1. Chapter 13 How companies raise capital

2. Learning objectives
After studying this presentation, you should be able to: 13.1 explain the role of bootstrapping when raising seed financing 13.2 discuss the advantages and disadvantages of going public, and calculate the proceeds from an IPO 13.3 discuss the costs of bringing an open public offer to market, and calculate the total cost of issuing an open public offer.
Learning objectives

3. Introduction
This chapter is about how companies raise capital so that they can acquire the productive assets needed to grow and remain profitable.
To raise money, a company can borrow (debt), sell equity (share) or both.
How a company actually raises capital depends on factors such as where the company is in its life cycle, its expected cash flows and its risk characteristics.
Management’s goal is to raise the amount of money necessary to finance the business at the lowest possible cost.
We explain how companies sell their first issue of ordinary shares in the public markets, known as initial public offerings or IPOs, and the role of investment banks in completing these sales.

4. 13.1 Bootstrapping How new businesses get started:
- Most businesses are started by an entrepreneur with a vision for a new business or product and a passionate belief in the concept’s viability.
The entrepreneur often fleshes out his or her ideas and makes them operational through informal discussions with people whom the entrepreneur respects and trusts, such as friends and early investors.
- The founder and his or her advisers often have a common bond that has drawn them together e.g. Microsoft, Facebook).
Learning objective 13.1

5. Bootstrapping Initial funding of the company:
The process used by entrepreneurs to raise “seed” money and obtain other resources necessary to start their businesses is often called bootstrapping.
The initial “seed” money usually comes from the entrepreneur or other founders.
Other cash may come from personal savings, the sale of assets such as cars and boats, loans from family members and friends, and loans secured from credit cards.
The seed money, in most cases, is spent on developing a prototype of the product or service and a business plan.
Learning objective 13.1

6. 13.2 Venture capital
The bootstrapping period usually lasts no more than one or two years.
When the founders have developed a prototype of the product and a business plan, they ‘take it on the road’ to seek venture capital funding to grow the business.
Venture capitalists are individuals or companies that help new businesses get started and provide much of their early-stage financing.
Learning objective 13.2

7. Venture capital The venture capital industry:
Individual venture capitalists, angels (or angel investors) are typically wealthy individuals who invest their own money in emerging businesses at the very early stages in small deals.
Venture capital is important because entrepreneurs have only limited access to traditional sources of funding.
Learning objective 13.2

8. Venture capital Why venture capital funding is different:
The high degree of risk involved in starting a new business.
Types of productive assets.
Often intangibles (patents or trade secrets).
Informational asymmetry problems.
An entrepreneur knows more about his or her company’s prospects than a lender does.
Learning objective 13.2

9. The venture capital funding cycle
Learning objective 13.2

10. 13.3 Initial public offering
If a business is very successful then, it will need more than the private sources of equity, such as family and friends and venture capitalists, to fund its growth.
More money will be needed for investments in property, plant and equipment and research and development (R&D).
- One way to raise larger sums of cash to facilitate the growth is the initial public offering, or IPO, of the company’s ordinary shares.
- First-time share issues are given a special name because the marketing and pricing of these issues are distinctly different from those of seasoned offerings.
Learning objective 13.3

11. Initial public offering
Advantages and disadvantages of going public:
A company’s decision to go public depends on an assessment of whether the advantages outweigh the disadvantages.
Going public has a number of potential advantages.
1- The amount of equity capital that can be raised in the public equity markets is typically larger than the amount that can be raised through private sources.
Learning objective 13.3

12. Initial public offering
Advantages and disadvantages of going public:
2- Once an IPO has been completed, additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost.
3- Going public can enable an entrepreneur to fund a growing business without giving up control.
4- After the IPO, there is an active secondary market in which shareholders can buy and sell their shares.
Learning objective 13.3

13. Initial public offering
5- Publicly traded companies find it easier to attract top management talent and to better motivate current managers if a company’s shares are publicly traded.
There are several disadvantages to going public:
the high cost of the IPO itself.
the costs of complying with ongoing ASIC disclosure (transparency) requirements.
encourages managers to focus on short-term profits rather than long-term wealth maximisation.
Learning objective 13.3

14. Initial public offering
Investment banking services:
To complete an IPO, a company will need the services of investment bankers, who are experts in bringing new securities to market.
An important task as not all investment banks are equal.
Securing the services of an investment banking company with a reputation for quality and honesty will improve the market’s receptivity and help ensure a successful IPO.
Learning objective 13.3

15. Initial public offering
Investment banking services:
Investment bankers provide three basic services when bringing securities to market:
1- origination,
2- underwriting, and
3- distribution.
Learning objective 13.3

16. Initial public offering
1- Origination:
Origination includes giving the company financial advice and getting the issue ready to sell.
During the origination phase, the investment banker helps the company determine whether it is ready for an IPO.
Once the decision to sell shares:
is made, the company’s management must obtain a number of approvals with ASIC and the ASX.
Learning objective 13.3

17. Initial public offering
2- Underwriting:
Underwriting is the risk-bearing part of investment banking.
The securities can be underwritten in two ways:
on a stand-by basis
on a best-effort basis.
Learning objective 13.3

18. Initial public offering
Underwriting:
Stand-by underwriting: investment banker guarantees the issuer a fixed amount of money from the share sale (more typical).
Best-effort underwriting: investment banking company makes no guarantee to sell the securities at a particular price.
Investment banker does not bear the price risk associated with underwriting – compensation is based on the number of shares sold.
Learning objective 13.3

19. Initial public offering
One of the investment banker’s most difficult tasks is to determine the highest price at which the bankers will be able to quickly sell all of the shares being offered and that will result in a stable secondary market for the shares.
Learning objective 13.3

20. Initial public offering
Before the shares are sold, representatives from the underwriting syndicate hold a due diligence meeting with representatives of the issuer.
The due diligence meetings protect their reputations and reduce the risk of investors’ lawsuits in the event the investment goes bad.
Once complete, underwriters and issuer determine final offer price.
Learning objective 13.3

21. Initial public offering
3- distribution (The proceeds)
We now arrive at the bottom line: How much money do the company, and the underwriter, make from the sale of the new shares?
The net proceeds are determined by the offer price and the underwriters spread (i.e. fee).

22. IPO pricing and cost The cost of an IPO:
Three basic costs are associated with issuing share in an IPO:
underwriting spread: the difference between the proceeds the issuer receives and the total amount raised in the offering.
out-of-pocket expenses: Legal fees, ASIC lodgement fees and other expenses.
Underpricing: the difference between the offer price and the closing price at the end of the first day of the IPO.
Learning objective 13.4