Raising Capital Flashcards
What are the two different types of Private Equity?
- “Angel” Finance - informal market to small number of high net worth investors
- Venture Capital - providing financing to early-stage and high-potential startups up companies
What are the two types of Public Equity?
- Initial Public Offering (IPO)
- Seasoned Equity Offering (SEO)
What are the advantages of ‘going public’?
- Access to additional capital
- Current stockholders can diversify
- Liquidity increased (shares sold fast)
- Establishes firm value
- Employee incentives
- Venture capitalists can cash out
What are the disadvantages of ‘going public’?
- Substantial fees for IPO
- Greater degree of disclosure
- Special “deals” to insiders are difficult to undertake
- Time consuming investor relations
What are the 3 steps of an IPO?
- Engage an investment banker - issues a prospectus and underwriter guarantees all issues will be sold
- The roadshow - investment bankers will advertise the float and gauge investor interest
- Set the price and list
How does a firm decide on its share issue price?
- Fixed pricing; or
- Book building - underwriters ask investors to indicate quantities and prices they would invest at
What are the direct and indirect costs of an IPO?
- Direct Costs - underwriters, admin, lawyers, accountants etc.
- Indirect Costs - underpricing
What are the potential explanations for underpricing an IPO?
- Information asymmetry - to ensure uninformed investors stay in the market - IPOs need to - on average be significantly underpriced
- Market Feedback - underpricing as an incentive for investors to reveal their “true” values of the company
- Investment Bankers - underprice IPOs to benefit themselves and clients
- Litigation Insurance - less likely to be sued for misstatements or issues in prospectus if shares are underpriced
- Signalling - will leave investors with a positive image of the company for future equity offerings to raise funds
What are reasons for the long run underperformance of an IPO?
- Impresario Hypothesis - investment bankers attempt create demand by underpricing IPOs which would fall
- Window of Opportunity - management will time an issue when markets are hot therefore expect to see decline as markets also decline
What are the three types of Seasoned Equity Offerings?
- Private Placement - issue of new shares to a limited number of investors
- Rights Issues - shareholders receive an entitlement to new shares at a fixed price and fixed proportion of already owned shares
- Dividend Reinvestment Plans - use part or all of dividends to apply for new shares without transaction costs
What are the advantages of Private Placements?
- Quicker to complete
- Lower issue costs - no underwriting
- Do not require a prospectus
What are the disadvantages of a Private Placement?
- Shares issued at discount transfers wealth from existing shareholders to new investors
- Dilutes control of exisiting shareholders
How do you calculate the theoretical ex-rights price of a share in a Rights Issue?
X = (M•N+S)/(N+I)
where X = theoretical ex-rights price
M = market cum-rights share price
S = subscription price
N = number of shares owned at M
I = number of shares issued per N
How do you calculate the value of the right in a Rights Issue?
R = X - S; or
R = N(M-S)/(N+I)
where X = theoretical ex-rights price
M = market cum-rights share price
S = subscription price
N = number of shares owned at M
I = number of shares issued per N
What are a shareholders options for a renounceable Rights Issue?
- Exercise Right - pay S & get I shares
- Right Expiry - keep S & keep N
- Sell Right - keep S, get R & keep N
