Equity Financing

Question 1

What are the source of capital for private companies (start-ups)?

Answer 1

1. Owner’s money
2. Angel investors
3. Venture Capital firms

Question 2

What are the source of capital for an existing private company?

Answer 2

1. Private Equity firms
2. Institutional investors
3. Corporate investors

Question 3

What do Angel investors get for investing in a private company?

Answer 3

Convertible notes

Question 4

What is a convertible note?

Answer 4

Pays interest and may be converted to equity at a discounted rate when the company starts issuing equity.

Question 5

What is a Venture Capital firm?

Answer 5

Firm that invests in many small business to provide diversification to investors.

Question 6

What do VC firms get for investing in a private company?

Answer 6

1. Management fees of 1,5% to 2,0% of committed capital
2. Carrier interest (20% of profits)
3. A third of the seats on the board of directors (VC firm gets control over the company)

Question 7

What is a private equity firm?

Answer 7

VC firm for existing private companies.

Question 8

What is a leveraged buyout?

Answer 8

Private Equity firms can buy out a public company using borrowed money to make it private.

Question 9

What is an institutional investor?

Answer 9

Investor who manages funds for his clients.

Question 10

What is the Pre-money valuation? Give the formula.

Answer 10

Pre-Money Valuation : value of the company before the funding round, based on the price-per-share of the NEW funding round
PreMV = (# shares before new funding) x (New PPS)

Question 11

What is the Post-money valuation? Give the formula.

Answer 11

Post-Money Valuation : value of the company after the funding round, based on the price-per-share of the NEW funding round
PostMV = (# shares after new funding) x (New PPS)

Question 12

What terms can be negociated by a VC firm in their financing agreement?

Answer 12

1. Liquidation preference
2. Seniority
3. Participation rights
4. Anti-dilution protection
5. Board membership

Question 13

What is the “liquidation preference” term in a VC firm’s financing agreement?

Answer 13

If the company is liquidated, the VC firm would receive a minimum amount before common shareholders get anything. (1 to 3 times the VC’s initial investment)

Question 14

What is the “seniority” term in a VC firm’s financing agreement?

Answer 14

Get seniority over ALL prior series.

Question 15

What is the “participating right” term in a VC firm’s financing agreement?

Answer 15

Convertible preferred stock do NOT participate in dividends until they convert into common stock or they would lose their liquidation preference. The participating rights lets them participate in dividends and retain the liquidation preference.

Question 16

What is a “down round” and why does it lead to dilution of ownership?

Answer 16

Down round : price-per-share of new funding round is lower than the previous one
Investors get more share (more ownership) for a given amount of money

Question 17

What is the “anti-dilution protection” term in a VC firm’s financing agreement?

Answer 17

The AD protection drops the price-per-share of previous rounds.

Question 18

What are the two types of AD protection?

Answer 18

1. Full ratchet protection

2. Broad-based weighted average protection

Question 19

How does the full ratchet protection works?

Answer 19

Lowers the conversion price to the new price-per-share form common stocks.

Question 20

How does the broad-based weighted average protection works?

Answer 20

The conversion price becomes a fraction multiplied by the old price.
Fraction =
[(# old shares) x (old PPS) + ($ received from funding)]
—————————————————————————–
(Total # of shares) x (old PPS)

Question 21

Shareholders in private companies can only cash their ownership if one of three events happens. Name those three events.

Answer 21

1. The company liquidates (bankruptcy)
2. The company is purchased by another company
3. The company goes public (IPO)

Question 22

What are the advantages of an IPO ?

Answer 22

1. Liquidity

2. Greater access to capital.

Question 23

What are the desadvantages of an IPO ?

Answer 23

1. Spreading of ownership

2. Costly requirements of financial disclosure

Question 24

What is the difference between a primary offering and a secondary offering?

Answer 24

Primary offering : new shares

Secondary offering : Stockholders of private company sell their shares to the public

Question 25

What are the three ways an underwriter can sell shares of an IPO ?

Answer 25

1. Best-effort basis
2. Firm commitment basis
3. Auction

Question 26

What is the best-effort basis (IPO) ?

Answer 26

Underwriter tries to sell all shares, but doesn’t guarantee success.

Question 27

What is the firm-commitment basis (IPO) ?

Answer 27

Underwriter guarantees all shares will be sold at the offering price.

Question 28

What is the greenshoe provision?

Answer 28

Allows selling additional shares above the amount the company is offering (10-15%).

Question 29

What is the over-allotement?

Answer 29

Additional shares that can be sold by the underwriter if he uses the greenshoe provision.

Question 30

True or false, pre existing shareholders are subject to a 180 lockup?

Answer 30

True : after an IPO, pre-existing shareholders can’t sell their shares for 180 days. After that, they can exit from their investment in the company at any time.

Question 31

What are the 4 IPO puzzles?

Answer 31

1. Underpricing
2. Cyclicality
3. Costs
4. Long-run underperformance