Chapter 10 #2 Flashcards
(64 cards)
1
Q
Most businesses are started by an entrepreneur who. ..
A
Has a vision for a new business or product and a passionate belief in the concepts viability
2
Q
What is bootstrapping?
A
The process by which many entrepreneurs raise “seed money” and obtain other resources necessary to start their businesses
3
Q
Where does the initial seed money come from and what is it usually spent on
A
- Personal savings
-selling assets
-friends as family
-full time job
-The seed money in most cases is spent developing a prototype of the product or service & business plan
4
Q
How long is the bootstrapping period?
A
No longer than one to two years
5
Q
Define venture capitalists
A
Individuals or firms that help new businesses get started and provide much of their early- stage financing
6
Q
Define angle investors
A
Individual venture capitalists who are typically wealthy individuals who invest their own money in emerging businesses t very early stages in small deals
7
Q
Define venture capital firms and their sources of funding
A
They pool money from various sources to invest in new businesses. Sources of funding are
- Financial and insurance firms
- private and public pension funds
- wealthy individuals & families
- corporate investments (outside of employee pensions)
- endowments and foundations
8
Q
What are the three primary reasons why tradition sources of funding do not work for new or emerging businesses
A
- high degree of risk involved in starting a new business: most fail
- Types of productive assets: new firms whose primary assets are intangible
- Information asymmetry problems: most investors do not have the expertise to distinguish between competent and incompetent entrepreneurs
9
Q
How do investors such as Financial, insurance, pension, endowment funds invest
A
They invest in venture Capital funds that specialize in identifying attractive investments in new businesses, managing those investments & selling them at the appropriate time
10
Q
When does the venture capital funding cycle begin
A
When the entrepreneur runs low on bootstrap financing. venture capitalists then provide equity financing and exit through a private or public sale of their equity
11
Q
How long is the venture capital funding cycle
A
Three to seven years
12
Q
Explain the venture capital funding cycle
A
1) first starts when entrepreneur runs low on bootstrapping financing. Start up company provides detailed business plan
2)once venture capitalist that will fund the project is selected, they state their terms of funding: how much money they will supply in what stages, criteria’s of success, etc
3) exit strategy is developed: VC not long-term investors. How VC can exit is in initial agreement.
13
Q
Now venture capitalists reduce their risk
A
- Funding in stages
- requiring entrepreneurs to make personal investments
- syndicating investments
- maintaining in depth knowledge of industry in which they specialize
14
Q
What does each stage in the cycle provide the VC
A
- An opportunity to recesses the management team and the firms financial performance. They evaluate performance, provide support, risk reduction to determine if they want to provide funding
15
Q
What do the VC investments give VC
A
Equity interest in the company. Typically in peffered stock that’s convertible into common stock. Preferred insures VC have most Senior claim if firm fails. Common stock conversion enables the VC to share in the gains if business is successful
16
Q
What is syndication & 2 ways it reduces risk
A
Occurs when the originating venture capitalist sells a percentage of a deal to other venture capitalists- reduces risk in
1) increases diversification of originating VC investment portfolio
2) willingness or other venture capitalists to share in the investment provides independent corroboration that investment is reasonable decision
17
Q
What is the goal of venture capitalists?
A
Sell their investment
18
Q
What 3 items are discussed in the agreement on the exit of VC
A
- timing (when to exit)
- the method of exit
- what price is acceptable
19
Q
Who do venture capital investors sell their investment to?
A
Strategic buyer: selling to strategic buyer in private market. Buyer looking to create value through synergies between the acquisition and the firms existing productive assets
Financial buyer: private equity firm buying the new firm with intention of holding it for a period of time then selling it for higher price
Initial Public offering: selling common stock in an initial Public offering
20
Q
Why is venture capital cost high?
A
- Taking substantial amount of risk when they fund new business
- spend considerable amount of their time monitoring the progress of businesses they fund und intervening when help is needed
21
Q
Explain IPO
A
- funding requirements are beyond private investors, therefor,need to access the Public market to fund their own growth
- one way to raise larger sums of cash or to facilitate the exit of UC is through IPO of company’s common Stock
-IPO is a company’s first sale of common stock in the Public market
22
Q
Who determines the offer price during IPO?
A
. Investment banker most difficult task determine the highest price at which the bankers will be able to quickly sell all of the shares offered and what will result in a stable secondary market
23
Q
Advantages of going public are….?
A
- Raise more money than from private investors
- once an IPO has been completed, additional equity capital can be raised through follow-on seasoned Public offerings at a lower cost
- enable entrepreneur to fund business without giving up control
- after IPO, active secondary market which stakeholders can buy and sell its shares
- public traded films find it easier to attract top management talent and to better motivate current managers if a firms stock is publicly traded
24
Q
Disadvantages of going public
A
- High cost of the IPO
- cost is due to the unseasoned stock and out of pocket costs, sec filing fees
- the cost of complying and transparency with ongoing sec disclosure requirements
- change in focus. Investors argue that the secs requirement of quarterly earningfinancial statements encourages managers to focus on short-term profits
25
What Services to investment bankers provide when bringing Securities to market?
1) origination: providing Financial advice & getting issue ready to sell
2) underwriting: the risk bearing part of investment banking
3) distribution: reselling the securities to the public
26
Describe the first service investment bankers provide
Origination: includes giving the firm financial advice and getting the issue ready to sell
Helps determine whether firm is ready for an IPO
If the answer is no, the investment banker might help the firm find private capital to see is through
Once decision to sell stock is made, firms management must obtain number of approvals
- BOD must approve all security sales , stokeholder must approve if # of shares of stock is increased
Since securities sold to the public must be registered in advance with sec, the first step is to file a registration statement with SEC
Preliminary prospectus is the initial registration statement
27
Describe the second service investment bankers provide
Underwriting is the risk-bearing part of investment banking and happens once origination work is complete
Securities can be underwritten in two ways
- on a firm commitment basis
- on a best- efforts basis
28
Describe firm commitment underwriting
- underwriting agreement in which the underwriter purchases securities for a specified price and resells them
Investment banker gaurentees issuer fixed amount of money from the stock sale
Investment banker buys the stocks from a firm at a fixed price then resells it to the public
Underwriter bears the rise that the resale price might be lower than the price. Underwriters pays → price risk
Investment bankers compensation is called the underwrites spread
29
Describe best effort underwriting
Best effort underwriting- underwriting agreement in which the underwriter dues not agree to purchase the securities but promises to only make its best effort to sell as much of the issue as possible above a certain price
- Investment banker does not bear risk associated with underwriting
- Compensation based on #of shares sold
- Most corporations issuing stocks prefer firm commitment arrangements to best effort contracts
30
What is underwriting syndicate
Group of underwriters that join forces to reduce underwriting risks & sell new securities
- entitles each underwriter to receive a portion of the underwriting fee & allocation of the securities to set its own customers
- underwriting syndicates may enlist other investment banking firms in a syndicate known as a selling group
- firms relive commission for each security they sell & bear no risk
31
What is one of investment banners most difficult tasks
To determine the highest price at which the bankers Will be able to quickly sell all of the shares being offered & result in a stable secondary market
- will conduct road show which management makes presentations about the firm and its prospects to potential investors
32
What is the reason for a due-diligence meeting?
Representatives from the underwriting syndicate hold this meeting with representatives of the issuer
Hold this meeting to protect their reputations and reduce the risk of investors lawsuits in the event the investment goes sour
Meeting ensures all material issues abut the film and offender is discovered
33
Explain distribution
-Happens when due diligence is completed
- Under writers and issuer determine final offer price in a pricing call
- during call lead underwriter (book runner -assembles the book of orders for offering)make it recommendations about price, firms management decides it price is acceptable
- management makes pricing decision
34
In first day of trading, why is speed of sale important?
Because the offer price, reflects market conditions at the end of the previous daythese conditions can change quickly
35
In first day of trading: describe successful offerings
- Most secunties will have been pre sold to investors prior to delivery & will fully be sold out within a few hours
36
In first day of trading: describe unsuccessful offerings
Securities are not sold within a few days; the underwriting syndicate disbands, and members sell the securities at whatever price they can
37
Describe the closing of a firm-commitment offering
-The issuing firm delivers the security certificates to the underwriter delivers the payment for the securities, net of the underwriting fee, to the issuer
- closing takes Place on the third business day after trading has started
38
What is under pricing?
- Offering new securities for sale at a price below their true value
- issuer prefers highest stock price possible, underwriters prefer some degree of underpricing
- attracts long term institutional investors who help provide stability for the stock price once the stock price once secondary market established
39
What happens if price is set too high
firm-commitment offering-underwriters suffer financial loss
Best-effort agreement- issuing firm raise less money then expected
40
What happens if stock price is below the value?
Firms existing stockholders will experience opportunity loss
Investment banking firm suffer loss of reputation for failing to price the new issue correctly & raising less money for its clients
41
Average first-day return is a measure of the amount of…….
underpricing
42
Cost of an IPO
Underwriting spread: is the difference between the proceeds the issuer receives and the total amount raised in the offering
Out of pocket expenses including other investment banking fees, legal fees, SEC filing,etc. All reported in the prospectus
Underpricing: difference between the offering price and the closing price at the end of the first day of trading in the public market. It is the opportunity loss that the issuers stockholders incur from selling security below its true market value
43
What is General cash offer by a public company?
General cash offer: Sale of debt or equity, open to all investors, by a registered Public company that has previsory sold stock to the Public
44
Similarities between general cash offer and those involved in IPO
1) type of security and amount to be raised- management decides type of security & amount to be raised
2) approvals- obtained by board of directors to issue securities
3) registered statement: issuer files a registration statement and satisfies al of the securities law enforced by SEC
4) Offer Price - After assessing demand, the underwriter and the issuer agree on an offer price
5. Closing - At the closing of a firm-commitment offering, the issuer delivers the securities to the underwriter, and the underwriter pays for them, net of its fees
45
Describe the two ways management can decide whether to sell securities
Competitive Sale: the firm specifies the type and amount of securities it wants to sell and hires an investment banking firm to do the origination work
- Once origination is completed, the firm invites underwriters to bid competitively to buy the issue. Highest bid wins, pays for all securities and makes them available to investors
Negotiated Sale: the issuer selects the underwriter at the beginning of the origination process
- The offer price is set, and the underwriter pays the issuer for the securities and sells them to individual investors
46
Lowest cost method of sale in general cash offer
- Competitive bidding keeps everyone honest: the greater the number of bidders, the greater the competition for the security issue, and the lower the cost to the issuer
- Negotiated sales lack competition and therefore should be the more costly method of sale
47
Now to select the best method in general cash offer?
- depends on complexity of the sale, the Market conditions - type of security
- For debt issues, most experts believe that competitive sales are the least-costly method of selling so called vanilla bonds when market conditions are stable
- For equity securities, negotiated sales provide the lowest cost method
48
What is shelf registration? Explain benefits
a type of SEC that allows a firm to register an inventory of securities for a two-year period, during which time the firm can take the securities “off the shelf” and sell them as needed
Benefits:
- greater flexibility in bringing securities to market
- allow firms to periodically sell small amounts of securities
49
The cost of general cash offer
Total cost includes underwriting spread & out-of-pocket expenses
- Issuing common stock is the most costly alternative, and issuing corporate bonds (nonconvertible) is the least costly
- The higher cost for the equity issues reflects the greater underwriting risk, the higher sales commissions for those involved in selling the issue, and the higheradministrative expenses required to bring equity securities to market
50
Public vs private markers, define flight to quality
- many firms with lower credit standing have limited or no access to Public markets
- cheapest source of external funding is often the private markets
- when market conditions are unstable, smaller firms that previously were able to sell securities in public markets no longer can
- because investors are reluctant to purchase/ hold high risk securities
-flight to quality: moving capital to the safest possible investments to protect oneself during unsettled period in the
51
Bootstrapping & VC fiancino are part of what market?
Private market
52
Why do private companies decide their choice of private market?
- Desire to avoid regulatory costs and transparency requirements
- preference for working with a small group of sophisticated investors rather than the public at large
53
What is private placement? And investment banks & money centres have what role
Private placement occurs when u firm sees unregistered securities directly to investors such as insurance companies, commercial banks, wealthy individuals
- investment banks and money Center Banks assist firms with private placements by helping locate potential buyers, put deal together, do origination work, but do not underwrite the issue
- in traditional private placements, the issuer sells the securities directly to investors
54
Private placement advantages
- The cost of funds, net transaction costs, lower
- private lenders willing to negotiate
- if firm suffers financial distress, problems likely to be resolved without bankruptcy
- speed & flexibility
55
Private placement disadvantages
- Restrictions on the resale of the securities
- SEC limits sale of private placements to several dozen "knowledgeable" investors who can evaluate Securities investment potential and risk
- higher build the n public offering because of lack of marketability
56
Explain private equity firms
- Private equity films pool money from wealthy investors, pension funds, insurance companies, other sources to make investments
- invest in mature companies and often purchase 100 percent of a business
- look to increase value of the firm
- once value is increased, they sell the firm for profit ( hold investments for 3-5 years )
- PE investments funds are organized as limited partnerships or limited liability companies
- PE firms focus on stable cash flows because they use not of debt to finance acquisitions
57
What is a leveraged buyout
When n large amount of debt is used to take over a company
58
How do PE firms improve the performance of firms in which they invest in
- Making sure the firms have best possible management teams
- closely monitoring each firms performance & providing advice
- facilitating mergers & acquisitions
59
Private investments in Public equity
Private investments in public equity are transactions in which a public company sells unregistered stock to an investor
- investors purchase Securities directly from a publicly traded company in a private placement
- Securities always sold at discount to the price at which they would sell in the public market to compensate the buyer for limits on liquidity
- transactions not registered with SEC they are "restricted Securities"
- cannot be resold to investors in Public Market for 1-2 years unless company registers them
- company usually registers them with SEC within 90 days of PIPE closing
60
Commercial bank lending: What is prime-rate loans?
- Most common type of bank loans
- are loans in which the borrowing rate is based on the prime rate of interest (loan rate, bank charges most credit worthy customers)
- used to finance working capital heeds such as inventory purchase
- not for long-term use: banks require loan balance brought to zero for short-time each year
61
Commercial lending: what is bank term loans?
- are business loans with maturities greater than one year, are the most common form of intermediation term financing provided by commercial banks
- most maturities with 1-5 year range
-May be secured or unsecured
- funds used to by inventor or finance plant & equipment
62
Explain prime rate?
Not a market determined interest rate, since bank management sets it
Subject to market forces that affect the banks cost of funds and rate the bank customers will accent
63
How to determine interest rate to charge on a loan?
Formula: k1 = PR + DRP + MAT
K1= the loan rate (٪)
PR = the prime rate (٪)
DRP = adjustment for default risk above the prime rate (٪)
MAT= adjustment for the yield curve for term loans (٪)
MAT= yn - Y3-mon
Yn: yield on a treasury security with nyear maturity
Y3-mo: yield on a three-month treasury security
-Creditworthiness determines DRP higher risk → higher markup)
- loan rate maturity determines MAT (longer-term loans → higher adjustments)
64
Determine customers credit category
- First step before making loan
- Bank assign customers to 5-7 credit risk categories similar to bond ratings)
prime rate customer:
- highest credit standing
- borrows at prime ratel or (below, if minimal services required)
Non-prime customers
- charged a default risk premium (DRP) above the prime rate
