lecture chapter 23 Flashcards
advantages of venture capital firms
Limited partners are more diversified
Limited partners benefit from the expertise of the general partners
Disadvantages of venture capital firms
General partners usually charge substantial fees
Most firms charge 20% of any positive return they make
They also generally charge an annual management fee of about 2% of the funds committed capital
Pre-money valuation
The new valuation of the firms outstanding shares before the infusion of capital and the issuance of new shares
Post money valuation
The value of the whole equity (old plus new shares) at the price at which the new equity is sold
Venture capital financing terms (liquidation preference, seniority and participation rights)
Liquidation preference:
The liquidation preference specifies aminimum amount that must be paid to these shareholders before any payment to common stakeholders
Seniority: In case of liquidation investors get paid as long as every investor with higher seniority has already been paid
Participation rights: Holders of convertible shares without participation rights must choose between demanding their liquidation preference or converting their share to common stock. Participation rights allow investors to double dip
Initial public offering
The process of selling stock to the public for the first time
Advantages/disadvantages of IPO
advantages: Raising capital, increase in credibility, increased liquidity, access to debt financing, good way to raise capital, improved corporate governance
Disadvantages: costly, increased regulatory compliance, loss of control, increased risk, loss of privacy, short term focus and share dilution
Best effort basis (types of offerings)
For smaller IPO’s a situation in which the underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price
Firm commitment (types of offerings)
An agreement between an underwriter and an issuing firm in which the underwriter guarantees that it will sell all of the stock at the offer price
auction IPO (types of offerings)
A method of selling new issues directly to the public. The underwriter in a auction IPO takes bids from investors and then sets the price that clears the market
two ways to value a company
Compute the present value of the estimated future cash flows
Estimate the value by examining comparable IPOs
two mechanisms to reduce risk
Lockup: a restriction that prevents existing shareholders from selling their shares for some period, usually 180 days, after an IPO
Over-allotment allocation (green shoe provision): an option that allows the underwriter to issue more stock, usually 15% of the offer size at the IPO price
Green shoe provision
Uderwriters initially market both the initiall allotment and the allotment in the green shoe provision by short selling the green shoe allotment
If the issue is a success: the underwriter exercises the green shoe option
If not: the underwriter covers the short position by repurchasing the green shoe allotment in the aftermath, thereby supporting the price
The green shoe provision is similar to a call option
Green shoe: you can buy (create) shares at the IPO price
option: you can buy shares at a pre-determined strike price
check out non student version for ipo puzzle
