Raising capital Chapter 15

Key concepts and skills Understand the venture capital market and its role in financing new businesses Understand how securities are sold to the public and the role of investment bankers Understand initial public offerings and the costs of going public Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Chapter outline The financing life cycle of a firm: Early-stage financing and venture capital Selling securities to the public: The basic procedure Alternative issue methods Underwriters IPOs and underpricing New equity sales and the value of the firm The cost of issuing securities Issuing long-term debt Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Venture capital Private financing for relatively new businesses in exchange for shares in the firm Individual investors Venture capital firms Usually involves active participation by VC Ultimate goal to take company public; the VC will benefit from the capital raised in the IPO Many VC firms are formed from a group of investors that pool capital and then have partners in the firm decide which companies will receive financing Some large corporations have a VC division Click on the information icon to go to <http://wholesaleinvestor.com.au/> to search for VC in Australia. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Venture capital stage financing Funding provided in several stages Contingent upon specified goals at each stage First stage ‘Ground floor’ financing or ‘seed money’ Fund prototype and manufacturing plan Second stage ‘Mezzanine’ financing Begin manufacturing, marketing and distribution Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Choosing a venture capitalist Look for financial strength. Choose a VC that has a management style that is compatible with your own. Obtain and check references. What contacts does the VC have? What is the exit strategy? Financial strength—you want to have the option to obtain additional financing. Style—do you want a hands-on or hands-off VC? Contacts—will the VC provide you with additional business contacts that can help your business succeed? Exit strategy—VCs are not long-term investors; what are the provisions for the VC getting out of the business? The internet is a tremendous source of venture capital information, both for suppliers and demanders of capital. For example, click on the information icon to see the <www.businessangels.com.au> site. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Selling securities to the public: The basic procedure Management must obtain permission from the Board of Directors. Appoint an underwriter. Firm must file a prospectus with ASIC or NZSC. ASIC or NZSC examines the prospectus and approves it. The period between filing and approval is called the registration period. Securities may not be sold during the registration period. The price is usually determined on the effective date of the registration. Prospectus—A legal document filed with ASIC or the NZSC that discloses all material information required by the corporations law concerning the firm making a public offering. Registration period—The period from lodgement of the prospectus with ASIC or the New Zealand Securities Commission to its approval and registration. Click on the information icon to go to <www.asx.com.au> to search for firms going public. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Issue methods Public issue—Initial public offering (IPO) General cash offer = offered to general public Usually open for six to eight weeks Only cash offers Private issue—Rights issue Opportunity for existing share holders to buy more shares A new issue by a company with shares issued already Existing shareholders can sell their entitlement if issue is renounceable Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Total equity raised and bank lending 1999–2008 (A$ in billions) Table 15.1 Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

The methods of issuing new securities Table 15.2 Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Underwriters Services provided by underwriters: Formulate method used to issue securities Price securities Sell securities Syndicate—group of investment bankers (underwriters) that market securities and share the risk associated with selling the issue Underwriters—Investment firms that act as intermediaries between a company selling securities and the investing public. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Standby underwriting At the end of the issue, the issuer buys any shares not bought by the public. The underwriter charges a fee for this service. The underwriter bears the risk of not being able to sell the entire issue to the public. Most common type of underwriting in Australia. This is a good place to review the difference between primary and secondary market transactions. Technically, the sale to the syndicate is the primary market transaction and the sale to the public is the secondary market transaction. Note that the cost of the issue includes the price paid to the issuing company plus the expenses of selling the issue. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Best efforts underwriting Underwriter must make their ‘best effort’ to sell the securities at an agreed-upon offer price. The company bears the risk of the issue not being sold. The offer may be pulled if there is not enough interest at the offer price and the company does not get the capital while still incurring substantial flotation costs. Not as common as it used to be. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

IPO underpricing Initial public offering – IPO. May be difficult to price an IPO because there is not a current market price available. Additional asymmetric information associated with companies going public. Underwriters want to ensure that their clients earn a good return on IPOs on average. Underpricing causes the issuer to ‘leave money on the table’. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Average first-day returns Figure 15.1 Average first-day returns by month for ASX initial public offerings: February 1993–December 2009 Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Number of offerings by month Figure 15.2 Number of offerings by month for ASX-listed initial public offerings: February 1993–December 2009 Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

IPO underpricing reasons Underwriters want offerings to sell out Reputation for successful IPOs is critical Underpricing = insurance for underwriters Oversubscription and allotment ‘Winner’s curse’ Smaller, riskier IPOs underprice to attract investors. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

New equity issues and price Private placement An exclusive issue of new securities to an investor or group of investors who may or may not be current investors in the firm. Share prices tend to decline when new equity is issued Possible explanations for this phenomenon: Signalling and managerial information Signalling and debt usage Issue costs Since the drop in price can be significant and much of the drop may be attributable to negative signals, it is important for management to understand the signals that are being sent and try to reduce the effect when possible. Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

The cost of issuing securities Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Types of long-term debt Bonds/Debentures—public issue of long-term debt Private issues Term loans Direct business loans from commercial banks, insurance companies, etc. Maturities 1–5 years Repayable during life of the loan Private placements Similar to term loans with longer maturity Easier to renegotiate than public issues Lower costs than public issues Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Quick quiz What is venture capital and what types of firms receive it? What are some of the important services provided by underwriters? What type of underwriting is the most common in Australia and how does it work? What is IPO underpricing and why might it persist? What are some of the costs associated with issuing securities? What are some of the characteristics of private placement debt? Copyright © 2011 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance 2e by Ross et al. Slides prepared by David E. Allen and Abhay K. Singh

Chapter 15 END