Lecture Essentials of corporate finance (2/e) – Chapter 15: Raising capital

Raising capital
Chapter 15


Key concepts and skills
• Understand the venture capital market
and its role in financing new
businesses
• Understand how securities are sold to
the public and the role of investment
bankers
• Understand initial public offerings and
the costs of going public
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

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Chapter outline
• The financing life cycle of a firm: Earlystage financing and venture capital
• Selling securities to the public: The basic
procedure
• Alternative issue methods
• Underwriters
• IPOs and underpricing
• New equity sales and the value of the firm
• The cost of issuing securities
• Issuing long-term debt
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

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Venture capital
• Private financing for relatively new businesses
in exchange for shares in the firm
– Individual investors
– Venture capital firms

• Usually involves active participation by VC
• Ultimate goal to take company public; the VC
will benefit from the capital raised in the IPO
• Many VC firms are formed from a group of
investors that pool capital and then have
partners in the firm decide which companies
will receive financing
• Some large corporations have a VC division
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

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Venture capital stage
financing
• Funding provided in several stages

• Contingent upon specified goals at
each stage
• First stage
– ‘Ground floor’ financing or ‘seed money’
– Fund prototype and manufacturing plan

• Second stage
– ‘Mezzanine’ financing
– Begin manufacturing, marketing and
distribution
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

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Choosing a venture
capitalist
• Look 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?

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

15-6


Selling securities to the public:
The basic procedure
• Management 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.
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

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Issue methods
• Public issue—Initial public offering (IPO)
– General cash offer = offered to general public
– Usually open for six to eight weeks
– Only cash offers

• Private issue—Rights issue
– Opportunity for existing share holders to buy
more shares
– A new issue by a company with shares issued
already
– Existing shareholders can sell their
entitlement if issue is renounceable
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

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Total equity raised and bank lending
1999–2008 (A$ in billions)
Table 15.1

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

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The methods of issuing new securities
Table 15.2

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

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Underwriters
• Services provided by underwriters:
– Formulate method used to issue securities
– Price securities
– Sell securities

• Syndicate—group of investment
bankers (underwriters) that market
securities and share the risk associated
with selling the issue
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

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Standby underwriting
• At 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.
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

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Best efforts underwriting
• Underwriter 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.
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

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IPO underpricing
• Initial 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’.
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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 returns
Figure 15.1
Average first-day returns by month for ASX initial public
offerings: February 1993–December 2009

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

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Number of offerings by month
Figure 15.2

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

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

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IPO underpricing reasons
• Underwriters want offerings to sell out
– Reputation for successful IPOs is critical
– Underpricing = insurance for underwriters
– Oversubscription and allotment
– ‘Winner’s curse’

• Smaller, riskier IPOs underprice to
attract investors.
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

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New equity issues and price
• Private placement
– An 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 issued
• Possible explanations for this phenomenon:
– Signalling and managerial information
– Signalling and debt usage
– Issue costs

• Since 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.

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

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The cost of issuing
securities

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

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Types of long-term debt
• Bonds/Debentures—public issue of long-term
debt
• Private issues
– Term loans
• Direct business loans from commercial banks,
insurance companies, etc.
• Maturities 1–5 years
• Repayable during life of the loan

– Private placements
• Similar to term loans with longer maturity

– Easier to renegotiate than public issues
– Lower costs than public issues
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

15-20


Quick quiz
• What 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?
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

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Chapter 15
END

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