offerings Flashcards
chapter 11 (49 cards)
two types of offering
- public
2. private placement
advantages and disadvantages of public offering
The primary advantage of a public offering is that an unlimited number of investors (both retail and institutional) are permitted to participate. However, the disadvantages of a public offering include the regulatory costs (legal and accounting) and time required to fulfill the disclosure requirements of the Securities Act of 1933.
Private Placements
In some cases, institutional investors (e.g., pension funds, insurance companies, venture capitalists, and private equity investors) provide start-up capital to new companies. The capital is typically raised through a form of non-public offering that’s referred to as a private placement. The primary advantages of a private placement is that it’s faster and less costly than a public offering. However, there may be limits as to the type and number of investors that may participate in these types of transactions.
Initial Public Offering (IPO) Versus Follow-On Offering
When an issuer offers securities to the public for the first time, the process is referred to as its initial public offering (IPO). However, if a company has already gone public and intends to raise additional capital through a sale of common stock, it’s conducting a follow-on offering. Keep in mind; these additional (post-IPO) offerings are still considered primary distributions. The best way to define a primary distribution is that it’s an offering in which the proceeds of the deal are paid to the issuer.
Disclosure of Participation or Interest in Primary or Secondary Distribution (FINRA Rule 2269)
While involved in a follow-on offering, a FINRA member firm may be recommending or trading the existing shares of a company in the secondary market, while also soliciting potential investors for the additional shares being offered. FINRA rules generally require written disclosure to customers for trades in any security in which a firm is participating in the distribution or is otherwise financially interested.
primary distributions
The best way to define a primary distribution is that it’s an offering in which the proceeds of the deal are paid to the issuer.
Combined (Split) Offerings
In a combined offering, some of the shares are offered by the issuer, while the remainder are offered by selling shareholders. The shares being sold by the company are newly created, constitute a primary offering, and increase the company’s number of outstanding shares. The company issuing the securities receives the proceeds on this portion of the sale. When the company’s existing shares are sold by some of its current (selling) shareholders, it’s considered a secondary offering. The selling shareholders receive the proceeds on this portion of the offering, not the issuer. Selling shareholders may include officers of the company or early-entrance investors (e.g., the institutional investors that were mentioned previously) that are seeking to either cash out or reduce their holdings in the company.
If the offering is split, it’s imperative for the underwriters to disclose
to any purchaser that a portion of the offering’s proceeds will be paid to the selling shareholders.
underwriter
raising capital. When acting as an underwriter, an investment banker may assume risk by buying the new issue from the issuing corporation and reselling it to the public. The investment banking function brings together the issuer and potential buyers. The proceeds of these offerings may represent new funds to the issuer or they may be used to refinance its capital structure.
underwriting syndicate.
The sale of a public offering is typically conducted through a group of broker-dealers that’s referred to as an underwriting syndicate. The responsibilities of the syndicate members are dependent on the type of underwriting agreement.
Firm-Commitment (
If a syndicate agrees to purchase the entire offering from the issuer and absorb any securities that remain unsold, it’s engaging in a firm-commitment underwriting. In this case, the syndicate is firmly committing itself to the issuing corporation for the entire amount of the offering. Regardless of whether it can sell all of the securities, the syndicate acts in a principal (at risk) capacity.
For example, a corporation wants to sell $10,000,000 of stock, but the syndicate is only able to sell $8,000,000. In a firm commitment, the syndicate members will absorb the $2,000,000 of unsold stock for their own accounts.
Best-Efforts
(Acting as Agent) In a best-efforts underwriting, the syndicate agrees to sell as much of the new offering as they’re able. Best-efforts underwriters are acting in the capacity of an agent by finding purchasers for the issuer, rather than as a principal for their own accounts.
For example, a corporation wants to sell $10,000,000 of stock, but the underwriters are only able to sell $8,000,000. In a best-efforts underwriting, only the $8,000,000 of stock will be issued. The unsold portion is returned to the issuer.
All-or-None
One of these contingencies is the best-efforts-all-or-none. As in a simple best-efforts arrangement, the underwriters act as agents for the issuer and attempt to sell as much of the offering as possible. However, if the entire offering is not sold, all sales that were made must be cancelled and the money must be returned to the subscribers.
Mini-Maxi
Another variation of a best efforts underwriting is the mini-maxi underwriting. With this form, there is a minimum threshold of sales that must be met for the offering to avoid being cancelled. However, once that minimum is met, additional sales may be made up to a specified maximum amount.
For example, a corporation intends to sell $10,000,000 of stock. Based on the company’s capital needs, it requires that at least 70% of the offering be sold. Therefore, a minimum of $7,000,000 of the stock must be sold or the entire issue will be cancelled. Once the minimum sales level has been satisfied, the underwriters will continue to sell the remaining securities ($3,000,000) without the risk that the offering will be cancelled.
preemptive rights offering
In this offering, the current shareholders are given rights which provide them with the opportunity to purchase additional shares at a small discount before the offering is made public.
standby underwriting arrangement
However, out of the fear that a significant number of existing shareholders will choose to leave the rights unsubscribed, the issuer may arrange for a standby underwriting. In a standby underwriting arrangement, the syndicate (in return for a fee) agrees to purchase any unsubscribed shares remaining after the rights offering. Standby agreements are executed on a firm-commitment basis.
market-out clause
If the written agreement that’s entered into by the underwriting syndicate and the issuer contains a market-out clause, the syndicate may be permitted to cancel the agreement. The justification for cancelling the commitment is based on certain events occurring that make marketing the issue difficult or impossible. Examples include a material adverse event that affects the (proposed) issuer or a general disruption in financial markets
Shelf Registration
Certain issuers of existing publicly traded securities can utilize a form of registration that allows them to sell additional securities on either a delayed or continuous basis. This process is referred to as shelf registration and is allowed only for an amount that may reasonably be sold within three years after the initial date of registration. The advantage of the shelf registration method is that the issuer can complete all the necessary paperwork in advance and be prepared to market the shares to the public when conditions are the most favorable
Syndicate
If the syndicate manager is interested in working with an issuer, it will then form a syndicate by inviting other firms to participate in the distribution and share in liability. The written agreement between the manager and syndicate members (referred to as the syndicate letter or agreement among underwriters) is signed by the participants and specifies each firm’s rights and obligations
selling group
In some cases, the syndicate will recruit other broker-dealers to assist in the distribution. These firms are selling group members that do not assume financial liability for the offering; instead, they act as sales agents. Any shares that are not sold by the selling group are retained by the syndicate since the syndicate members remain financially liable for any unsold shares. To join a selling group, a broker-dealer must sign a selling group agreement which provides details regarding the relationship and responsibilities between the selling group and the syndicate manager. The underwriters and selling group members are collectively referred to as distribution participants.
Underwriting Spread
The term underwriting spread refers to the difference between the amount paid by the investing public and the amount received by the issuing corporation. In fact, the spread represents the syndicate’s gross profit. Depending on how the shares are sold, the spread may be shared by the manager, syndicate members, and selling group members.
The spread consists of the following components:
Manager’s Fee—the portion that’s paid to the managing underwriter for each share of the offering
Member’s/Underwriter’s Fee—the portion that’s paid to the syndicate member that assumes the risk or liability for the shares
Concession—the portion that’s paid to the firm that sells the shares
Payments for Market Making
Broker-dealers that act as underwriters may also choose to act as a market maker for an issuer’s securities in the secondary market. In this scenario, FINRA is concerned that issuers may compensate these firms to agree to act as market makers. Since issuers are not regulated by FINRA, the rule prohibits a FINRA member firm or any person who is employed by the member from accepting any payment or other compensation (either directly or indirectly) from an issuer of a security or any affiliate or promoter for:
Publishing a quote (including indications of interest)
Acting as a market maker in a security
Submitting an application in connection with market-making activity
The rule does not prohibit a member firm from accepting (1) payment for bona fide services, such as investment banking (which includes underwriting fees), and (2) reimbursement for registration fees that are paid to the SEC or a state regulator, or for listing fees that are imposed by an SRO.
registration statement
The Securities Act of 1933 attempts to prevent fraud in the sale of new issues by requiring registration and ensuring that investors are provided with adequate information about the offering to make an informed investment decision. This information is provided through the registration statement, which is a public document that issuers file with the SEC.
Registration Statement According to the Securities Act of 1933, a registration statement must contain detailed information about the issuer, its business, its owners, and its financial condition. The required information includes:
The character of the issuer’s business
A balance sheet created within 90 days prior to the filing of the registration statement
Financial statements that show profits and losses for the latest fiscal year and for the two preceding fiscal years
The amount of capitalization and use of the proceeds of the sale
Funds paid to affiliated persons or businesses of the issuer
Shareholdings of senior officers, directors, and underwriters, and identification of individuals who hold at least 10% of the company’s securities
Issuers are also required to prepare a prospectus for distribution to potential purchasers. The prospectus is essentially an abbreviated version of the registration statement
The Registration Process
The Registration Process Let’s take a look at the process by which securities are registered. The process includes the following three phases: 1. The preregistration period 2. The cooling-off (waiting) period 3. The post-effective period
