Raising Equity Capital

Question 1

What is venture capital and what is its aim?

Answer 1

• equity investment in young private companies
• help growing firms before they are large enough to go public

Question 2

Describe role of venture capitalists

Answer 2

• provide ongoing advice to firms
• play a major role in recruiting senior management
• provide valuable judgement

Question 3

Where do returns to venture capital come from?

Answer 3

• when it is sold to larger firm
• when company goes public there is the opportunity to cash out

Question 4

What is IPO?

Answer 4

• first offering of stock to the general public

Question 5

Describe the primary and secondary offering

Answer 5

Primary offering - issuing new shares

Secondary offering - existing shareholders sell part of their holdings

Question 6

Deduce role of underwriters

Answer 6

• provide financial advice
• buy and resell shares

Question 7

Describe firm commitment of underwriters

Answer 7

• but securities and resell all of them to the public

Question 8

Describe best effort basis of underwriters

Answer 8

• agree to sell as much of the issue as possible but don’t guarantee sale of entire issue

Question 9

What are the rationales for underpricing IPO

Answer 9

• raise price when stock is traded
• attract uninformed investors
• also benefits underwriters

Question 10

What are the costs of a public offer

Answer 10

• administrative costs
• spread for underwriters
• underpricing

Question 11

What is the spread?

Answer 11

• difference between the public offer price and the price paid by the underwriter

Question 12

What is the benefit of rights issues?

Answer 12

• issue of stocks first to existing stockholders
• lowers issuing costs
• no concerns for underpricing
• prevents shareholders from losing control

Question 13

Describe market reaction to stock issues

Answer 13

• announcement reduces stock price
• Excess supply: supply>demand so stock price falls
• Asymmetric info: issue of stock signals it is overpriced hence investors mark stock price down
• Financial distress: issuing of equity may signal financial distress
• investors know this and mark it down

Question 14

What is private placement and describe the pros and cons

Answer 14

• sale of securities to limited number of investors without a public offering

Pro
- avoid costly process of public offering

Con
- investors cannot easily resell the security

Question 15

What are the disadvantages of public corporations?

Answer 15

• selling shares at discount
• longer term costs