Chapter 7 Financing a business 2: raising long-term finance LEARNING OUTCOMES You should be able to: Discuss the role and nature of the Stock Exchange Identify the problems that smaller businesses experience in raising finance and describe the ways in which they may gain access to long-term finance Discuss the nature and implications of stock market efficiency Outline the methods by which share capital may be issued

The stock exchange Secondary market Primary market Two important roles

Distribution of UK listed businesses by equity market value 50 200 150 100 Number of businesses 125 175 25 75 0 to 2 Market value range (£m) 28 26 53 99 104 176 120 91 69 1,000 to 2,000 500 to 1,000 250 to 500 100 to 250 50 to 100 25 to 50 10 to 25 5 to 10 2 to 5 117 Over 2,000 September 2010 Source: chart compiled from information in Primary Market Fact Sheet, London Stock Exchange, www.londonstockexchange.com September 2010.

Stock exchange listing Advantages for a business Enables other businesses to be acquired by shares rather than cash Shares valued in an efficient manner Broadens investor base Raises profile Funds acquired at lower cost Easier to raise funds Can help attract and retain employees (share incentives)

Stock exchange listing (Continued) Increased vulnerability to takeover Close monitoring of actions and decisions Increased regulatory burden Cost (including management time) Disadvantages for a business

The three levels of market efficiency The weak form of efficiency The semi-strong form of efficiency The strong form of efficiency

Lessons of market efficiency Timing doesn’t matter Don’t search for undervalued businesses Take note of market reaction You can’t fool the market The market decides the level of risk, not the business Champion the interests of shareholders

Common methods of share issue Rights issue Placing Offer for sale Bonus issue Public issue Common issue methods

Bonus share issue Three possible reasons for an issue: To improve the marketability of shares by reducing their price To increase lender confidence Three possible reasons for an issue: To signal investors the directors confidence in the future

Problems of smaller businesses in raising finance Lack of financial management skills Lack of knowledge concerning the availability of finance Inability to meet assessment criteria of lenders Bureaucratic screening processes Inability to provide security

Long-term finance for small businesses Small business finance Business angels Alternative investment market Private equity Government assistance

Private equity – types of investment Expansion capital Venture capital Replacement capital Buy-out and buy-in capital Rescue capital

Amount invested, by financing stage, 2009 50 100 300 250 200 150 £m Venture capital Expansion capital Replacement capital MBO/MBI Rescue and other 400 388 335 30 71 76 Source: chart compiled from information in BVCA Private equity and venture capital report on investment activity 2009, p. 7, www.bvca.co.uk.

The investment process Obtain funds Evaluate available investment opportunities and make a selection Structure the terms of the investment Step 1 Step 2 Step 3 Step 4 Implement the deal and monitor progress Step 5 Achieve returns and exit from the investment Source: M. Van der Wayer, ‘The venture capital vacuum’, Management Today, July 1995, pp. 60–4, Figure 7.9.

UK finance raised by private-equity firms by source, 2009 Funds of funds Pension funds Insurance companies Corporate investors Banks Government agencies Sovereign wealth funds Other Private individuals Academic institutions £m 100 300 200 271 130 65 90 161 163 12 102 30 155 Source: chart compiled from information in BVCA Private equity and venture capital report on investment activity 2009, p. 14, www. bvca.co.uk.

Business angels Make decisions quickly Expect lower financial returns Offer useful skills and experience Make decisions quickly Expect lower financial returns

Alternative investment market Advantages over main market Admission documents not pre-vetted No prior shareholder approval for transactions No trading record required No minimum shares issued to public No minimum market capitalisation

Distribution of AIM-listed businesses by equity market value Number of businesses 50 250 200 150 100 0 to 2 103 173 181 261 194 122 99 37 17 4 1,000 to 2,000 500 to 1,000 250 to 500 100 to 250 50 to 100 25 to 50 10 to 25 5 to 10 2 to 5 Market value range (£m) 300 350 September 2010 Source: chart compiled from information in AIM market statistics, London Stock Exchange, www.londonstockexchange.com, September 2010.