-of-
Lecture Tip: You may wish to link the stock behavior associated
with the ex rights date to that of the ex dividend date. Point out
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E. The Underwriting Arrangements
F. Effects on Shareholders
15.9. Dilution
A. Dilution of Proportionate Ownership
B. Dilution of Value: Book versus Market Values
15.10. Issuing Long-Term Debt
The process for issuing long-term debt is similar to issuing stock
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Most corporate debt is privately placed. Term loans are direct
It is much cheaper to issue debt than equity.
Real-World Tip: Corporate issuers continued to exploit the
15.11. Shelf Registration
Shelf registration – SEC Rule 415 allows a company to register all
Qualifications:
-Securities must be investment grade
15.12. Summary and Conclusions