There Is No Tutorial — Part II

Week #N/A
Raising Capital
RTBWJ: Chapter 15
BDHFMF: Chapter 14
RTBWJ: ROSS, TRAYLOR, BIRD, WESTERFIELD, & JORDAN — Essentials of Corporate Finance (4E Aus & NZ), &
BDHFMF: BERK, DEMARZO, HARFORD, FORD, MOLLICA, & FINCH — Fundamentals of Corporate Finance (3E Aus)
YOUR TUTOR & TUTOR-IN-CHARGE
Peter Kjeld Andersen
peter.andersen@unsw.edu.au
Peter Kjeld Andersen
 IPO UNDERPRICING
Watson Ltd and McInroy Ltd have both announced IPOs at $37 per share. One of these is undervalued by
$6, and the other is overvalued by $3.75, but you have no way of knowing which is which. You plan to buy
1000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be
filled.
Q. If you could get 1,000 shares in Watson and 1,000 shares in McInroy, what would your profit be?
A. [1,000 x $6.00] + [1,000 x (–$3.75)] = $2,250
Q. What profit do you actually expect?
A. [500 x $6.00] + [1,000 x (–$3.75)] = –$750
You will only receive half of the oversubscribed/underpriced issue.
Q. What principle have you illustrated?
A. Winner’s Curse

Peter Kjeld Andersen

 IPO UNDERPRICING
Watson Ltd and McInroy Ltd have both announced IPOs at $40 per share. One of these is undervalued by
$8, and the other is overvalued by $4.75, but you have no way of knowing which is which. You plan to buy
1000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be
filled.
Q. If you could get 1,000 shares in Watson and 1,000 shares in McInroy, what would your profit be?
A. [1,000 x $8.00] + [1,000 x (–$4.75)] = $3,250
Q. What profit do you actually expect?
A. [500 x $8.00] + [1,000 x (–$4.75)] = –$750
You will only receive half of the oversubscribed/underpriced issue.
Q. What principle have you illustrated?
A. Winner’s Curse

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Shoalhaven River Boats Ltd. needs to raise $64 million to finance its expansion into new markets. The
company will sell new shares of equity via a general cash offering to raise the needed funds.
Q. If the offer price is $35 per share and the company's underwriters charge an 6.5% spread, how many
shares need to be sold?
A. ( )
Value $Shares Sold  1 − Spread% = Funds Needed$

The key point is that we need to raise more than $64m, such that when we pay our 6.5% underwriting
spread we are left with exactly $64m for our project.
Value $Shares Sold  ( 1 − 0.065 ) = $64,000,000

$64,000,000
Value $Shares Sold = = $68,449,197.86
( 1 − 0.065 )
Value $Shares Sold $68,449,197.86
# of Shares Sold = = = 1,955,692 shares
Issue Price $35/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Shoalhaven River Boats Ltd. needs to raise $64 million to finance its expansion into new markets. The
company will sell new shares of equity via a general cash offering to raise the needed funds.
Q. If the offer price is $35 per share and the company's underwriters charge an 6.5% spread, how many
shares need to be sold?
A. ALTERNATIVELY….
Out of each share sold at the $35 issue price to the public by the underwriting investment bank, Digger Corp
will receive $35 x (1 – 0.065) = $32.725.
Funds Needed $64,000,000
# of Shares Sold = = = 1,955,692 shares
$ Received per share $32.725/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. In the previous problem, if the ASIC filing fee and associated administrative expenses of the offering are
$670,000, how many shares need to be sold now?
A. We CANNOT just sell 19,143 shares at $35 each to get the money for the ASIC fees, because after we
subtract the 6.5% underwriting fee we’ll only have $626,454.68. Instead…
( )
Value $Shares Sold  1 − Spread% = Funds Needed$

Value $Shares Sold  ( 1 − 0.065 ) = ( $64,000,000 + $670,000 )

$64,670,000
Value $Shares Sold = = $69,165,775.40
( 1 − 0.065 )
Value $Shares Sold $69,165,775.40
# of Shares Sold = = = 1,976,166 shares
Issue Price $35/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Down Feather Limited needs to raise $73 million to finance its expansion into new markets. The company
will sell new shares of equity via a general cash offering to raise the needed funds.
Q. If the offer price is $45 per share and the company's underwriters charge an 7% spread, how many shares
need to be sold?
A. ( )
Value $Shares Sold  1 − Spread% = Funds Needed$

The key point is that we need to raise more than $73m, such that when we pay our 7% underwriting spread
we are left with exactly $73m for our project.
Value $Shares Sold  ( 1 − 0.07 ) = $73,000,000

$73,000,000
Value $Shares Sold = = $78,494,624
( 1 − 0.07 )
Value $Shares Sold $79,494,624
# of Shares Sold = = = 1,744,325 shares
Issue Price $45/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. In the previous problem, if the ASIC filing fee and associated administrative expenses of the offering are
$550,000, how many shares need to be sold now?
A. We CANNOT just sell 12,223 shares at $45 each to get the money for the ASIC fees, because after we
subtract the 7% underwriting fee we’ll only have $511,532.55. Instead…
( )
Value $Shares Sold  1 − Spread% = Funds Needed$

Value $Shares Sold  ( 1 − 0.07 ) = ( $73,000,000 + $550,000 )

$73,550,000
Value $Shares Sold = = $79,086,022
( 1 − 0.07 )

Value $Shares Sold $79,086,022

# of Shares Sold = = = 1,757,467 shares
Issue Price $45/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Digger Corporation needs to raise $49 million to finance its expansion into new markets. The company will
sell new shares of equity via a general cash offering to raise the needed funds.
Q. If the offer price is $26 per share and the company's underwriters charge an 7.5% spread, how many
shares need to be sold?
A. ( )
Value $Shares Sold  1 − Spread% = Funds Needed$

The key point is that we need to raise more than $73m, such that when we pay our 7% underwriting spread
we are left with exactly $73m for our project.
Value $Shares Sold  ( 1 − 0.075 ) = $49,000,000

$49,000,000
Value $Shares Sold = = $52,972,973
( 1 − 0.075 )
Value $Shares Sold $52,972,973
# of Shares Sold = = = 2,037,422 shares
Issue Price $26/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Digger Corporation needs to raise $49 million to finance its expansion into new markets. The company will
sell new shares of equity via a general cash offering to raise the needed funds.
Q. If the offer price is $26 per share and the company's underwriters charge an 7.5% spread, how many
shares need to be sold?
A. Out of each share sold at the $26 issue price to the public by the underwriting investment bank, Digger Corp
will receive $26 x (1 – 0.075) = $24.05.
Funds Needed $49,000,000
# of Shares Sold = = = 2,037,422 shares
$ Received per share $24.05/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. In the previous problem, if the ASIC filing fee and associated administrative expenses of the offering are
$1,450,000, how many shares need to be sold now?
A. We CANNOT just sell 55,770 shares at $26 each to get the money for the ASIC fees, because after we
subtract the 7.5% underwriting fee we’ll only have $1,341,268.5. Instead…
( )
Value $Shares Sold  1 − Spread% = Funds Needed$

Value $Shares Sold  ( 1 − 0.075 ) = ( $49,000,000 + $1,450,000 )

$50,450,000
Value $Shares Sold = = $54,540,540.54
( 1 − 0.075 )
Value $Shares Sold $54,540,540.54
# of Shares Sold = = = 2,097,714 shares
Issue Price $26/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. In the previous problem, if the ASIC filing fee and associated administrative expenses of the offering are
$1,450,000, how many shares need to be sold now?
A. We CANNOT just sell 55,770 shares at $26 each to get the money for the ASIC fees, because after we
subtract the 7.5% underwriting fee we’ll only have $1,341,268.5. Instead…
Funds Needed = $49,000,000 + $1,450,000 = $50,450,000

Funds Needed $50,450,000

# of Shares Sold = = = 2,097,714 shares
$ Received per share $24.05/share

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Cunningham Company has just gone public. Under a firm-commitment agreement, Cunningham received
$15.40 for each of the 5.6 million shares sold. The initial offering pricing was $16.50 per share, and the
share price rose to $20 in the first few minutes of trading. Collins paid $1,350,000 in legal and other direct
costs, and $190,000 in indirect costs.
Indirect costs could be managers focussing on
the IPO process instead of running the
Q. What was the flotation cost as a percentage of funds raised? business, therefore they lose some money

A. We need to calculate the net amount raised and the costs associated with the offer. The net amount raised
is the number of shares offered times the price received by the company, minus the costs associated with
the offer, so:
Net amount raised = (5,600,000 shares)($15.40) – 1,350,000 – 190,000
Net amount raised = $84,700,000
The company received $84,700,000 from the share offering. This is the incremental amount of $ that the
company will be able to spend on new investments and projects as a result of the issue.

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. What was the flotation cost as a percentage of funds raised?
A. We just said that the company received $84,700,000 from the share offering.
Now, we can calculate the direct costs. Part of the direct costs are given in the problem, but the company
also had to pay the underwriters.
The share was offered at $16.50 per share, and the company received $15.40 per share. The difference,
which is the underwriters spread, is also a direct cost. The total direct costs were:
Total direct costs = $1,350,000 + ($16.50 – $15.40)(5,600,000 shares)
Total direct costs = $7,510,000
We are given part of the indirect costs in the problem. Another indirect cost is the immediate price
appreciation. The total indirect costs were:
Total indirect costs = $190,000 + ($20.00 – $16.50)(5,600,000 shares)
Total indirect costs = $19,790,000 Whenever an IPO is underpriced, this indirect flotation cost
represents a wealth loss to the pre-IPO owners.

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. What was the flotation cost as a percentage of funds raised?
A. This makes the total costs:
Total costs = $7,510,000 + $19,790,000
Total costs = $27,300,000
The floatation costs as a percentage of the amount raised is the total cost divided by the amount raised, so:
Floatation cost percentage = $27,300,000 / $84,700,000 = 32.23%
Note: Many people don’t understand why we include the immediate price appreciation in our indirect
costs. This is an example of IPO underpricing, which can be thought of as an opportunity cost or money
left on the table. It is a wealth loss to the original owners.
The $20 that the stock rises to implies that the underwriters could have sold the shares for $4.00 more
than the $22.00 that they issued them for. Or... sold a fewer number of shares to raise the same amount
of money total.

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Collins Company has just gone public. Under a firm-commitment agreement, Collins received $20.56 for
each of the 7.5 million shares sold. The initial offering pricing was $22 per share, and the share price rose
to $26 in the first few minutes of trading. Collins paid $1,200,000 in legal and other direct costs, and
$250,000 in indirect costs.
Indirect costs could be managers focussing on the IPO
Q. What was the flotation cost as a percentage of funds raised? process instead of running the business, therefore they
lose some money

A. We need to calculate the net amount raised and the costs associated with the offer. The net amount raised is
the number of shares offered times the price received by the company, minus the costs associated with the
offer, so:
Net amount raised = (7,500,000 shares)($20.56) – 1,200,000 – 250,000
Net amount raised = $152,750,000
The company received $152,750,000 from the share offering. This is the incremental amount of $ that the
company will be able to spend on new investments and projects as a result of the issue.

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. What was the flotation cost as a percentage of funds raised?
A. We just said that the company received $152,750,000 from the share offering.
Now, we can calculate the direct costs. Part of the direct costs are given in the problem, but the company
also had to pay the underwriters.
The share was offered at $22 per share, and the company received $20.56 per share. The difference, which is
the underwriters spread, is also a direct cost. The total direct costs were:
Total direct costs = $1,200,000 + ($22 – 20.56)(7,500,000 shares)
Total direct costs = $12,000,000
We are given part of the indirect costs in the problem. Another indirect cost is the immediate price
appreciation. The total indirect costs were:
Total indirect costs = $250,000 + ($26.00 – $22)(7,500,000 shares)
Whenever an IPO is underpriced, this indirect flotation cost
Total indirect costs = $30,250,000 represents a wealth loss to the pre-IPO owners.

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. What was the flotation cost as a percentage of funds raised?
A. This makes the total costs:
Total costs = $12,000,000 + $30,250,000
Total costs = $42,250,000
The floatation costs as a percentage of the amount raised is the total cost divided by the amount raised, so:
Floatation cost percentage = $42,250,000 /$152,750,000 = 27.66%
Note: Many people don’t understand why we include the immediate price appreciation in our indirect
costs. This is an example of IPO underpricing, which can be thought of as an opportunity cost or money
left on the table. It is a wealth loss to the original owners.
The $26 that the stock rises to implies that the underwriters could have sold the shares for $4.00 more
than the $22.00 that they issued them for.

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Swan Songs Ltd has just gone public. Under a firm-commitment agreement, Swan Songs received $31.75
for each of the 7.3 million shares sold. The initial public offering price was $34 per share, and the share
price rose to $43.85 in the first few minutes of trading. Swan Songs paid $1,350,000 in legal and other
direct costs, and $210,000 in indirect costs.
Q. What was the flotation cost as a percentage of net funds raised?
A. We need to calculate the net amount raised and the costs associated with the offer. The net amount raised is
the number of shares offered times the price received by the company, minus the costs associated with the
offer, so:

Net amount raised = (7,300,000 shares)($31.75) – $1,350,000 – $210,000

Net amount raised = $230,215,000

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. What was the flotation cost as a percentage of net funds raised?
A. The company received $230,215,000 from the share offering. Now, we can calculate the direct costs. Part of
the direct costs are given in the problem, but the company also had to pay the underwriters.
The share was offered at $34 per share, and the company received $31.75 per share. The difference, which is
the underwriters spread, is also a direct cost. The total direct costs were:
Total direct costs = $1,350,000 + ($34 – $31.75)(7,300,000 shares)
Total direct costs = $17,775,000
We are given part of the indirect costs in the problem. Another indirect cost is the immediate price
appreciation. The total indirect costs were:
Total indirect costs = $210,000 + ($43.85 – $34)(7,300,000 shares)
Total indirect costs = $72,115,000

Peter Kjeld Andersen

 CALCULATING FLOTATION COSTS
Q. What was the flotation cost as a percentage of net funds raised?
A. This makes the total costs:
Total costs = $17,775,000 + $72,115,000
Total costs = $89,890,000
The floatation costs as a percentage of the amount raised is the total cost divided by the amount raised, so:
Floatation cost percentage = $89,890,000/ $230,215,000
Floatation cost percentage = 39.05%

Peter Kjeld Andersen

 Your firm is selling 3 million shares in an IPO. You are targeting an offer price of $16.94 per share. Your
underwriters have proposed a spread of 6.9%, but you would like to lower it to 4.9%. However, you are
concerned that if you do so, they will argue for a lower offer price.
Q. Given the potential savings from a lower spread, how much lower can the offer price go before you prefer
to pay 6.9% to get $16.94 per share?
A. At the original $16.94/share offer price and 6.9% spread, we would have raised:
(
Funds Raised$ = # of Shares Sold  OfferPrice old
$
)(
1 − Spread%old )
= ( 3,000,000 shares  $16.94/share )( 1 − 0.069 ) = $47,313,420
Find the NEW offer price at the new 4.9% spread that gives the SAME funds:
(
Funds Raised$ = # of Shares Sold  OfferPrice new
$
)(
1 − Spreadnew
%
)
OfferPrice $
=
(
Funds Raised$  1 − Spreadnew
%
) = $47,313,420  ( 1 − 0.049 ) = $16.5837/share
new
# of Shares Sold 3,000,000 shares
Alternatively on a per-share basis:
$
OfferPrice new = OfferPrice old
$

( 1 − Spread ) = 16.94/share  ( 1 − 0.069 ) = $16.5837/share
%
old

( 1 − Spread )
%
new ( 1 − 0.049 )
Peter Kjeld Andersen
Peter Kjeld Andersen
 Starware Software was founded last year to develop software for gaming applications. The founder
initially invested $900,000 and received 11 million shares. Starware now needs to raise a second round of
capital, and it has identified a venture capitalist (“VC”) who is interested in investing. The venture
capitalist will invest $1.4 million and wants to own 18% of the company after the investment is
completed.
Q. How many shares must the VC receive to end up with 18% of the company
A. If the VC is going to own 18% of the firm, this implies that the founder’s 11 million shares will now only
represent the other 100% – 18% = 82%:
$
SharesOwnedFounder ( )
= 1 − StakeBought %VC  TotalSharesOutstanding

11,00,000 shares = ( 1 − 18% )  TotalSharesOutstanding

11,000,000 shares
TotalSharesOutstanding = = 13,414,634.15 shares
82%
So the new number of shares that must be issued to the VC is:
NewSharesIssued = TotalSharesOutstanding − SharesOwnedFounder
$

= 13,414,634.15 shares − 11,000,000 shares = 2,414,634.15 shares

…this is also 18% of the total.

Peter Kjeld Andersen

Q. What is the implied price per share of this funding round?
A. Looking at how much capital the VC provided in exchange for how many shares:
CapitalProvided$VC $1,400,000
Price implied = = = $0.5798/share
NewSharesIssued 2,414,634.15 shares

Q. What will the value of the whole firm be after this investment (i.e. the post-money valuation)?
A. The price paid for 18% of the firm’s equity implies the value of the full 100%:
CapitalProvided$VC = StakeBought %VC  MVEquity → $1,400,000 = 18%  MVEquity
$1,400,000
MVEquity = = $7,777,777.77
18%
Alternatively, we could find the market value of equity using the total number of shares outstanding and the
price per share:
MVEquity = TotalSharesOutstanding  Price implied

= 13,414,634.15 shares  $0.5797/share

= $7,777,777.77

Peter Kjeld Andersen

Peter Kjeld Andersen
 The firm you founded currently has 9 million shares, of which you own 5 million. You are considering an
IPO where you would sell 2 million shares for $22 each.
Q. If all of the shares are sold by way of a primary offering, how much will the firm raise?
A. Because the firm is selling 2 million NEW shares via this primary offering, firm raises $22/share x 2 million =
$44,000,000 of new funding
This example would be the same as if to say “Mark Zuckerberg keeps his existing number of shares, but
Facebook creates more new shares to sell to the public”. A primary offering raises capital for the firm to
spend on projects/etc.

Q. What will your percentage ownership of the firm be after the IPO?
A. The firm has sold 2 million new shares to the public, but you have kept your existing 5 million personal. So
your ownership holding is diluted from 5/9 to:
SharesOwned 5,000,000 shares
StakeOwned% = = = 45.45%
SharesOutstanding 9,000,000 shares + 2,000,000 shares

Peter Kjeld Andersen

 The firm you founded currently has 13 million shares, of which you own 6 million. You are considering an
IPO where you would sell 2 million shares for $29 each.
Q. If all of the shares sold are from your holdings, how much will the firm raise?
A. Because the firm is NOT creating any new shares as this is NOT a primary offering, THE FIRM RAISES
NOTHING.
This example would be the same as if to say “Mark Zuckerberg sells some more of his shares in Facebook to
the public, but Facebook does not sell any new shares”. This type of offering allows the founders (& other
early investors) to cash out through the IPO, but raises no funds for the firm itself.

Q. What will your percentage ownership of the firm be after the IPO?
A. The firm hasn’t sold ANY new shares to the public, but you have sold 2 milllion out of your 6 million personal
shares. So your holding falls from 6/13 to:
SharesOwned 6,000,000 shares − 2,000,000 shares
StakeOwned% = = = 30.77%
SharesOutstanding 13,000,000 shares

Peter Kjeld Andersen

 The firm you founded currently has 14 million shares, of which you own 9.8 million.
Q. What is the maximum number of shares you could sell by way of a secondary offering and still retain
more than 50% ownership of the firm?
A. A secondary offering does NOT mean the firm will create any new shares.
It means that YOU, the founder, will be giving up some more of your existing shares from your holdings.
At the moment you own 9,800,000 shares.
The firm has 14,000,000 shares.
To retain > 50% control, you must own [(14m / 2) + 1] = 7,000,001 shares.
Thus you could sell 9,800,000-7,000,001 = 2,799,999 of your shares
You can’t sell EXACTLY 2,800,000 shares and take your ownership to exactly 7,000,000 shares, because if
someone else bought the OTHER 7,000,000 then both of you would have an equal say and neither of you
would have “CONTROL”.

Peter Kjeld Andersen

Peter Kjeld Andersen
 Live Deliciously is a start-up firm in need of financing. Phillip Black, the founder, finds a Series A venture
capital investor group willing to pay $18 million in order to acquire a 30% stake in the firm.
Q. What was Live Deliciously’s firm value after the Series A financing round?
A. If the $18 million capital provided is worth 30% of the equity in the firm, we can re-arrange to find what that
implies the total value of 100% of the equity is:
CapitalProvided$SeriesA = StakeBought %SeriesA MVEquity → $18,000,000 = 30%  MVEquity
$18,000,000
MVEquity = = $60,000,000
30%

Q. What was Phillip Black’s % stake and dollar value after the Series A financing?
A. Phillip Black owns the rest of the equity value that the Series A VCs don’t own:
%
StakeOwnedFounder = 1 − StakeBought %SeriesA = 100% − 30% = 70%
$
StakeOwnedFounder = StakeOwnedFounder
%
 MVEquity = 70%  $60,000,000 = $42,000,000
This could be found by subtracting the $18,000,000 of VC capital away from $60,000,000 total value of the
equity.

Peter Kjeld Andersen

 Three years after the first round of financing, Live Deliciously received a second Series B round of venture
capital financing. The investors provided $75 million for a 50% stake of the firm.
Q. What was the firm value after the Series B round of financing?
A. As before, the 50% of equity purchased for $75 million implies that 100% is…
CapitalProvided$SeriesB = StakeBought %SeriesB MVEquity → $75,000,000 = 50%  MVEquity
$75,000,000
MVEquity = = $150,000,000
50%
Q. What were Phillip Black’s and the Series A VC investors’ respective stakes after this financing round?
A. Phillip Black & the Series A VCs own 70% and 30% still of the equity left over:
%
StakeOwnedFounder,new = StakeOwnedFounder,pre-2ndVC
%
(
 100% − StakeBought %SeriesB )
= 70%  ( 100% − 50% ) = 35%

(
StakeOwned%SeriesA,new = StakeOwned%SeriesA,pre-2ndVC  100% − StakeBought %SeriesB )
= 30%  ( 100% − 50% ) = 15%

Peter Kjeld Andersen

% OWNERSHIP CONTROL AFTER SECOND ROUND
A
30%
PRE
SERIES B
PB
70%

PREVIOUS
SERIES B
INVESTORS
50%
50%
% OWNERSHIP CONTROL AFTER SECOND ROUND
A
30%
PRE
SERIES B
PB
70%

PHILLIP
BLACK
35%
PREVIOUS
SERIES B
INVESTORS
50%
50%

SERIES A
15%
Q. How much were the stake of Phillip Black’s / Series A investors’ stakes worth?
A. Knowing now their reduced percentages of ownership of the post-2nd round financing equity, we can work
out how much each of their stakes are worth:
$
StakeOwnedFounder = StakeOwnedFounder
%
 MVEquity
PB
= 35%  $150,000,000 = $52,500,000 B PRE
$150m
35%
50% TOTAL
IPO
StakeOwned$SeriesA = StakeOwned%SeriesA  MVEquity A
15%
= 15%  $150,000,000 = $22,500,000
Q. Comment on what you observe about the change in their % ownership control vs the change in the worth
of their investments:
A. Phillip Black & the Series A investors control stake on Live Deliciously have both DECREASED after
2ndRound’s financing, but their wealth has INCREASED.
• Phillip Black’s has stake increased in value from $42m to $52.5m, but his ownership has decreased
from 70% to 35%
• The Series A VCs’ has increased in value from $18m to $22.5m, but their stake has decreased from 30%
to 15%
Peter Kjeld Andersen
 The owners of the firm (Phillip Black, the Series A investors, & the Series B investors) collectively decided
5 years later to undergo an IPO. The IPO was intended to raise $162.5 million of capital by floating 25
million new shares corresponding to 40% of Live Deliciously’s ownership. The issue price was set at
$7.25/share. However, on the first day of trading after the IPO, the firm’s stock closed at $10.25/share.
The underwriting fees were $18.75 million.
Q. What was the IPO spread per share?
A. Divide total underwriting fees by the number of shares issued:
UnderwriterFees $ $18,750,000
Spread =
$
= = $0.75/share
NewSharesIssued 25,000,000 shares
If the question had not told us that the underwriters were taking $18.75 million in total, we could still find
this same answer as the question told us the net capital that the firm needed to raise was $162.5 million:
NetCapitalRaised$
Spread = Price
$ $
Issue −
NewSharesIssued
$162,500,000
= $7.25/share − = $7.25/share − $6.50/share = $0.75/share
25,000,000 shares

Peter Kjeld Andersen

 The owners of the firm (Phillip Black, the Series A investors, & the Series B investors) collectively decided
5 years later to undergo an IPO. The IPO was intended to raise $162.5 million of capital by floating 25
million new shares corresponding to 40% of Live Deliciously’s ownership. The issue price was set at
$7.25/share. However, on the first day of trading after the IPO, the firm’s stock closed at $10.25/share.
The underwriting fees were $18.75 million.
Q. What was the capital amount raised net of underwriting costs from the IPO?
A. The question itself TOLD US that our intent was to raise $162.5 million of capital. But if it didn’t, we could
just subtract any direct cost of issuance (i.e. the underwriter fees) from the total amount that the new
investors paid for the shares:
(
NetCapitalRaised$ = PriceIssue
$
)
 NewSharesIssued − UnderwriterFees $

= ( $7.25/share  25,000,000 shares ) − $18,750,000

= $181,250,000 − $18,750,000
= $162,500,000
$18.75 million of the total capital raised went to finance Live Deliciously’s operations. The total amount of
capital raised was $181.25 million.

Peter Kjeld Andersen

% OWNERSHIP CONTROL AFTER INITIAL PUBLIC OFFERING

PB
35%
B PRE
50%
IPO
A
15%

IPO
INVESTORS
40%

PREVIOUS INVESTORS
60%
% OWNERSHIP CONTROL AFTER INITIAL PUBLIC OFFERING

PB
35%
B PRE
50%
PHILLIP IPO
BLACK A
15%
21%
IPO
INVESTORS
40%
SERIES A
9%

SERIES B
30%
Q. How much was the underpricing per share and total underpricing cost?
A. The underpricing per share was:
$
Underpricingper-share = PriceMarket
$
− Price Issue
$

= $10.25/share − $7.25/share = $3.00/share

TotalUnderpricingCost $ = Underpricingper-share
$
NewSharesIssued
= $3.00/share  25,000,000 shares = $75,000,000
The underwriters underpriced Live Deliciously’ IPO by $3.00 per share, corresponding to a total cost of $75
million. The existing shareholders are worse off by $75,000,000.

Q. How much was total cost of issuance?

A. The total cost of the issuance for Live Deliciously is the sum of the underpricing costs and the underwriters
fees.
TotalFlotationCost $ = TotalUnderpricingCost $ + UnderwriterFees $
= $75,000,000 + $18,750,000 = $93,750,000
In this problem there were no other direct or indirect costs given.

Peter Kjeld Andersen

Q. What was the firm value after IPO?
A. The post-IPO value of the firm’s equity can be found in a similar (but not identical) way to how we found it
after the previous funding rounds.
$
MVNewSharesIssued = StakeBoughtIPO
%
 MVEquity
But instead of considering the $181.25 million of capital provided by the public through the IPO in
determining the current value, we need to consider the CURRENT market price of $10.25/share of those
25,000,000 shares:
(Price $
Market )
 NewSharesIssued = StakeBought IPO
%
MVEquity

( $10.25/share  25,000,000 shares ) = 40% MVEquity

$256,250,000
MVEquity = = $640,625,000
40%

Alternatively, we could have just inferred that the 25 million shares sold under the IPO that equated to 40%
of all shares outstanding must imply that there are 25,000,000/(40%) = 62,500,000 shares outstanding
post-IPO in total at a market price of $10.25/each for a $640,625,000 market value of equity at the close of
trading on the IPO day.

Peter Kjeld Andersen

POST IPO FIRM VALUE CALCULATION

IPO
INVESTORS
40%
BOUGHT
25 MILLION
SHARES

NOW worth
$10.25 each

= $256.25
MILLION
POST IPO FIRM VALUE CALCULATION

IPO
INVESTORS
40%
BOUGHT
25 MILLION
SHARES $640.625 PREVIOUS
INVESTORS
NOW worth MILLION 60%
$10.25 each
TOTAL
= $256.25 $384.375
MILLION MILLION
Q. How much did Phillip Black, the Series A investors, & the Series B investors as a group realize in wealth
loss due to underpricing?
A. If there had been no underpricing, the post-IPO market value would have STILL been the $640,625,000 that
it finished at on the close of trading on the IPO day.
Similarly, the underwriters would have STILL charged their $18,750,000 spread and the firm would have still
received $162,500,000.
 TotalCapitalRaised 
WealthNoUnderpricing = StakeKeptNoUnderpricing
%
 MVEquity =  1 −   MVEquity
 MVEquity 
 $181.25m 
=  1−   $640.625m = 71.7073%  $640.625m = $459.375m
 $640.625m 
As you can see, the pre-IPO parties would have only had to give 28.293% control of the firm in order to raise
that $162,500,000 if there was no underpricing.
( )
Wealthw/Underpricing = StakeKept %w/Underpricing  MVEquity = 1 − StakeSold%w/Underpricing  MVEquity

= ( 1 − 40% )  $640,625,00 = $384,375,000

The pre-IPO parties jointly lost $459.375 million – $384.375 million = $75 million due to the underpricing.

Peter Kjeld Andersen

Q. How much did Phillip Black, the Series A investors, & the Series B investors each realize in wealth loss due
to underpricing?
A. The wealth loss due to underpricing was split among the pre-IPO parties. Each realized losses based on their
original pre-IPO stakes in Live Deliciously:
$
WealthLostFounder = StakeOwnedpre-IPO,
%
Founder  TotalWealthLost

= 35%  $75,000,000 = $26,250,000 PB

35%
$75m
B
50%
PRE
WEALTH
WealthLost $
SeriesA = StakeOwned %
pre-IPO, SeriesA  TotalWealthLost FOREGONE
IPO
A
= 15%  $75,000,000 = $11,250,000 15%

WealthLost $SeriesB = StakeOwnedpre-IPO,

%
SeriesB  TotalWealthLost

= 50%  $75,000,000 = $37,500,000

Note: This is NOT to say that overall the NET experience of the IPO was a negative hit to their wealth. They
all GAINED wealth in total.
i.e. Phillip Black’s wealth has increased from a pre-IPO $52.5m → $134.531m
$
WealthFounder = 21%  $640,625,00 = $134,531,250
This question JUST asks about the wealth FOREGONE from underpricing.
Peter Kjeld Andersen
Q. If there had been no underpricing and the firm now raises the target capital through selling shares at
$10.25 each, how many shares would be sold to the new investors? How many shares would be kept by
the pre-IPO investors?
A. The firm still must raise $181.25 million of capital with the $10.25 shares. Thus:
TotalCapitalRaised$ $181,250,000
NewSharesIssued = $
= = 17,682,927 shares
PriceIssue $10.25/share
As this is a correctly-priced IPO, these 17.7 million shares must only correspond to 28.2927% of the firm’s
ownership (not 40%). Thus the total shares are:
17,682,927 shares = 28.2927%  TotalSharesOutstandingpost-underpiced IPO
17,682,927 shares
TotalSharesOutstandingpost-underpiced IPO = = 62,500,000 shares
28.2927%
This means that the number of shares owned by the pre-IPO investors must be:
SharesOwnedWesker/SeriesA/SeriesB = TotalSharesOutstandingpost-underpiced IPO − NewSharesIssued
= 62,500,000 − 17,682,927 = 44,817,073 shares
These 44.8 million shares would be worth $10.25 each, for a total wealth of 44.8 million x $10.25 =
$459.375 million. This confirms our prior calculations of the pre-IPO investors wealth under the no-
underpricing scenario.
Peter Kjeld Andersen
Q. Alternatively, if there had been no underpricing and this was an issue where pre-IPO investors retain the
same number of shares across both underpriced IPOs & correctly-priced IPOs, what would be the ACTUAL
share price?
A. HINT: The answer is NOT the $10.25 price that the underpriced shares rose to!
First, the question says that when the firm issued the 25 million underpriced shares, that this was 40% of
the firm. Thus the total post-IPO shares must be:
NewSharesIssued = StakeBoughtIPO
%
 TotalSharesOutstandingpost-underpiced IPO
25,000,000 shares = 40%  TotalSharesOutstandingpost-underpiced IPO
25,000,000 shares
TotalSharesOutstandingpost-underpiced IPO = = 62,500,000 shares
40%
This means that the founders / Series A / Series B investors must jointly own:
SharesOwnedWesker/SeriesA/SeriesB = TotalSharesOutstandingpost-underpiced IPO − NewSharesIssued
= 62,500,000 − 25,000,000 = 37,500,000 shares
HOWEVER, they already owned those 37.5m shares PRE-IPO! It is a CONSTANT as this is a PRIMARY OFFERING that doesn’t change the
pre-IPO investors’ shares. The only variable is the number of NEW shares issued to the IPO investors. Giving up only 28.29% control
instead of 40% means that LESS shares will be issued to the new investors than the original 25m issued when it was underpriced. But
the pre-IPO owners STILL jointly own the same 37,500,000 shares as before.

Peter Kjeld Andersen

 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO
INVESTORS
40%

62.5 MILLION
25 million
shares SHARES
issued TOTAL
 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO
INVESTORS
40%

62.5 MILLION
25 million
shares SHARES PB+A+B
issued TOTAL 60%
PB+A+B
72%

STILL
37.5 million # shares for pre-IPO investors
remains constant 37.5 million
shares
Shares!!!
A. So if the pre-IPO investors’ 30 million shares represents 72%, then we can find
The total number of shares after the correctly-priced IPO:
SharesOwnedWesker/SeriesA/SeriesB
TotalSharesOutstandingpost-correctly priced IPO =
StakeKept %Wesker/SeriesA/SeriesB
37,500,000 shares
= = 52,295,918 shares
71.7073%
AND how many new shares were issued to the public in the IPO:
…as a percentage of the total:
NewSharesIssued = StakeBoughtIPO
%
 TotalSharesOutstandingpost-correctly priced IPO
= 28.2927%  52,295,918 shares
= 14,795,918 new shares issued in the IPO
….. OR by subtracting what we know the pre-IPO investors own from the total #:
NewSharesIssued = TotalSharesOutstandingpost-correctly priced IPO − SharesOwnedWesker/SeriesA/SeriesB
= 52,295,918 shares − 37,500,000 shares
= 14,795,918 new shares issued in the IPO

Peter Kjeld Andersen

 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO IPO
INVESTOR INVESTOR
S S
40% 28%
11⅔ million
shares
50 MILLION issued 41⅔ MILLION
20 million
shares SHARES W+A+B SHARES
issued TOTAL 60% TOTAL W+A+B
72%

STILL
30 million # shares for pre-IPO investors
remains constant 30 million
shares
Shares!!!
 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO IPO
INVESTOR INVESTOR
S S
40% 28%
11⅔ million
shares
50 MILLION issued 41⅔ MILLION
20 million
shares SHARES W+A+B SHARES
issued TOTAL 60% TOTAL W+A+B
72%

STILL
30 million # shares for pre-IPO investors
remains constant 30 million
shares
Shares!!!

TotalCapitalRaisedIPO $105 million

Price = = = $9/share
NewSharesIssuedIPO 11.6 million shares
MVEquity $375 million
Price = = = $9/share
TotalSharesOutstandingpost-IPO 41.6 million shares

Wealth$W+A+B $270 million

Price = = = $9/share
SharesOwnedW+A+B 30 million shares
 Umbrella Corp. is a start-up pharmaceutical distributor in need of financing. Wesker, the founder, finds a
Series A venture capital investor group willing to pay $12 million in order to acquire a 25% stake in the
firm.
Q. What was Umbrella’s firm value after the Series A financing round?
A. If the $12 million capital provided is worth 25% of the equity in the firm, we can re-arrange to find what that
implies the total value of 100% of the equity is:
CapitalProvided$SeriesA = StakeBought %SeriesA  MVEquity → $12,000,000 = 25%  MVEquity
$12,000,000
MVEquity = = $48,000,000
25%

Q. What was Wesker’s stake and what was it worth after the Series A financing?
A. Wesker owns the rest of the equity value that the Series A VCs don’t own:
%
StakeOwnedFounder = 1 − StakeBought %SeriesA = 100% − 25% = 75%
$
StakeOwnedFounder = StakeOwnedFounder
%
 MVEquity = 75%  $48,000,000 = $36,000,000
This could be found by subtracting the $12,000,000 of VC capital away from $48,000,000 total value of the
equity.
Peter Kjeld Andersen
 Three years after the first round of financing, Umbrella received a second Series B round of venture
capital financing. The investors provided $36 million for a 40% stake of the firm.
Q. What was the firm value after the Series B round of financing?
A. As before, the 40% of equity purchased for $36 million implies that 100% is…
CapitalProvided$SeriesB = StakeBought %SeriesB  MVEquity → $36,000,000 = 40%  MVEquity
$36,000,000
MVEquity = = $90,000,000
40%
Q. What were Wesker’s and the Series A VC investors’ respective stakes after this financing round?
A. Wesker & the Series A VCs own 75% and 25% still of the equity left over:
%
StakeOwnedFounder,new = StakeOwnedFounder,pre-2ndVC
%
(
 100% − StakeBought %SeriesB )
= 75%  ( 100% − 40% )
= 45%
(
StakeOwned%SeriesA,new = StakeOwned%SeriesA,pre-2ndVC  100% − StakeBought %SeriesB )
= 25%  ( 100% − 40% )
= 15%
Peter Kjeld Andersen
% OWNERSHIP CONTROL AFTER SECOND ROUND
A
25%
PRE
SERIES B
W
75%

SERIES B
40%

PREVIOUS
INVESTORS
60%
% OWNERSHIP CONTROL AFTER SECOND ROUND
A
25%
PRE
SERIES B
W
75%

SERIES B
40% WESKER
45%

PREVIOUS
INVESTORS
60%

SERIES A
15%
Q. How much were the stake of Wesker’s & the Series A investors’ stakes worth?
A. Knowing now their reduced percentages of ownership of the post-2nd round financing equity, we can work
out how much each of their stakes are worth:
$
StakeOwnedFounder = StakeOwnedFounder
%
 MVEquity
= 45%  $90,000,000 = $40,500,000 B W
40% PRE
$90m
TOTAL
45%
StakeOwned$SeriesA = StakeOwned%SeriesA  MVEquity IPO
A
= 15%  $90,000,000 = $13,500,000 15%

Q. Comment on what you observe about the change in their % ownership control vs the change in the worth
of their investments:
A. Wesker & the Series A investors control stake on Umbrella have both DECREASED after 2ndRound’s
financing, but their wealth has INCREASED.
• Wesker’s has stake increased in value from $36m to $40.5m, but his ownership has decreased from
75% to 45%
• The Series A VCs’ has increased in value from $12m to $13.5m, but their stake has decreased from 25%
to 15%
Peter Kjeld Andersen
 The owners of the firm (Wesker, the Series A investors, & the Series B investors) collectively decided 5
years later to undergo an IPO. The IPO was intended to raise $100 million of capital by floating 20 million
new shares corresponding to 40% of Umbrella’ ownership. The issue price was set at $5.25 per share.
However, on the first day of trading after the IPO, the firm’s stock closed at $7.50 per share. The
underwriting fees were $5 million.
Q. What was the IPO spread per share?
A. Divide total underwriting fees by the number of shares issued:
UnderwriterFees $ $5,000,000
Spread =
$
= = $0.25/share
NewSharesIssued 20,000,000 shares
If the question had not told us that the underwriters were taking $5 million in total, we could still find this
same answer as the question told us the net capital that the firm needed to raise was $100 million:
NetCapitalRaised$
Spread = Price
$ $
Issue −
NewSharesIssued
$100,000,000
= $5.25/share − = $5.25/share − $5.00/share = $0.25/share
20,000,000 shares

Peter Kjeld Andersen

 The owners of the firm (Wesker, the Series A investors, & the Series B investors) collectively decided 5
years later to undergo an IPO. The IPO was intended to raise $100 million of capital by floating 20 million
new shares corresponding to 40% of Umbrella’ ownership. The issue price was set at $5.25 per share.
However, on the first day of trading after the IPO, the firm’s stock closed at $7.50 per share. The
underwriting fees were $5 million.
Q. What was the capital amount raised net of underwriting costs from the IPO?
A. The question itself TOLD US that our intent was to raise $100 million of capital. But if it didn’t, we could just
subtract any direct cost of issuance (i.e. the underwriter fees) from the total amount that the new investors
paid for the shares:
(
NetCapitalRaised$ = PriceIssue
$
)
 NewSharesIssued − UnderwriterFees $

= ( $5.25/share  20,000,000 shares ) − $5,000,000

= $100,000,000
$5 million of the total capital raised went to finance Umbrella Technologies’ operations. The total amount of
capital raised was $105 million.

Peter Kjeld Andersen

% OWNERSHIP CONTROL AFTER INITIAL PUBLIC OFFERING

B
W
40% PRE 45%
IPO
A
15%

IPO
INVESTORS PREVIOUS
40% INVESTORS
60%
% OWNERSHIP CONTROL AFTER INITIAL PUBLIC OFFERING

B
W
40% PRE 45%
IPO
A
WESKER 15%
27%
IPO
INVESTORS
40%

SERIES A
9%

SERIES B
24%
Q. How much was the underpricing per share and total underpricing cost?
A. The underpricing per share was:
$
Underpricingper-share = Price Market
$
− Price Issue
$

= $7.50/share − $5.25/share = $2.25/share

TotalUnderpricingCost $ = Underpricingper-share
$
 NewSharesIssued
= $2.25/share  20,000,000 shares = $45,000,000
The underwriters underpriced Umbrella’ IPO by $2.25 per share, corresponding to a total cost of $45 million.
The existing shareholders are worse off by $45,000,000.

Q. How much was total cost of issuance?

A. The total cost of the issuance for Umbrella is the sum of the underpricing costs and the underwriters fees.
TotalFlotationCost $ = TotalUnderpricingCost $ + UnderwriterFees $
= $45,000,000 + $5,000,000 = $50,000,000
In this problem there were no other direct or indirect costs given.

Peter Kjeld Andersen

Q. What was the firm value after IPO?
A. The post-IPO value of the firm’s equity can be found in a similar (but not identical) way to how we found it
after the previous funding rounds.
$
MVNewSharesIssued = StakeBoughtIPO
%
 MVEquity
But note that instead of considering the $105 million of capital provided by the public through the IPO in
determining the current value, we need to consider the CURRENT market price of $7.50/share of those
20,000,000 shares:
(Price $
Market )
 NewSharesIssued = StakeBought IPO
%
 MVEquity

( $7.50/share  20,000,000 shares ) = 40%  MVEquity

$150,000,000
MVEquity = = $375,000,000
40%

Alternatively, we could have just inferred that the 20 million shares sold under the IPO that equated to 40%
of all shares outstanding must imply that there are 20,000,000/(40%) = 50,000,000 shares outstanding
post-IPO in total at a market price of $7.50/each for a $375,000,000 market value of equity at the close of
trading on the IPO day.

Peter Kjeld Andersen

POST IPO FIRM VALUE CALCULATION

IPO
INVESTORS
40%
BOUGHT
20 MILLION
SHARES

NOW worth
$7.50 each

= $150
MILLION
POST IPO FIRM VALUE CALCULATION

IPO
INVESTORS
40%
BOUGHT
20 MILLION
SHARES $375 PREVIOUS
INVESTORS
NOW worth MILLION 60%
$7.50 each
TOTAL
= $150 $225
MILLION MILLION
Q. How much did Wesker, the Series A investors, & the Series B investors as a group realize in wealth loss
due to underpricing?
A. If there had been no underpricing, the post-IPO market value would have STILL been the $375,000,000 that
it finished at on the close of trading on the IPO day.
Similarly, the underwriters would have STILL charged their $5,000,000 spread and the firm would have still
received $100,000,000.
 TotalCapitalRaised 
WealthNoUnderpricing = StakeKeptNoUnderpricing
%
 MVEquity =  1 −   MVEquity
 MVEquity 
 $105,000,000 
=  1−   $375,000,000 = 72%  $375,000,000 = $270,000,000
 $375,000,000 
As you can see, the pre-IPO parties would have only had to give 28% control of the firm in order to raise that
$105,000,000 if there was no underpricing.
( )
Wealthw/Underpricing = StakeKept %w/Underpricing  MVEquity = 1 − StakeSold%w/Underpricing  MVEquity

= ( 1 − 40% )  $375,000,00 = $225,000,000

The pre-IPO parties jointly lost $270 million – $225 million = $45 million due to the underpricing where they
gave up 40% of Umbrella instead of only 28%
Peter Kjeld Andersen
Q. How much did Wesker, the Series A investors, & the Series B investors each realize in wealth loss due to
underpricing?
A. The wealth loss due to underpricing was split among the pre-IPO parties. Each realized losses based on their
original pre-IPO stakes in Umbrella:
$
WealthLostFounder = StakeOwnedpre-IPO,
%
Founder  TotalWealthLost

= 45%  $45,000,000 = $20,250,000 B W

$45m
40% PRE
WEALTH 45%
WealthLost $SeriesA = StakeOwnedpre-IPO,
%
SeriesA  TotalWealthLost
FOREGONE
IPO
A
= 15%  $45,000,000 = $6,750,000 15%

WealthLost $SeriesB = StakeOwnedpre-IPO,

%
SeriesB  TotalWealthLost

= 40%  $45,000,000 = $18,000,000

Note: This is NOT to say that overall the NET experience of the IPO was a negative hit to their wealth. They
all GAINED wealth in total.
i.e. Wesker’s wealth has increased from a pre-IPO $40.5m → $101.25m
$
WealthFounder = 27%  $375,000,00 = $101,250,000
This question JUST asks about the wealth FOREGONE from underpricing.
Peter Kjeld Andersen
Q. If there had been no underpricing and the firm now raises the target capital through selling shares at
$7.50 each, how many shares would be sold to the new investors? How many shares would be kept by the
pre-IPO investors?
A. The firm still needs to raise $105 million of capital with the $7.50 shares. Thus:
TotalCapitalRaised$ $105,000,000
NewSharesIssued = $
= = 14,000,000 shares
PriceIssue $7.50/share
As this is a correctly-priced IPO, these 14 million shares must only correspond to 28% of the firm’s
ownership (and not 40% like before). Thus the total shares are:
14,000,000 shares = 28%  TotalSharesOutstandingpost-underpiced IPO
14,000,000 shares
TotalSharesOutstandingpost-underpiced IPO = = 50,000,000 shares
28%
This means that the number of shares owned by the pre-IPO investors must be:
SharesOwnedWesker/SeriesA/SeriesB = TotalSharesOutstandingpost-underpiced IPO − NewSharesIssued
= 50,000,000 − 14,000,000 = 36,000,000 shares
These 36 million shares would be worth $7.50 each, for a total wealth of 36 million x $7.50 = $270 million.
This confirms our prior calculations of the pre-IPO investors wealth under the no-underpricing scenario.

Peter Kjeld Andersen

Q. Alternatively, if there had been no underpricing and this was an issue where pre-IPO investors retain the
same number of shares across both underpriced IPOs & correctly-priced IPOs, what would be the ACTUAL
share price?
A. HINT: The answer is NOT the $7.50 price that the underpriced shares rose to!
First, the question says that when the firm issued the 20 million underpriced shares, that this was 40% of
the firm. Thus the total post-IPO shares must be:
NewSharesIssued = StakeBoughtIPO
%
 TotalSharesOutstandingpost-underpiced IPO
20,000,000 shares = 40%  TotalSharesOutstandingpost-underpiced IPO
20,000,000 shares
TotalSharesOutstandingpost-underpiced IPO = = 50,000,000 shares
40%
This means that the founders / Series A / Series B investors must jointly own:
SharesOwnedWesker/SeriesA/SeriesB = TotalSharesOutstandingpost-underpiced IPO − NewSharesIssued
= 50,000,000 − 20,000,000 = 30,000,000 shares
HOWEVER, they already owned those 30m shares PRE-IPO! It is a CONSTANT as this is a PRIMARY OFFERING that doesn’t change the
pre-IPO investors’ shares. The only variable is the number of NEW shares issued to the IPO investors. Giving up only 28% control instead
of 40% means that LESS shares will be issued to the new investors than the original 20m issued when it was underpriced. But the pre-
IPO owners STILL jointly own the same 30,000,000 shares as before.

Peter Kjeld Andersen

 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO
INVESTORS
40%

50 MILLION
20 million
shares SHARES
issued TOTAL
 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO
INVESTORS
40%

50 MILLION
20 million
shares SHARES W+A+B
issued TOTAL 60%
W+A+B
72%

STILL
30 million # shares for pre-IPO investors
remains constant 30 million
shares
Shares!!!
A. So if the pre-IPO investors’ 30 million shares represents 72%, then we can find
The total number of shares after the correctly-priced IPO:
SharesOwnedWesker/SeriesA/SeriesB
TotalSharesOutstandingpost-correctly priced IPO =
StakeKept %Wesker/SeriesA/SeriesB
30,000,000 shares
= = 41,666,666.67 shares
72%
AND how many new shares were issued to the public in the IPO:
…as a percentage of the total:
NewSharesIssued = StakeBoughtIPO
%
 TotalSharesOutstandingpost-correctly priced IPO
= 28%  41,666,666.67 shares
= 11,666,666.67 new shares issued in the IPO
….. OR by subtracting what we know the pre-IPO investors own from the total #:
NewSharesIssued = TotalSharesOutstandingpost-correctly priced IPO − SharesOwnedWesker/SeriesA/SeriesB
= 41,666,666.67 shares − 30,000,000 shares
= 11,666,666.67 new shares issued in the IPO

Peter Kjeld Andersen

 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO IPO
INVESTORS INVESTORS
40% 28%
11⅔ million
shares
50 MILLION issued 41⅔ MILLION
20 million
shares SHARES W+A+B SHARES
issued TOTAL 60% TOTAL W+A+B
72%

STILL
30 million # shares for pre-IPO investors
remains constant 30 million
shares
Shares!!!
 UNDERPRICED ISSUE CORRECTLY PRICED ISSUE

IPO IPO
INVESTORS INVESTORS
40% 28%
11⅔ million
shares
50 MILLION issued 41⅔ MILLION
20 million
shares SHARES W+A+B SHARES
issued TOTAL 60% TOTAL W+A+B
72%

STILL
30 million # shares for pre-IPO investors
remains constant 30 million
shares
Shares!!!

TotalCapitalRaisedIPO $105 million

Price = = = $9/share
NewSharesIssuedIPO 11.6 million shares
MVEquity $375 million
Price = = = $9/share
TotalSharesOutstandingpost-IPO 41.6 million shares

Wealth$W+A+B $270 million

Price = = = $9/share
SharesOwnedW+A+B 30 million shares
 John is the founder of Prospects Technologies. Prospects is a high technology firm with great prospects. In
1999, John needed capital to finance growth. SkyHigh Venture Capital was willing to provide John with
$1M for a 35% stake of the firm value. John accepted SkyHigh’s offer.
Q. What was Prospects’ firm value after SkyHigh VC’s financing?
A. If the $1 million capital provided is worth 35% of the equity in the firm, we can re-arrange to find what that
implies the total value of 100% of the equity is:
CapitalProvided$SkyHigh = StakeBought %SkyHigh  MVEquity → $1,000,000 = 35%  MVEquity
$1,000,000
MVEquity = = $2,857,142.86
35%
Q. What was John’s stake and what was it worth after the financing?
A. John owns the rest of the equity value that the SkyHigh VC firm doesn’t own:
%
StakeOwnedFounder = 1 − StakeBought %SkyHigh = 100% − 35% = 65%
$
StakeOwnedFounder = StakeOwnedFounder
%
 MVEquity = 65%  $2,857,142.86 = $1,857,142.86
This could be found by subtracting the $1,000,000 of VC capital away from $2,857,142.86 total value of the
equity.

Peter Kjeld Andersen

 In 2001, only two short years after the first round of financing, Prospects received 2nd round of financing
from 2ndRound VC. 2ndRound provided $3M for a 45% stake of the firm.
Q. What was the firm value after the 2nd round of financing?
A. As before, the 45% of equity purchased for $3 million implies the value of 100%:
$
CapitalProvided2ndVC = StakeBought 2ndVC
%
 MVEquity → $3,000,000 = 45%  MVEquity
$3,000,000
MVEquity = = $6,666,666.67
45%

Q. What were John’s and SkyHigh VC’s stake after this financing round?
A. John and SkyHigh own 65% and 35% still (respectively) of the equity left over:
%
StakeOwnedFounder,new = StakeOwnedFounder,pre-2ndVC
%
(
 100% − StakeBought 2ndVC
%
)
= 65%  ( 100% − 45% ) = 35.75%
(
StakeOwned%SkyHigh,new = StakeOwned%SkyHigh,pre-2ndVC  100% − StakeBought 2ndVC
%
)
= 35%  ( 100% − 45% ) = 19.25%

Peter Kjeld Andersen

Q. How much were the stake of John & SkyHigh VC worth?
A. Knowing now their reduced percentages of ownership of the post-2nd round financing equity, we can work
out how much each of their stakes are worth:
$
StakeOwnedFounder = StakeOwnedFounder
%
 MVEquity
= 35.75%  $6,666,666.67 = $2,383,333.33
StakeOwned$SkyHigh = StakeOwned%SkyHigh  MVEquity
= 19.25%  $6,666,666.67 = $1,283,333.33

Q. Comment on your result:

A. John’s and SkyHigh’s percentage control stake on Prospects have both decreased after 2ndRound’s financing,
but their wealth has increased.
• John’s has stake increased in value from $1,857,142.86 to $2,383,333.33
• SkyHigh VC’s has increased in value from $1,000,000 to $1,283,333.33

Peter Kjeld Andersen

 John, Skyhigh and 2ndRound VC decided in 2003 to undergo an IPO. The IPO was intended to raise $10M
by floating 1M shares corresponding to 1/2 of Prospects’ stake. The issue price was set to be $12 per
share. The underwriting fees were $2M. On the day of the IPO, the stock price closed at $15.
Q. What was the IPO spread per share?
A. Divide total underwriting fees by the number of shares issued:
UnderwriterFees $ $2,000,000
Spread =
$
= = $2/share
NewSharesIssued 1,000,000 shares

Q. What was the capital amount raised net of underwriting costs from the IPO?
A. (
NetCapitalRaised$ = PriceIssue
$
)
 NewSharesIssued − UnderwriterFees $

= ( $12/share  1,000,000 shares ) − $2,000,000 = $10,000,000

$10M of the total capital raised went to finance Prospects Technologies’ operations. The total amount of
capital raised was $12M.

Peter Kjeld Andersen

Q. How much were the underpricing per share and total underpricing cost?
A. The underpricing per share was:
$
Underpricingper-share = PriceMarket
$
− Price Issue
$

= $15/share − $12/share = $3/share

TotalUnderpricingCost $ = Underpricingper-share
$
 NewSharesIssued
= $3/share  1,000,000 shares = $3,000,000
The underwriters underpriced Prospects’ IPO by $3 per share, corresponding to a total cost of $3M. The
existing shareholders are worse off by $3M.

Q. How much was total cost of issuance?

A. The total cost of the issuance for Prospects is the sum of the underpricing costs and the underwriters fees.
TotalFlotationCost $ = TotalUnderpricingCost $ + UnderwriterFees $
= $3,000,000 + $2,000,000 = $5,000,000

In this problem there were no other direct or indirect costs given.

Peter Kjeld Andersen

Q. What was the firm value after IPO?
A. The post-IPO value of the firm’s equity can be found in a similar way to the previous funding rounds.
$
MVNewSharesIssued = StakeBoughtIPO
%
 MVEquity
But note that instead of considering the $12 million of capital provided by the public through the IPO in
determining the current value, we need to consider the current market price of $15/share of those
1,000,000 shares:
(Price $
Market )
 NewSharesIssued = StakeBought IPO
%
 MVEquity

( $15/share  1,000,000 shares ) = 50%  MVEquity

$15,000,000
MVEquity = = $30,000,000
50%

Alternatively, we could have just inferred that the 1 million shares sold under the IPO that equated to 50% of
all shares outstanding must imply that there are 1,000,000/(50%) = 2,000,000 shares outstanding post-IPO
in total at a market price of $15/each for a $30,000,000 market value of equity at the close of trading on
the IPO day.

Peter Kjeld Andersen

Q. How much did John, SkyHigh, and 2ndRound VC as a group realize in wealth loss due to underpricing?
A. If there had been no underpricing, the post-IPO market value would have STILL been the $30,000,000 that it
finished at on the close of trading on the IPO day.
Similarly, the underwriters would have STILL charged their $2,000,000 spread and the firm would have still
received $10,000,000.
 TotalCapitalRaised 
WealthNoUnderpricing = StakeKeptNoUnderpricing
%
 MVEquity =  1 −   MVEquity
 MV
 Equity 
 $12,000,000 
= 1−   $30,000,00 = 60%  $30,000,00 = $18,000,000
 $30,000,000 
As you can see, the pre-IPO parties would have only had to give 40% control of the firm in order to raise that
$12,000,000 if there was no underpricing.
( )
Wealthw/Underpricing = StakeKept %w/Underpricing  MVEquity = 1 − StakeSold%w/Underpricing  MVEquity

= ( 1 − 50% )  $30,000,00 = $15,000,000

The pre-IPO parties have jointly lost $18 million – $15 million = $3 million due to the underpricing where
they gave up 50% of Prospects instead of only 40%

Peter Kjeld Andersen

Q. How much did John, SkyHigh, and 2ndRound VC each realize in wealth loss due to underpricing?
A. The wealth loss due to underpricing was split among the pre-IPO parties. Each shareholder realized losses
based on their original pre-IPO stakes in Prospects:
$
WealthLostFounder = StakeOwnedpre-IPO,
%
Founder  TotalWealthLost

= 35.75%  $3,000,000 = $1,072,500

WealthLost $SkyHigh = StakeOwnedpre-IPO,

%
SkyHigh  TotalWealthLost

= 19.25%  $3,000,000 = $577,500

$
WealthLost 2ndRound = StakeOwnedpre-IPO,
%
2ndRound  TotalWealthLost

= 45%  $3,000,000 = $1,350,000

Note: This is NOT to say that overall the NET experience of the IPO was a negative hit to their wealth. They
all GAINED wealth in total.
i.e. John’s wealth has increased from a pre-IPO $2,383,333.33 → $5,362,500
$
WealthFounder = 35.25%  50%  $30,000,00 = $5,362,500
This question JUST asks about the wealth FOREGONE from underpricing.

Peter Kjeld Andersen

Peter Kjeld Andersen
 Chloe Enterprises’ shares are trading for $57 each and there are currently 18 million shares outstanding. It
would like to raise $115 million. Assume its underwriter charges 5% of gross proceeds.
Q. How many shares must it sell?
A. As always, the firm investors need to pay an amount in total for the shares such that after the 5%
underwriter spread is taken away from it, the firm will be left with the $115 million they need for their
project.
( )
Value $Shares Sold  1 − Spread% = Funds Needed$

Value $Shares Sold  ( 1 − 0.05 ) = $115,000,000

$115,000,000
Value $Shares Sold = = $121,052,631.58
( 1 − 0.05 )
Value $Shares Sold $121,052,631.58
# of Shares Sold = = = 2,123,731 shares
Issue Price $57/share

Peter Kjeld Andersen

 Chloe Enterprises’ shares are trading for $57 each and there are currently 18 million shares outstanding. It
would like to raise $115 million. Assume its underwriter charges 5% of gross proceeds.
Q. If it expects the share price to drop by 1% upon the announcement of the SEO, how many shares should it
plan to sell?
A. The firm still needs to have $121,052,631.58 raised from investors to cover both the 5% underwriter spread
and the $115,000,000 they need for their project.
Now, however, the negative signal that a SEO sends to the market means they will only be able to sell each
share at $57x(1–0.01) = $56.43 each.
So now they need to sell a LARGER number of shares:
Value $Shares Sold $121,052,631.58
# of Shares Sold = = = 2,145,183 shares
Issue Price $56.43/share

Peter Kjeld Andersen

 Chloe Enterprises’ shares are trading for $57 each and there are currently 18 million shares outstanding. It
would like to raise $115 million. Assume its underwriter charges 5% of gross proceeds.
Q. If all of the shares are sold by the way of a primary offering and are sold to new investors, what
percentage reduction in ownership will all of the existing shareholders experience?
A. Making the assumption that we’re working with the answer from part A where the SEO announcement
didn’t cause the price to drop…
The existing investors maintain their 18,000,000 shares owned after the new shares are issued under a
primary offering.
The total number of shares outstanding now is 20,123,731 (the 18,000,000 original shares plus the
2,123,731 new shares).
As a proportion, the existing investors now control 89.45% (18,000,000 out of the 20,123,731 shares).
Compared to their original 100% control, this is a decrease of:
• 100% – 89.45% = 10.55%

Peter Kjeld Andersen

 On 20 January, Sullivan sold 9 million shares in an SEO. The market price of Sullivan at the time was
$42.50 per share. Of the 9 million shares sold, 4 million shares were sold by way of a primary offering, and
the remaining 5 million shares were being sold by the venture capital investors by way of a secondary
offering. Assume the underwriter charges 5.5% of the gross proceeds as an underwriting fees.
Q. How much money did Sullivan raise?
A. The firm would now have the following new funds available for operations:
( ) (
FundsRaised$Sullivan = NewSharesIssued  OfferPrice $  1 − Spread% )
= ( 4,000,000 shares  $42.50/share )  ( 1 − 0.055 )
= $170,000,000  0.945 = $160,650,000

Q. How much money did the venture capitalists receive?

A. The VC firm would have cashed out 5,000,000 shares of their investment for:
( ) (
FundsReceived$VC = SharesSold  OfferPrice $  1 − Spread % )
= ( 5,000,000 shares  $42.50/share )  ( 1 − 0.055 ) = $200,812,500

Peter Kjeld Andersen

 On 20 January, Sullivan sold 9 million shares in an SEO. The market price of Sullivan at the time was
$42.50 per share. Of the 9 million shares sold, 4 million shares were sold by way of a primary offering, and
the remaining 5 million shares were being sold by the venture capital investors by way of a secondary
offering. Assume the underwriter charges 5.5% of the gross proceeds as an underwriting fees.
Q. If the share price dropped 3.2% on the announcement of the SEO and the new shares were sold at that
price, how much money would Sullivan receive?
A. The announcement of the SEO sends a negative signal to the market about the firm’s future prospects (i.e.
see Pecking-Order Theory & Signalling Theory).
Thus Sullvian will only be able to issue new shares at:
NewPrice $ = MarketPricePre-Announce
$
( )
 1 − PriceDrop % = $42.50/share  ( 1 − 0.032 ) = $41.14/share
So for the 4,000,000 new shares being sold, the firm will raise for operations:
( ) (
FundsRaised$Sullivan = NewSharesIssued  NewPrice $  1 − Spread% )
= ( 4,000,000 shares  $41.14/share )  ( 1 − 0.055 ) = $155,509,200
This could also have been found by taking 3.2% directly off of the $160,650,000 that the firm would have
raised if the price had not fallen (see previous slide).

Peter Kjeld Andersen

THE END

Peter Kjeld Andersen