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Corporate Finance

Week 7~9
How Corporations
Issue Securities

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Topics Covered
Venture Capital
The Initial Public Offering
Other New-Issue Procedures
Security Sales by Public Companies
– Rights Issue
Private Placements and Public Issues

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Venture Capital
Venture capital: money invested ( )
Steps to obtaining venture funding:
Prepare a business
plan

Receive first-stage
financing

Receive subsequent
staged financing

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Venture Capital

Venture Capital

– Success of new firm dependent on managers

– Restrictions placed on management by venture
capital company
– Funds usually dispersed in stages after certain
level of success

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Venture Capital
First Stage Market Value Balance Sheet ($mil)
Assets Liabilities and Equity
Cash from new equity 1.0 New equity from venture capital 1.0
Other assets 1.0 Your original equity 1.0
Value 2.0 Value 2.0

 3 entrepreneurs had purchased 1mil. shares in the

new company  ( ) stage investment
 A venture capitalist agreed to buy 1mil. new shares
for $1 each
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Venture Capital
Second Stage Market Value Balance Sheet ($mil)
Assets Liabilitie s and Equity
Cash from new equity 4.0 New equity from 2nd stage 4.0
Fixed assets 1.0 Equity from 1st stage 5.0
Other assets 9.0 Your original equity 5.0
Value 14.0 Value 14.0

 Venture capitalists rarely give a young company up

front all the money it will need
 at each stage they give enough to reach the
( ) Founders
noted an
 Second- stage financing was $4 mil additional $4
mil. paper gain 6- 6
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Venture Capital
 Third-stage mezzanine financing : Full-scale
production began on schedule loans
– ( ) of debt and equity financing that is typically
used to finance the expansion of existing companies
– Mezzanine financing is basically debt capital that gives the
( ) the rights to convert to an ( ) or
( ) interest in the company if the loan is not paid
back in time and in full.
– Since mezzanine financing is usually provided to the
borrower very quickly with little ( ) on the part
of the lender and little or no ( ) on the part of the
borrower, this type of financing is aggressively priced with
the lender seeking a return in the 20-30% range. Then,
 Go public 6- 7
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Venture Capital
 Most new companies rely initially on family funds and
bank loans
– Some of them continue to grow with the aid of
equity investment provided by wealthy individuals,
( )

 However, many companies raise capital from specialist

venture-capital firms
– In addition, some large technology firms act as
corporate venturers by providing equity capital to
new innovative ones
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U.S. Venture Capital Investments

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Initial Public Offering

Primary offering : ( ) are sold to raise
additional cash for the company

Secondary offering: the ( ) decide to

cash in by selling part of their holdings
– Secondary offerings are not confined to small,
immature companies
– The biggest secondary offerings occur when
governments sell their shareholdings in companies
– 2006 IPO of China’ ICBC raised US$21.9 billion in
the world’s largest IPO
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Motives for an IPO

Percent of CFOs who strongly agree with the reason for an IPO

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Initial Public Offering

 Initial Public Offering (IPO) : ( )
offering of stock to the general public

 Underwriter : triple role

– 1) providing the company with (
), then
– 2) ( ), and
– 3) ( ) it to the public
– Spread: difference b/w public ( ) and
( ) underwriter

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Initial Public Offering

 Registration statement (for approval of the SEC)
: : presenting information about the proposed financing
and the firm’s history, existing business, and plans for
the future (유가증권 발행 신고서)
– Prospectus (red herring): formal summary that
provides information on the issue of security
(발행취지서, 사업설명서)

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The Top Managing Underwriters

Value of Issues
Underwriter ($billion) Number of issues
J.P.Morgan $455 1210
Barclays Capital 401 1041
Citi 309 986
Deutsche Bank 309 807
Merrill Lynch 241 852
Goldman Sachs 228 584
Morgan Stanley 220 661
RBS 214 712
Credit Suisse 205 682
UBS 204 867
Notes: as of 2008, values includes global debt and equity issues
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Initial Public Offering

 Underwriting Spread: the difference between the
public offer price and the price paid by
underwriter
– allowed to buy the shares for ( ) the
offering price at which the shares were sold to
investors
– Since many of costs incurred by underwriters
are ( ), % spread would decline with (
)
– Empirical evidence: clustering at 7% (IPO b/w
$20 and $80 million)
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Underwriting Arrangements
 Firm Commitment - Underwriters buy the
securities from the firm and then ( ) to
the public
 Best Efforts Commitment - Underwriters agree to
sell as much of the issue as possible but do (
) the sale of the ( ) issue
 Flotation Costs - The costs incurred when a firm
issues ( )
– What are some of the specific costs incurred
when a firm issues new securities?

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Exercise I
Example
How much will a firm receive in net funding from a
firm commitment underwriting of 250,000 shares
priced to the public at $40 if a 10% underwriting
spread has been added to the price paid by the
underwriter? Additionally, the firm pays $600,000 in
legal fees.

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Underwriting Spreads (2014)

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Underpricing of an IPO
 Underpricing : Issuing securities at an offering price
set below ( ) of the security (저가발행)
– Underpricing costs are ( ) but nevertheless
real
– Very difficult to judge how much investors will be
prepared to pay for the stock
– 2006 McDonal’s IPO – 7.9 mil shares at a price of
$22 each  opened at $39.51 and rose to a first-day
high of 48.28 before closing at $44, a 100 percent
gain!
– http://dealbook.nytimes.com/2011/05/27/why-i-p-o-s-get-
underpriced/?_php=true&_type=blogs&_r=0# 6-20
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Underpricing of an IPO
 Reasons for Underpricing
– Counteracting the ( )
– Reducing the ( ) of underwriters
– Enhancing the firm’s ability to raise further
capital

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Exercise II
Example
Assume the issuer incurs $1 million in other
expenses to sell 3 million shares at $40 each to an
underwriter and the underwriter sells the shares at
$43 each. By the end of the first day’s trading, the
issuing company’s stock price had risen to $70.
What is the total cost of underpricing?

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Average Initial IPO Returns

Denmark
Canada
Netherlands
Spain
Turkey
France
Australia
Norway
Hong Kong
UK
USA
Italy
Japan
Singapore 256 %
Sweden
Taiwan
Germany
Switzerland
Korea
Brazil
India
0 20 40 60 80 100
China
return (percent)
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Initial Offering
Average Expenses on 1767 IPOs from 1990-1994
Value of Issues Direct Avg First Day Total
($mil) Costs (%) Return (%) Costs (%)
2 - 9.99 16.96 16.36 25.16
10 - 19.99 11.63 9.65 18.15
20 - 39.99 9.7 12.48 18.18
40 - 59.99 8.72 13.65 17.95
60 - 79.99 8.2 11.31 16.35
80 - 99.99 7.91 8.91 14.14
100 - 199.99 7.06 7.16 12.78
200 - 499.99 6.53 5.70 11.10
500 and up 5.72 7.53 10.36
All Issues 11.00 12.05 18.69
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IPO Proceeds

IPO Proceeds and First Day Returns

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 Alternative Issue Procedures for 1- 27

IPOs
 Bookbuilding method :
– Similar to an auction, but indications are not
binding
– Advantage: underwriters can give preference to
those investors whose bids are most helpful in
setting the issue price and to offer them a reward
in the shape of underpricing
– Disadvantage: dangers of allowing the
underwriter to decide who is allotted stock

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 Alternative Issue Procedures for 1- 28

IPOs
Auction: investors are invited to submit their bids,
stating how many securities they wish to buy and the
price
– Common in selling of Government bonds, but rare
in case of common stocks (Google)
– Level of underpricing decrease
 Example: a gov’t wishes to auction four million bonds
and three would-be buyers submit bids
– Investor A bids $1020 for one million bonds, B bids
$1000 for three million bonds, and C bids $980 for
two million bonds
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 Alternative Issue Procedures for 1- 29

IPOs
Auction:
Example (cont’d)
– The bids of the two highest bidders absorb all the
bonds on offer and C is left empty-handed. What
price do the winning bidders pay?
In a discriminatory auction, (
)
In a uniform auction, ( )

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 Alternative Issue Procedures for 1- 30

IPOs
 Auction:
 Discriminatory vs. uniform-price auction
– The first: pay the price they bid
– The latter: pay the lowest winning price
– Uniform-price auction  reduce winner’s curse
problem

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Security Sales by Public Companies

 General cash offers (일반공모): Sale of securities
open to all investors by an already public company
– Similar procedure of an IPO
– Shelf registration: a procedure that allows firms
to file one registration statement for several issues
of the same security (일괄 등록)
– Costs: administrative costs, underwriters’ spread
 Spread for debt securities < spread for common stock
 Larger issues tend to have lower spreads
– Better known and easier for underwriters to
monitor larger companies
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Underwriting Spreads

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Total Direct Costs of Raising Capital

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Security Sales by Public Companies

 Market Reaction to Stock Issues: : announcement
of seasoned issues of common stock results in a fall
in the stock price
– Price is simply depressed by the prospect of the
additional supply?
– Information the issue provides:
– CFO optimistic: selling common stock  favor (
) investor at the expense ( ) shareholders
– Price overvalued: selling common stock  favor (
) shareholders at the expense of ( ) ones

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Security Sales by Public Companies

 Rights Issue (주주배정): Issue of securities
offered only to ( ) stockholders.
 Example – BNP Paribas Bank needs to raise €5.50
billion of new equity. The market price is
€77.40/sh. Lafarge decides to raise additional funds
via a 1 for 10 rights offer at €65.40 per share. If
we assume 100% subscription, what is the value of
a right?

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Rights Issue
 Example - BNP Paribas Bank needs to raise €5.50 billion of
new equity. The market price is €77.40/sh. Lafarge decides
to raise additional funds via a 1 for 10 rights offer at €65.40
per share. If we assume 100% subscription, what is the
value of each right?

Current Market Value = 10 x €77.40 = €774.00

Total Shares = 10 + 1 = 11
Amount of funds = 774 + 65.40 = €839.40
New Share Price = (839.40) / 11 = €76.31
Value of a Right = 76.31 – 65.40 = €10.91
= diff. b/w new share price and offered price
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Exercise III
Example - BNP Paribas Bank needs to raise
€5.50 billion of new equity. The market price is
€77.40/sh. Instead of offering 1-for-10 at €65.40,
Lafarge could have sold twice as many shares at
half the price. If we assume 100% subscription,
what is the value of a right?

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Exercise IV
 Slightly More Difficult Example
Lafarge Corp needs to raise €1.28billion of new
equity. The market price is €60/sh. Lafarge
decides to raise additional funds via a 4 for 17
rights offer at €41 per share. If we assume 100%
subscription, what is the value of a right?

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Exercise V
RBS Case
– In 2007, many famous banks lost huge amount
of money due to subprime mortgage
investment. RBS was one of those banks who
suffered loss.
– RBS decided to raise additional funds via a 11
for 18 rights offer at £2 per share.
– Initially, the bank had 10 bil. shares of
outstanding and the market price was £3.725.
– What is the new share price of RBS?

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Bonus Issue
Case 1: On April 1, 2011, Korea Semiconductor
System's stock price surged in the KOSDAQ market.
The stock rose 4.71% (470 KRW) from the previous
day to 10,450 KRW. On the same day, Korea
Semiconductor announced that it has decided to
issue a bonus stock of 0.5 shares per share.
Case 2: Yuhan Corporation has been offering a
bonus issues almost every year since it’s listing in
1962 except during the Asian Financial Crisis.
What is the effect of bonus issue on a firm
value and its stock price? Why?
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Bonus Issue
An offer of free additional shares to existing
shareholders
– A company may decide to distribute further
shares as an alternative to increasing the dividend
payout
– Also known as a "scrip issue" or "capitalization
issue”: no increase in the firm’s capital, only a
transfer from capital surplus/earned surplus
reserve to common stock share
– New shares are issued to shareholders in
proportion to their holdings. For example, the
company may give one bonus share for every five
shares held. 6-44
 Bonus Issue (cont’d)
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An offer of free additional shares to existing

shareholders
– In case of a bonus issue, the share price of the
company falls in the same proportion as the bonus
shares issued. So, in a 1:1 bonus issue, the share
price will fall by 50%. Other metrics, such as
earnings per share (EPS), will also go down.
– However, over the long term, and as stock price
increases, investors tend to gain. There is no tax on
allotment of bonus shares.
– Bonus issues are generally an indicator of a
company’s good health and show that its earnings
would rise over the next years. 6-45
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Security Sales by Public Companies

 Seasoned Offering - Sale of securities by a
firm that is ( )

 General Cash Offer - Sale of securities open

to ( ) by an already public
company

 Shelf Registration - A procedure that allows

firms to file one registration statement for
several issues of the same security

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Public Issues
Private Placement - Sale of securities to a (
) number of investors without a
public offering.

Qualified Institutional Buyer – Entity

entitled under SEC Rule 144A to purchase
and trade private placements.

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