IPO - Q3 potentially Flashcards
(34 cards)
Why raise capital
To finance growth.
To pay off debts.
For mergers and acquisitions.
R&D
What are the 2 types of External capital a firm can raise
Equity: common, preferred, warrants
Debt: Bank loans, Bonds, Leases, Commercial paper
Main difference between bank loans and Bonds
Bank loans cannot be traded whereas bonds can be traded on the public market
Main difference between Preferred and common equity
Preferred equity typically has a higher dividend yield compared to common equity. Because of this, preferred equity investors usually receive more cash flow earlier in the life of the investment
What are equity warrants
options on the equity of the company
Long term financing: How do debt contracts work
Debt holders have a contract specifying their claims must be met before equity holders
If obligations are not met creditors can legally claim assets interest payments are tax deductible
Long term financing: equity
Shareholders are the owners of the firm and have voting rights
they have the right to dividend payments if the company chooses to pay them
Dividend payments are considered profits so are not tax deductible
Equity financers bennefit from upside potential, once interest payments are paid proceeds go to equity holders
What are business angels
Wealthy individuals, generally with
substantial business & entrepreneurial experience.
Typically invest in equity finance but also debt and preference shares.
Usually they do not seek control of companies and normally target firms at an earlier stage than VCs.
BAs are “hands on investors” as their expertise is as valuable as their capital
What are venture capitalists
Wealthy individuals, generally with a substantial business and entrepreneurial experience.
They provide managerial assistance.
Mostly after high-growth unlisted
companies.
Typically, they are industry specialized/ institutional investors who attract funds from elsewhere
Different types of VC’s
Seed corn: development of a business concept.
Start-up: product or idea is further developed and/or initial
marketing.
Other early stage: for initial commercial manufacturing and sales.
Expansion (development): increase production capacity and working capital.
Management buy out (MBO): funding for managers making a bid to buy the business of a large company.
Management buy in (MBI): funding for new team of managers from outside the company.
Public to private: funding for returning a company to its unquoted status.
Two types of shares can be sold in an IPO:
Primary (new shares)
New shares available in a public offering that raise new capital.
Secondary (held by founders)
Shares sold by existing shareholders in an equity offering
what is the debt overhang problem
Debt overhang refers to a debt burden so large that an entity cannot take on additional debt to finance future projects. The burden is so large that all earnings pay off existing debt rather than fund new investment projects, making the potential for defaulting higher.
Advantages for a firm going public
New capital for the company to finance new
investments, make company acquisitions,
refinance current borrowings, increase payouts.
Facilitates raising new finance in the future:
going public strengthens the equity base and reduces leverage therefore reducing the debt overhang problem
Investors value liquidity. The fact that equity
is traded in a stock market minimises
transaction costs you do not have to find a
buyer yourself
Less asymmetric info enhances company image: it provides “certification” by financial market professionals; more financial press attention; provides more credibility to customers and suppliers.
Allows Cashing in
Diversification of risk for managers who could have been large stakeholders and therefore risk averse
Disadvantage of a public listing
Financial costs of an IPO: Expensive undertaking, Increase in legal requirements
Stock-price emphasis: Management short-termism, Separation between ownership and control, Hostile take-over bid risk.
More public scrutiny
More disclosure to product market competitors
Requirements for listing on the stock exchange
Prepare a detailed Prospectus of the company
Minimum 3 years of audited accounts must be available
All major contracts entered in the past 3 year
Disclosure of all ownership info at/above 3% (5% in the US).
Strict regulation and a set of demanding rules by the stock exchange.
Must ensure that at least 25% of their shares will be “public”.
Managers must comply with insider dealing regulations.
4 Steps in the process of an IPO
Choosing and meeting with the underwriter/ sponsor
Valuation of the company
Road Show
Alternative underwriting Practises
Difference between a lead underwriter and a syndicate
Lead underwriter - The primary investment banking firm responsible for managing a security issuance
Syndicate - A group of underwriters who jointly underwrite and distribute a security issuance
What does the underwriter do
All the necessary filings (registration statement, prospectus).
Valuation of the company. Recommendations on share price, capital needs, composition of BoD, methods of floating, timetable, marketing strategy (road show).
2 Ways sponsors sell equity
Best-effort: investment bank promises to give its best effort to sell the firm’s securities. If the demand is insufficient, the firm withdraws the issue
Firm-commitment: investment bank agrees to underwrite the issue. It actually purchases the shares from the firm and resells them to the public
Sponsor recieves underwriting spread of ~ 7%
4 Anomalies in IPO’s that challenge the efficient market hypothesis
(a) Short-Run Underpricing.
(b) Long-Run Underperformance.
(c) Hot Issue Markets Phenomenon.
(d) Lock-in agreements
Short run underpricing: the risk Averse underwriter
Most ipo’s are by firm commitment and their reputation is at stake.
In theory however UWR should just adjust the spread to cover their risk.
If this was true we would see greater underpricing in firm commitment IPO’s than Best effort ones
5 hypothesis for short run underpricing
The Risk Averse Underwriter
The Winner’s Curse
Ownership structure hypothesis
The Signalling Hypothesis
The UWRs monopsony power
Short run underpricing: The winners Curse
Given that, typically firms issue a fixed
number of shares, rationing will result if demand is excessive.
Assume there are informed and uninformed investors
Informed investors will only try to buy shares when they are under-priced
Uninformed investors on the other hand,
cannot discriminate ex ante and will always
demand the stock
Consequently, they will have only a fraction of the shares if it is indeed under-priced and will be able to buy all the stocks if it is overpriced.
In other words, they are facing the winner’s curse. If all their demand is met (no rationing) it must be
because they are facing the winner’s curse
To the extent that uninformed buyers are aware of this issue, they will impose a “discount factor” on the price they will be willing to buy
Short run underpricing: Ownership Structure
Underpricing is used to insure oversubscription of the issues.
This way shares allocation can be rationed and managers can discriminate between investors and allocate shares to many small investors
