Raising Capital: Equity - L Flashcards
(26 cards)
Shares
What are firms’ financing decisions related to?
What is cash flow in the context of shares?
What is the difference between income stocks and growth stocks?
What are the key points in the valuation of stocks? (3)
What are firms’ financing decisions related to?
- Investment in property, plant, equipment, and current assets like inventory and accounts receivables.
What is cash flow in the context of shares?
- Cash flows from investors to corporations when raising equity or debt.
What is the difference between income stocks and growth stocks?
- Income stocks provide dividends, while growth stocks offer capital gains.
What are the key points in the valuation of stocks?
- Stock prices may not always reflect true value (e.g., dot-com bubble, GFC).
- Valuation helps identify worthwhile investments and risky stocks.
- Financial analysts, investors, and regulators assess stock values.
Asset Managers and Corporate Governance: Responsibilities and Voting Practices
What pressure do asset managers face regarding corporate governance?
Why are asset managers becoming more proactive in opposing company management?
What concerns do clients have regarding AGM voting?
How do asset managers reflect disagreements with companies?
What pressure do asset managers face regarding corporate governance?
- They are urged to tackle high pay, board diversity, and poor management in businesses.
Why are asset managers becoming more proactive in opposing company management?
- Due to their growing responsibility as stewards of investor money.
What concerns do clients have regarding AGM voting?
- Clients increasingly ask how asset managers vote, as AGM votes are considered a client asset requiring responsible use.
How do asset managers reflect disagreements with companies?
- They avoid conflicts but express concerns through their voting decisions.
What is Equity Capital? - Ordinary Shares
What is Equity Capital? (3)
What control do stockholders have? (3)
What is the free rider problem in investing?
What financial entitlements do shareholders have? (3)
What is Equity Capital?
- Ordinary shares represent the equity share capital of the firm.
- Shareholders benefit from the company’s success.
- Owners of the firm with rights over its assets and liabilities.
What control do stockholders have?
- Right to vote at shareholder meetings.
- Influence appointments to the board of directors.
- Decide on major corporate actions like mergers and acquisitions.
What is the free rider problem in investing?
- Small investors rely on large shareholders to monitor firms.
What financial entitlements do shareholders have?
- Right to receive dividends.
- Access to the company’s annual report.
- No guarantee of recovering their initial investment—returns depend on company performance.
Advantages (2) and disadvantages (5) of share issues
Advantages
- Usually there is no obligation to pay dividends
- The capital does not have to be repaid.
Disadvantages
- High cost
- Direct costs of initial issue (as high as 7-10% of funds raised)
- The return required to satisfy shareholders
- Loss of control (dilution of ownership and influence that existing shareholders experience)
- Dividends cannot be used to reduce taxable profit
Authorised, issued and par values
Example Shrives Plc
- Authorised capital of £5m, split between £1m of preference shares and £4m of ordinary shares
- Issued all of the preference shares (at par) but the issued ordinary share capital is only £2.5m
- Leaving £___ as authorised but unissued ordinary share capital
Par value
- Assume Shrives Plc has 10 million ordinary shares issued, each with a par value of 25p.
- These were originally sold for or issue price 200p each, raising £20m, and the present market value or current market value or the share is currently trading at £3.80 per share.
What was the premium on each share?
Authorised capital:
- the maximum amount of capital that a company is legally allowed to issue as shares to its shareholders.
Example Shrives Plc
- Authorised capital of £5m, split between £1m of preference shares and £4m of ordinary shares
- Issued all of the preference shares (at par) but the issued ordinary share capital is only £2.5m
- Leaving £1.5m as authorised but unissued ordinary share capital
Par value
- Assume Shrives Plc has 10 million ordinary shares issued, each with a par value of 25p.
- These were originally sold for or issue price 200p each, raising £20m, and the present market value or current market value or the share is currently trading at £3.80 per share.
Share premium account is NOT affected by the market value
For Shrives Plc, the premium on each share was 200p − 25p = 175p.
Limited companies, plcs and listed companies
What is limited liability? (2)
What are private companies? (3)
What are public limited companies? (4)
What does it mean for a company to be listed?
What is limited liability?
- Ordinary shareholders are only liable up to the amount they have invested or have promised to invest.
- The company is considered a separate legal “person.”
What are private companies?
- Private companies are referred to as “Limited” or “Ltd.”
- No minimum share capital required.
- Restrictions on who can purchase shares.
What are public limited companies?
- Public limited companies are referred to as “plc.”
- Minimum share capital of £50,000.
- Can offer shares to a wide range of investors.
- Not all public companies are listed on a stock market.
What does it mean for a company to be listed?
- Only companies on the Official List are considered “listed.”
What is a “fair game” and why do we want one?
What do stock exchanges and regulators do to create a fair game?
How important is the perception of a stock exchange being well-run and fair?
What is a “fair game” and why do we want one?
- To prevent fraud
What do stock exchanges and regulators do to create a fair game?
- They establish rules and regulations to create the perception of a fair market.
How important is the perception of a stock exchange being well-run and fair?
- The perception of fairness and proper management is crucial for market confidence and investor trust.
Can you give three disadvantages a stock exchange and companies on it may have if investors are unsure that the market is a “fair game”? (3)
Can you give three advantages a stock exchange and companies on it may have if it’s considered to be a highly regulated “fair game” for investors? (3)
What if you had two exchanges in different countries (say either side of the Atlantic), one is considered well-run, the other isn’t. What do you think will occur? Capital flight to well-run market? Arbitrage profit (3)
Can you give three disadvantages a stock exchange and companies on it may have if investors are unsure that the market is a “fair game”?
- Reduced investor confidence leads to lower trading volumes and liquidity.
- Companies struggle to raise capital efficiently, affecting expansion and innovation.
- Potential capital flight, with investors seeking more stable markets elsewhere.
Can you give three advantages a stock exchange and companies on it may have if it’s considered to be a highly regulated “fair game” for investors?
- Increased investor trust encourages higher participation and market liquidity.
- Companies find it easier to raise capital for growth and development.
- Strong market oversight prevents fraud, insider trading, and manipulation.
What if you had two exchanges in different countries (say either side of the Atlantic), one is considered well-run, the other isn’t. What do you think will occur? Capital flight to well-run market? Arbitrage profit?
- Investors will likely shift capital to the well-run market for stability and reliability.
- Arbitrage opportunities may arise as traders exploit price differences between the two exchanges.
- Companies may prefer listing in the trusted market to attract global investors.
Globalisation of financial flows
Underline the causes of advances in UK Financial Markets.
- Deregulation of financial markets (3)
- Changes in Technology (3)
- Innovation (4)
- Institutionalisation (2)
Deregulation of financial markets
- Removal of domestic restrictions on financial markets (London Stock Exchange 1986)
- Increased market efficiency, increased competition, lower cost
- Economic growth, increased investment from overseas
Changes in Technology
- Communications and IT
- Lowering costs and breaking barriers
- Emergence of High-Frequency Trading
Innovation
- Creation of new financial instruments leading to new business for banks, exchanges, etc.
- Particularly financial derivatives
- Disintermediation
- Cryptocurrency
Institutionalisation
- Widely accepted practice, structure, or system within an organization.
- The process through which informal or less structured activities become formalized and ingrained in an organisation.
What do Capital Markets do? (3)
What are Secondary Markets?
What do Capital Markets do?
Primary Markets:
- Allow for the issuance of new securities (equity and debt) from the issuer to investors in an efficient and liquid environment.
Price Discovery:
- Buyers and sellers determine the price of an asset based on supply, demand, market sentiment, and available information.
Price Formation:
- Prices are shaped by market forces such as supply and demand, negotiation mechanisms, and external influences, ultimately emerging from continuous interaction between buyers, sellers, and market conditions.
What are Secondary Markets?
- The market where shares are traded after being initially sold on the primary market. Major stock exchanges, like the FTSE, function as both primary and secondary markets.
Financial System
What is the financial system?
What are the main components of the financial system and what are their functions (4/3,3,2,2)
What is the financial system?
- The financial system facilitates payments, borrowing and lending, pooling of risk, and provides information about the expected rate of return for investors.
What are the main components of the financial system?
-
Households
- Savings
- Loans
- Return on financial assets held
-
Financial institutions
- Net government borrowing
- Borrowing or the sale of shares for investment
- Return on bonds and shares
-
Businesses
- Direct purchase of shares
- Retained earnings
-
Government
- Net government borrowing
- Taxes
What do Capital Markets do?
What are the problems that arise in the absence of financial intermediaries? (6)
Who are the major constituents and institutions of the financial system? (4)
What preferences do primary investors (households) have? (3)
What costs do primary investors (households) face when dealing with ultimate borrowers (businesses)? (3)
What role do brokers play in the financial system?
What role do asset transformers play in the financial system?
What role do financial markets play in the financial system? (2)
What do ultimate borrowers (businesses) usually sell to attract investments?
What are the problems that arise in the absence of financial intermediaries?
- Information asymmetry
- Moral hazard problem
- Cost inefficiency/high fees
- Illiquidity
- Risk
- Lack of diversification
Who are the major constituents and institutions of the financial system?
- Banking sector: Retail Banks, Investment Banks, International Banks
- Long-term savings institutions: Pension Funds & Insurance Funds
- “Risk spreaders”: Unit Trusts, Investment Companies, Exchange-Traded Funds
- “Risk takers”: Private Equity & Hedge Funds
What preferences do primary investors (households) have?
- High liquidity
- Low risk
- Small investment amounts
What costs do primary investors (households) face when dealing with ultimate borrowers (businesses)?
- High search costs
- High agreement costs
- High monitoring costs
What role do brokers play in the financial system?
- Reduce search, agreement, and monitoring costs for primary investors
What role do asset transformers play in the financial system?
- Attract savers by offering securities with the required characteristics
What role do financial markets play in the financial system?
- Enhance liquidity
- Reduce risk, search, and monitoring costs
What do ultimate borrowers (businesses) usually sell to attract investments?
- Securities such as shares and bonds (often with low liquidity and high risk)
Key Roles of an Underwriter in an IPO (5)
Underwriting:
- Often guarantees the sale of shares by purchasing them if demand is low.
Managing Investor Interest:
- Books orders from institutional and retail investors.
Marketing the Offering:
- Conducts roadshows and presentations to attract investors.
Allocating Shares:
- Decides how shares are distributed among buyers.
Pricing the IPO:
- Helps determine the share price based on market demand.
Main Market Listing Requirements: A Breakdown
What is required to float on the Main Market (Official List)? (3)
What must be included in the prospectus? (11)
What is required to float on the Main Market (Official List)?
- The FCA, oversees the listing process.
- A separate application must be made to the London Stock Exchange (LSE) for securities admission to trading.
- The LSE has its own set of admission and disclosure standards.
What must be included in the prospectus?
- A marketing tool.
- Three years of audited accounts.
- Details of indebtedness.
- A statement on the adequacy of working capital.
- Statements by experts.
- Major contracts entered into in the past two years.
- A description of the risks facing the firm.
- Shareholding of more than 3% must be disclosed.
- A large amount of operational data is required.
- The expected market value of the company’s shares must be at least £50m.
- Adviser costs for the new issue will be at least £500,000.
Floating on the Main Market (Official List) (Continued)
What are the conditions and responsibilities imposed on companies floating on the Main Market? (3)
What are the suitability criteria for companies floating on the Main Market? (3)
What are the conditions and responsibilities imposed on companies floating on the Main Market?
- At least 10% of their share capital must be in public hands.
- Directors may find their discretion restricted when it comes to paying dividends.
- Loss of some privacy and autonomy.
- Rules concerning the buying and selling of the company’s shares by its own directors.
What are the suitability criteria for companies floating on the Main Market?
- Management team must have the necessary range and depth, including a strong track record.
- Timing of the flotation: The timing was strategic, as Lyft aimed to go public ahead of its larger rival, Uber, which was planning its own IPO shortly after.
- A healthy balance sheet, sufficient working capital, good financial control mechanisms, and clear accounting policies.
IPO Sponsors: Roles, Responsibilities, and Impact on Public Listings
What is the advisory role of IPO sponsors?
What does due diligence involve for IPO sponsors?
What is the role of IPO sponsors in liaising with regulators?
How do IPO sponsors contribute to marketing and investor relations?
What is the underwriting and pricing role of IPO sponsors?
What is the difference between sponsors and bookrunners? (2)
Can investment banks serve as both sponsors and bookrunners?
What is the advisory role of IPO sponsors?
- Help the company meet regulatory requirements and prepare for public listing.
What does due diligence involve for IPO sponsors?
- Assess the company’s financials, risks, and business prospects.
What is the role of IPO sponsors in liaising with regulators?
- Work with stock exchanges and financial authorities to secure approvals.
How do IPO sponsors contribute to marketing and investor relations?
- Help generate interest among institutional and retail investors.
What is the underwriting and pricing role of IPO sponsors?
- Often work alongside bookrunners to determine the IPO price and ensure smooth share distribution.
What is the difference between sponsors and bookrunners?
- Sponsors focus on regulatory approval and advisory services.
- Bookrunners lead the offering, manage demand, and allocate shares.
Can investment banks serve as both sponsors and bookrunners?
- In some cases, investment banks serve as both sponsors and bookrunners.
Role in the Process
What is the role of sub-underwriters?
What are the responsibilities of brokers?
What future expectations must companies meet after flotation?
What is the role of sub-underwriters?
- Promise to buy a parcel of shares if the general public will not (e.g. pension or insurance funds).
What are the responsibilities of brokers?
- Knowledgeable about the share market.
- Generates investor interest in new issues.
- Maintains a market in shares post-flotation.
What future expectations must companies meet after flotation?
- Disclosure of price-sensitive information promptly.
- Detailed annual financial statements, preliminary results, and interim report.
- Restrictions on and disclosure of dealings by directors in company shares.
- Fees to LSE and UKLA to maintain listing.
- High standards of behaviour expected of directors.
Flotation is the process of a company offering its shares to the public for the first time, essentially “going public”. It allows businesses to raise capital by selling shares on the stock market. In the UK, this term is commonly used, whereas in the US, it’s often called an initial public offering (IPO)
Issuing Methods
What are the methods of issuing shares? (3)
What are the types of ‘Offer for sale’? (2)
What is ‘Offer for sale by tender’? (6)
What is ‘Placing’?
What is ‘Stock Exchange Introduction’
What are the methods of issuing shares?
- Offer for sale
- Placing
- Stock Exchange Introduction
What are the types of ‘Offer for sale’?
- Shares are offered at a fixed price
- Offer for sale by tender
What is ‘Offer for sale by tender’?
- Commonly used when there is uncertainty in stock valuation
- Public and institutions bid price for shares
- Minimum “reserve” price set by company
- Issue price is highest that will dispose of all the shares
- Market forces determine the IPO price, potentially leading to higher proceeds if demand is strong
- Can result in price volatility compared to fixed-price IPOs
What is ‘Placing’?
- Refers to the process of allocating shares directly to selected institutional investors, such as pension funds, hedge funds, or high-net-worth individuals, rather than offering them to the general public
What is ‘Stock Exchange Introduction’?
- The company’s shares are listed, but no new money is raised
- Must already have a wide spread of shareholders and meet requirements such as minimum market capitalization, financial health, and governance standards
Issuing Methods: Post Flotation - Rights Issues
What are existing shareholders given the right to do?
What are pre-emption rights? (2)
What can shareholders do if they don’t want to subscribe for the new shares? (2)
What are existing shareholders given the right to do?
- Existing shareholders are given the right to subscribe for new shares offered at a discounted price.
What are pre-emption rights?
- Pre-emption rights are the first right to buy new shares issued by a company before they are offered to external investors.
- Helps protect shareholder value and control from being diluted by new investors.
What can shareholders do if they don’t want to subscribe for the new shares?
- Shareholders can sell the rights if they don’t want to subscribe for the new shares.
- Selling the rights allows shareholders to monetize their entitlement instead of subscribing to new shares.
Alternative Investment Market (AIM)
What type of companies does AIM target?
What are the risk and volatility characteristics of AIM stocks?
What are the rules for AIM membership and capital raising?
Who acts as an unofficial sponsor in AIM?
What are the administrative costs of capital raising in AIM?
What is the minimum cost of joining AIM?
What type of companies need to join AIM?
What documents are required for AIM?
What type of companies does AIM target?
- Smaller, growing companies that want to raise capital with less regulatory burden than the main market.
What are the risk and volatility characteristics of AIM stocks?
- Due to smaller, less established companies, AIM stocks tend to be more volatile and less liquid than those on the main exchange.
What are the rules for AIM membership and capital raising?
- Rules are kept as relaxed as possible to keep costs of membership and capital raising reasonably low.
Who acts as an unofficial sponsor in AIM?
- Nominated advisers act as an unofficial ‘sponsor’.
What are the administrative costs of capital raising in AIM?
- The (administrative) cost of capital raising is typically 9–10% of the amount being raised.
What is the minimum cost of joining AIM?
- AIM was designed so that the minimum cost of joining is £40,000–£50,000.
What type of companies need to join AIM?
- Need to be public limited companies.
What documents are required for AIM?
- Produce a prospectus (or AIM document).
What is the disclosure requirement for AIM?
- Do not have to disclose as much information.
Equity finance for unquoted firms - Business angels (informal venture capitalists)
What is the typical investment range for business angels?
What types of firms do business angels typically invest in?
What form do the majority of investments take? (2)
Do business angels usually have a controlling shareholding?
What role do business angels play in the firms they invest in? (2)
Are there networks for business angels?
What tax breaks are available for business angels? (3)
What is the typical investment range for business angels?
- Invest between £10,000 and £250,000.
What types of firms do business angels typically invest in?
- Start-up, early-stage, or expanding firms.
What form do the majority of investments take?
- Majority of investments are in the form of equity finance.
- They also purchase debt instruments and preference shares.
Do business angels usually have a controlling shareholding?
- Usually do not have a controlling shareholding.
What role do business angels play in the firms they invest in?
- Play a significant role in strategy and management.
- Most angels take a seat on the board.
Are there networks for business angels?
- Angel networks.
What tax breaks are available for business angels?
- Tax breaks under the Enterprise Investment Scheme (EIS).
- Investors can claim 30% income tax relief on investments up to £1 million per year.
- If at least £1 million is invested in “knowledge-intensive” companies, the limit increases to £2 million.
Equity finance for unquoted firms - Private equity / venture capital
What is venture capital?
What are Venture Capital Trusts (VCTs)?
What returns are required for the youngest companies by VC funds?
What returns are required for well-established companies by VC funds?
What is the minimum investment required for venture capital?
What is private equity?
What does private equity finance include?
What is the expected return for private equity investment?
What are the expected annual returns for firms receiving equity finance?
What is venture capital?
- VC funds provide finance to companies at an early stage of development with high growth potential.
What are Venture Capital Trusts (VCTs)?
- Popular tax-efficient savings vehicle accessible to all (£731m invested in 2018 Tax Year).
What returns are required for the youngest companies by VC funds?
- VC funds may require returns of 50–80% per annum for the youngest companies.
What returns are required for well-established companies by VC funds?
- Returns required may drop to the high 20s for well-established companies.
What is the minimum investment required for venture capital?
- Investment must be at least £250,000 – the average is £5m.
What is private equity?
- Medium- to long-term investment.
What does private equity finance include?
- Package of debt and equity finance.
What is the expected return for private equity investment?
- Expect a return between five and ten times initial equity investment in five to seven years.
What are the expected annual returns for firms receiving equity finance?
- Firms receiving equity finance are expected to produce annual returns of at least 26%.
Types of Private equity
Under what circumstances can a Management Buy-Out (MBO) occur?
What is a Management Buy-In (MBI)?
When do MBIs often occur?
What does an MBI involve?
What is a Leveraged Buy-Out (LBO)?
Under what circumstances can a Management Buy-Out (MBO) occur?
- Occurs when a company’s owners (such as private equity firms or family owners) want to exit or sell.
- The management team wishes to gain more control over the business.
What is a Management Buy-In (MBI)?
- An external management team (executives or managers) buys into a company and takes over management and control.
When do MBIs often occur?
- When a company’s existing management is ineffective.
- When owners want to bring in new leadership to improve the business.
- May also happen if the company is in financial distress or needs restructuring.
What does an MBI involve?
- A significant shift in the company’s strategy, operations, or culture due to new leadership.
What is a Leveraged Buy-Out (LBO)?
- An acquisition where a company is purchased using a large amount of borrowed funds (debt), typically secured against the company’s assets.
- Some equity from the buyer is also involved in the transaction.
Private equity / venture capital (Continued)
Is Private Equity activity “good” for society? (2)
Is Private Equity activity “good” for society?
- Private equity buyouts, which are often criticized for rent-seeking behaviors, are profitable for individuals but not beneficial to society as a whole.
- Buyouts can lead to large productivity gains in some cases, and also cause job losses and wage reductions for existing workers.
