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Raising capital

Chapter 15

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

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Chapter outline
The financing life cycle of a firm: Earlystage 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

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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
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

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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

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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?
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

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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.
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

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Issue methods
Public issueInitial public offering (IPO)
General cash offer = offered to general
public
Usually open for six to eight weeks
Only cash offers

Private issueRights 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

15-8

Total equity raised and bank


lending
19992008 (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

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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

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Underwriters
Services provided by underwriters:
Formulate method used to issue
securities
Price securities
Sell securities

Syndicategroup of investment
bankers (underwriters) that market
securities and share the risk
associated with 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

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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.
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

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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

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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

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Average first-day returns


Figure 15.1
Average first-day returns by month for ASX initial
public offerings: February 1993December 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

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Number of offerings by
month
Figure
15.2
Number of offerings by month for ASX-listed initial
public offerings: February 1993December 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

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IPO underpricing
reasons
Underwriters want offerings to sell
out
Reputation for successful IPOs is critical
Underpricing = insurance for
underwriters
Oversubscription and allotment
Winners 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

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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

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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

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Types of long-term
debt
Bonds/Debenturespublic issue of longterm debt
Private issues
Term loans
Direct business loans from commercial banks,
insurance companies, etc.
Maturities 15 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

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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

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Chapter 15
END

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