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FI3004 > Equity financing > Flashcards

Equity financing Flashcards

1
Q

sponsor/underwriter

A
  • financial institution that buys the shares of a company at IPO then sells them on.
  • Acts as a middleman
  • Assumes the risk as they need to keep any unsold shares
  • may insist on lower share price to ensure demand
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2
Q

methods of IPO

A
  • offer for sale
  • offer for sale by tender
  • offer for subscription
  • placing
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3
Q

SEO

A
  • Seasoned equity offering
  • secondary issues of shares made by companies already listed on the stock market
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4
Q

offer for sale

A
  • Shares are offered at a fixed price set by issuer
  • institutional and individual investors are invited to subscribe
  • Sponsor underwrites the shares
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5
Q

Offer for Sale by tender

A

A method of selling shares to the public through a bidding process.

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6
Q

pros of offer for sale by tender

A
  • Useful when the value of the company and the demand are unknown.
  • Can be used as valuation/demand gauge
  • Allows for more diverse investor base
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7
Q

cons of offer for sale by tender

A
  • More expensive for issuing company
  • investors may undervalue company
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8
Q

Example of offer for sale by tender

A
  • Google IPO in 2004
  • chose this method to allow for more diverse investor base
  • expected to raise 3 - 4 billion, only raised approx 1.67 billion
  • misestimated demand/ investor sentiment
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9
Q

offer for tender process

A
  • investors make bids on the share (can submit multiple at varying prices)
  • once all bids posted, sponsor orders them from highest to lowest
  • lowest accepted bid is the strike price
  • shares will be allocated to highest bidders first
  • all investors pay this regardless of their bid
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10
Q

offer for subscription

A
  • partially underwritten
  • cheaper than offers for sale/by tender
  • share issues can be aborted if not enough capital is raised
  • particularly attractive for new companies
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11
Q

possible reasons for google IPO failure

A
  • offer for sale by tender process was too complex (unlikely as the same process doesn’t usually have the same disparity)
  • investor sentiment/industry weakness post .com crash could’ve impacted the share price
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12
Q

types of SEO

A
  • Rights issues/offerings (usually deep discounted issues)
  • Placings
  • open offers
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13
Q

Placings (IPO)

A
  • Shares are placed with specific clients of sponsor/underwriter
  • cheaper than other equity financing options
  • however, secondary market is less liquid, lowering the share price
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14
Q

Rights issue

A
  • Firm offers existing shareholders the right to buy additional shares at a discount
  • the right can be exercised or sold
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15
Q

Features of rights issue

A
  • share holders have pre-emption rights
  • shares offered to existing shareholders based on their percentage of ownership
  • shares are offered at a discount, usually 15% to 20%
  • most rights issues are underwritten
  • if share holders exercise rights they maintain ownership %
  • if the sell rights their control is diluted
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16
Q

1 for 4 rights issue means?

A

for every 4 existing shares owned the shareholder can buy 1 share of new issue

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17
Q

How to calculate number of new shares issued with a rights issue

A

number of shares outstanding * rights issue
i.e.
2m * 1 to 4 = 500k

18
Q

Rights price

A
  • discounted price to which a company offers it’s new share to shareholders
  • how much you want to raise divided by number of new issued shares
19
Q

Ex rights price

A
  • theoretical weighted average of the share price after the issue has taken place
  • (total value of existing shares + total value of new issue ) divided by the total number of shares
20
Q

What is the value of the right

A

value of right = ex rights - rights price

21
Q

cum rights

A
  • a stock that is sold with the rights attached to it.
22
Q

why is shareholder wealth always unaffected by a rights issue

A

-exercising shareholder can buy new shares at disscount = value of right but share value drops proportionately with value of the right
- selling shareholders gain the value of the right but lose share value = to the value of right

23
Q

Deep discounted issues

A
  • Shares are offered at a huge discount to market value to ensure demand
  • usually underwritten despite ensured demand
24
Q

rights issue paradox

A
  • in Theory rights issues should not affect shareholder wealth, in practice, share prices often decline after a rights issue announcement
25
Q

Theoretical explanations for the use of underwritten offerings

A

According to smith paper 1977
- insurance
- distribution of ownership
- timing
- increase share price
- consulting advice

26
Q

Smiths Hypothesis on the explanation for underwritten offering preferences

A
  • underwriters send positive signal to the market by certifying the company
  • Managers gain personal benefit from using underwriter (i.e. Lunches, Day trips, when arranging offering)
  • Costs to shareholders of monitoring managers financing decisions exceeds underwriting costs (i.e underwriters monitor managers for shareholders)
  • in practice only the worst companies don’t use an underwriter simply because they can’t secure one
27
Q

open offers

A
  • Existing shareholders can buy new shares in proportion to their existing shareholding
  • No rights to sell ( share holders lose value if they don’t exercise rights)
  • restricted to maximum discount of 10%
  • No limits to offer size
28
Q

positives of pre-emption rights (Myners)

A

According to Myners report 2005
- pre-emption rights viewed as major strength of UK/European Law
- provides protection from dilution of monetary value and control
- rights issues are cheaper than other equity issuance methods (no book building, advertising costs, roadshows)
- Theoretically avoid underwriting fees through deep discounted issues but this is rarely practiced
- shareholders are possibly prepared to finance the company at a lower cost than new investors.

29
Q

issues with pre-emption rights (Myners)

A
  • companies cannot tap investors on demand, therefore they may miss investment opportunities due to the unnecessarily lengthy and cumbersome process
  • Guidelines suggest that when a company is seeking to raise more than 5% of share capital, pre-emption rights will not be dis-applied (treated as a rule, more emphasis needed on that it is a guideline)
  • as a result companies may be constrained in their ability to raise finance
30
Q

US position on pre-emption rights

A
  • Either opt in (no preemption rights) or opt out (preemption rights) for individual states
  • most states are opt in
  • suggests value of pre-emption rights are lower in the us than in the uk
31
Q

why are pre-emption rights less popular in the US?

A
  • Development of different types of securities make it difficult to determine which shares have pre-emption rights
  • protection through US common law on fiduciary duty (shareholders can sue if in breach)
  • US shareholders have less power than in the UK, rely on disciplining power of the market
32
Q

Placings (SEO)

A
  • Shares sold at discounted fixed rate to specific clients of the underwriter e.g. FIs, insurance companies, pension funds, other banks
  • Legal maximum discount is 5% of current MV
  • legal maximum placing of 5% market cap per year, 7.5% max over three years
33
Q

insurance (underwritten offerings)

A
  • underwriters offer insurance as if the existing shareholders don’t buy the new issues then the underwriter has to
34
Q

Distribution of ownership (underwritten offerings)

A
  • underwritten offerings help dilute the ownership of offerings
  • useful if the company doesn’t want control in the hands of a few shareholders
  • in practice 50-80% of shareholders don’t exercise rights (smith 1977)
35
Q

Timing (underwritten offerings )

A

proceeds of an underwritten offer are available sooner

36
Q

Consulting advice (underwritten offerings)

A

issuing company receives speciality advice from underwriters

36
Q

pre-emption rights

A

Existing shareholders have the right to buy their pro rata amount of new issue shares at a discount before outsiders

37
Q

litigation culture UK vs US

A
  • UK: uncommon for shareholders to take legal action against directors
  • US: regular occurence
38
Q

pre-emption group reformation

A
  • Board must be independent
  • Board should publish annual report with case study examples of best practice
  • Group must have a broad representation from Academia, corporate lawyers, fund managers, small company representatives etc
39
Q

Summary of Myners

A
  • pre-emption rights are valuable and shouldn’t be removed
  • suggests a greater need for dialogue between shareholders and directors
  • directors must aim to keep shareholders informed and maintain high standards of corporate governance to build trust
  • revive pre-emption group to renew and improve existing guidelines

FI3004 (4 decks)

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