1. Raising capital
Chapter 15

2. 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

3. 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

4. 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 < 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

5. 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

6. 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 < 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

7. 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 < 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. Chapter 15
END