1 IPOs

Pre IPO These are private companies  Generally smaller and newer companies Recently we seen firms that have fallen on hard times taken private (Ex. Kmart) They receive additional capital from: 1. Credit Cards 2. Friends and Family 3. Angel Investors 4. Venture Capital 2

Angel Investors Angels typically invest their own money Angels generally come in after “friends and family,” but before venture capitalists Unlike credit cards and friends and family Angels provide experience as well as money 3

Venture Capital These are typically limited partnerships, where investment managers raise money from qualified investors  They also provide experience and take a more active advisory role in the firm Four main suppliers of venture capital: 1. Old Money 2. Large firm with established venture-capital subsidiaries. 3. Qualified Individuals Individuals worth over $1,000,000 and incomes above $100,000

IPO This is when a private firm is made public It is the first time that the general public is able to invest in the firm Generally happens when a firm needs more money than it can raise from VC’s  Or when the market is “hot” 5

The Basic Process Management gets Board approval to go public  Once this happens it’s a 3-6 month process “All Hands Meeting” everyone gets together and starts doing due diligence  Review documents, audited financials, SEC filings File a registration statement with the SEC  This starts the waiting period & the road show Sell Sell Sell Amend the registration statement with the SEC Set a share price and sell shares to the public

Types of IPO’s Once the basic process is competed there are 3 ways to sell shares to the public  Firm Commitment  Best Efforts  Dutch Auction

Firm Commitment Firm sells shares to the underwriting syndicate  Primary Sale Syndicate resells to the public  Secondary Sale Syndicate makes money on the SPREAD  Difference between what the syndicate pays and sells the shares for This is typically about 7% in the US Syndicate bears the risk of not selling all the shares Most common type of IPO in the US

Best Effort Underwriter makes a “best effort” to sell the securities at an agreed-upon price  The firm bears the risk of not selling all shares  If there is not enough demand the firm can pull the offer Firm still pays the underwriter, but keeps all the shares Not very common

Dutch Auction The underwriter simply records investors bids  Number of shares and price per share  Greatly reduces the importance of the underwriter The price is the highest bid that clears the market Investors have an incentive to bid high  Higher bids are more likely to win, while you are unlikely to pay the price you bid Google was the first large Dutch Auction IPO

Dutch Auction Example F irm TUM is offering 1,000 shares through a Dutch Auction. What is the price of each share? 11 InvestorPrice BidShares Bid WinShares Received Price Paid Abbie$75500 Bill$70250 Charlie$65150 David$60100 Edward$5575 Fancy$50200

Problems With the Basic IPO Process Underpricing Winner’s Curse 12

IPO Underpricing IPOs are generally offered at a prices below their true market value  This implies that the firm is “leaving money on the table” IPOs are potentially underpriced because:  Of the difficulty in setting an accurate price Private companies are very hard to value  Underwriter wants to ensure a large day one return  Managers want to ensure their ability to go back to the market

Winner’s Curse IPO’s are generally a good short term bet  They tend to increase in value over the short term Therefore you want these However, underwriters choose who to allocate IPO shares too, and generally give preferential treatment to their big customers (favor bank) So if you aren’t a big customer and you get an IPO allocation, is it likely to be any good? 14

SEOs A Seasoned (Secondary) Equity Offering is when a public company offers additional equity to the public This is generally the result of the firm needing cash for investments 15

SEO Announcement and Firm Value The market value of existing equity drops on the announcement of a SEO The price may drop because:  Managers are likely to issue stock when they think it is overpriced  May be issuing equity to repurchase debt, because of a fear of financial distress  A share now entitles you to less of the company than it did before the SEO

The Costs of Equity Public Offerings Proceeds Direct CostsUnderpricing (in millions)SEOsIPOsIPOs %15.36%18.18% %11.63%10.02% %9.81%17.91% %9.21%29.57% %8.65%39.20% %8.34%45.36% %7.67%37.10% %6.72%17.72% 500 and up3.64%5.15%12.19%