Raising Capital: Financing a Business 9/18/2018 Financing a Business

Topics Basic Concepts Commercial Bank- Short Term Commercial Bank- Long Term Non Bank Financing Early Stage Financing Going Public Other 9/18/2018 Financing a Business

Basic Concepts Primary vs. Secondary Market I. Bank vs. C. Bank Efficient Markets 9/18/2018 Financing a Business

Financial Markets Investors Stocks and Bonds Firms Money Bob Sue securities Primary Market money Secondary Market 9/18/2018 Financing a Business

How to Create Value through Financing Fool Investors Empirical evidence suggests that it is hard to fool investors consistently. Reduce Costs or Increase Subsidies Certain forms of financing have tax advantages or carry other subsidies. Some ways of raising capital are cheaper than others. Create a New Security Sometimes a firm can find a previously-unsatisfied clientele and issue new securities at favorable prices. In the long-run, this value creation is relatively small, however. 9/18/2018 Financing a Business

Commercial Bank – Short Term Short term loans Compensation Collateral and protection Letter of credit (LC) Reverse repurchase agreement (REPO) 9/18/2018 Financing a Business

Commercial Bank – Short Term Loans Single payment loans Installment loans Discount loans Credit lines or bank facility Repayment on demand 9/18/2018 Financing a Business

Commercial Bank – Compensation Commitment fee (1/2 %) Compensating balances (10% in checking) Interest rate 9/18/2018 Financing a Business

Commercial Bank – Collateral and Protection Unsecured Collateralized (financial strength with escape) Asset-based loans (value of the assets) Key executive insurance (payable to bank) Personal guarantees 9/18/2018 Financing a Business

Commercial Bank – Letter of Credit (LC) Guarantee by bank Importing and exporting 9/18/2018 Financing a Business

Commercial Bank – Reverse Repurchase Agreement (REPO) Sell T-Bill for $998 Agree to buy back the T-Bill for $1000 in 10 days 9/18/2018 Financing a Business

Commercial Bank – Longer Term Loans Periodic repayment or interest w/ balloon Collateral (fixed assets) Lease financing Mortgage financing 9/18/2018 Financing a Business

4. Non-Bank Short-Term Financing Account payable (implicit cost) Commercial finance companies (risky asset backed, factoring, leases) Factoring (credit cards) Commercial paper (rated, 3-months, unsecured IOU from prestigious firm, $25,000 minimum) Direct or finance paper (GE Capital Corporation or GMAC) Indirect or dealer paper (through I. bank) Small business administration Guarantees to repay up to 90% of loan Paper work! But new micro loans Grants (i.e. Small Business Innovation Development Act) All federal agencies with R&D budgets must spend some on small tech business 9/18/2018 Financing a Business

Stages of Financing Seed-Money Stage: Start-Up First-Round Financing Small amount of money to prove a concept or develop a product. Start-Up Funds are likely to pay for marketing and product refinement. First-Round Financing Additional money to begin sales and manufacturing. Second-Round Financing Funds earmarked for working capital for a firm that is currently selling its product but still losing money. Third-Round Financing Financing for a firm that is at least breaking even and contemplating expansion; a.k.a. mezzanine financing. Fourth-Round Financing Financing for a firm that is likely to go public within 6 months; a.k.a. bridge financing. 9/18/2018 Financing a Business

5. Early Stage Financing Bootstrapping Early equity 9/18/2018 Financing a Business

Bootstrapping (few resources) Entrepreneur resources (Gates and Allen in a cheap apartment) Few employees (subcontract, temps,…) Lease, share, or barter OPM (i.e. suppliers) 9/18/2018 Financing a Business

Early Equity Personal resources(savings, cards, parents, friends and family) Private investors Angels Private placement Venture capital Strategic alliances Small Business Investment Company (SBIC) 9/18/2018 Financing a Business

Angels $20 – 750K Referral Former entrepreneurs, wealthy individuals Faster than VC’s Demand less control than VC’s Invest smaller amounts than VC’s 9/18/2018 Financing a Business

Private Placement SEC Regulation A (under $1.5 mill. New, no audit, less reporting) SEC Regulation D Rule 504 ($1 mill./yr. To any number, sophisticated or not) Rule 505 ($5 mill./yr. To 35 accredited investors) Rule 506 (unlimited amount to accredited and relations, but no general solicitation) Small Corporate Offering Registration, Form SCOR U-7 (question and answer) 9/18/2018 Financing a Business

Venture Capital The limited partnership is the dominant form of intermediation in this market. There are four types of suppliers of venture capital: Old-line wealthy families. Private partnerships and corporations. Large industrial or financial corporations have established venture-capital subsidiaries. Individuals, typically with incomes in excess of $100,000 and net worth over $1,000,000. Often these “angels” have substantial business experience and are able to tolerate high risks. Demand convertible preferred stock Demand control 9/18/2018 Financing a Business

Strategic Alliances Companies invest in other companies for strategic reasons (i.e., leverage technology). Fast deals, good valuations What if your product allows Adobe to increase the price of its products by $5? What if your product allows Sprint’s fiber optic cables to carry 10% more volume? Offer validation, introductions, promotions… 9/18/2018 Financing a Business

Small Business Investment Company (SBIC) VC investment companies licensed by the SBA. 9/18/2018 Financing a Business

6. Going Public (IPO vs. SEO) Approval from board Pick investment bank and pre-underwriting conference Prepare and file registration statement with SEC 20-day waiting period, letter of comment, 20 more days Road show, built a book, preliminary prospectus or red herring, syndicate registrar and transfer agent (but no selling) Pricing (file amendment), final prospectus, purchase, tombstone Resale After market, stabilization, and lockup Green shoe provision or over allotment option 9/18/2018 Financing a Business

Pick Investment Bank and Pre-Underwriting Conference Debt, equity, or hybrid Competitive bid or negotiated offer Public or private Firm commitment or best efforts Cash offer or rights offer Shelf registration, SEC Rule 415 Exchange (NYSE, AMSE, Nasdaq) 9/18/2018 Financing a Business

Issuing New Securities 9/18/2018 Financing a Business

Allocation of Underwriting Spread 9/18/2018 Financing a Business

Public vs Private Placement of Bonds 9/18/2018 Financing a Business

Costs Spread (7%) Other direct expenses (filing fees, legal fees, printing, mailing, registrar and transfer agent) Indirect expenses (management time, accountants time) Abnormal returns (seasoned issue price drop of around 3%) Underpricing (why are so many content to sell assets for 85% of value?) Green shoe option 9/18/2018 Financing a Business

The Costs of Public Offerings Proceeds Direct Costs Underpricing (in millions) SEOs IPOs IPOs 2 - 9.99 13.28% 16.96% 16.36% 10 - 19.99 8.72% 11.63% 9.65% 20 - 39.99 6.93% 9.70% 12.48% 40 - 59.99 5.87% 8.72% 13.65% 60 - 79.99 5.18% 8.20% 11.31% 80 - 99.99 4.73% 7.91% 8.91% 100 - 199.99 4.22% 7.06% 7.16% 200 - 499.99 3.47% 6.53% 5.70% 500 and up 3.15% 5.72% 7.53% 9/18/2018 Financing a Business

An Example of a Tombstone Advertisement 9/18/2018 Financing a Business

Average First-Day Returns by Month for SEC-Registered IPOs: 1960-2005 9/18/2018 Financing a Business

7. Other ADR and GDR Euromarket Swaps Convertibles Warrants Junk Bond Securitization 9/18/2018 Financing a Business