RAISING EQUITY

CAPITAL
Outline
 Equity Financing for Private Companies
 Securities and Valuation
 Pre money valuation vs Post money valuation
 Initial Public Offering
 Process of IPO
 Valuing an IPO
 Seasoned Equity Offering
Equity Financing for Private Companies

 When a private companies decides to raise outside

equity capital, it can seek funding from several
potential sources:
 Source of funding:

1) Angel Investors
2) Venture Capital Firms
3) Institutional Investors
4) Corporate Investors
Equity Financing for Private Companies

 Angel investors
Individual investors who buy equity in small private firm
 Venture Capital Firms

A limited partnership that specializes in raising money to

invest in the private equity of young firms
 Institutional Investors

Such as pension funds, insurance companies, endowments

and foundations. They manage large amount of money thus
also an active investors in private companies.
 Corporate Investors

Corporation that invests in private companies.

Securities and Valuation
 Preferred Stock
Issued by matured companies and usually has preferential dividend
and seniority in any liquidation. Most does not have voting right but
sometimes it does have special voting rights.
 Convertible Preferred Stock

A preferred stock that gives the owner an option to convert it into

common stock on some future date.
 Common stock

Represents shares of ownership in a corporation and confer voting

rights. Dividend are decided by the BOD based on the company
performance. They are last in line for the company's assets in
liquidation.
Securities and Valuation
 Pre-money valuation
The value of a firm’s prior shares outstanding at the price in
the funding round / prior to any investment @ financing

 Post money valuation

The value of the whole firm (old plus new share) at the price
at which the new equity is sold.

Post money valuation = Pre-money valuation + Amount

invested
Securities valuation
You founded your own company two years ago. Initially you
contributed $100,000 of your own money and in return received
1.5 million shares of stock. Since then, you have sold an
additional 500,000 shares to angel investors. Now you are
considering raising even more capital from a venture capitalist
(VC). This VC would invest $6 million and would received 3
million newly issued shares.
1. Calculate the post money valuation.
2. Calculate the percentage of the firm the VC end up owning.
3. Calculate the percentage of the firm will you own.
4. Calculate the final value of your share.
Securities valuation
After this funding, there will be a total of 5 million
shares outstanding:

Your shares 1,500,000

Angel investors' shares 500,000
Newly issued shares (VC) 3,000,000
Total 5,000,000
Securities valuation
1. Calculate the post money valuation.

The VC would be paying $6,000,000 / 3,000,000 shares = $2 per

share.

Post money valuation will be the total number of shares

outstanding multiplied by the price paid by VC.

Post money valuation:

5,000,000 x $2 = $10,000,000 (Pre-money valuation $4,000,000 +
Amount invested $6,000,000)
 Pre money valuation?

Post money valuation - Amount invested

= Pre-money valuation
$10,000,000 - $6,000,000 = $4,000,000
Securities valuation
2. Calculate the percentage of the firm, that the VC
end up owning.

VC will end up owning:

: 3,000,000 (share owned by VC) x 100 = 60%
5,000,000 (total shares outstanding)
Securities valuation
3. Calculate the percentage of the firm that you will
own.
1,500,000 (share owned by you) x 100 = 30%
5,000,000 (total shares outstanding)

4. Calculate is the value of your share.

Post money valuation of your share:
1,500,000 shares x $2 = $ 3,000,000.
Initial Public Offering
 The process of selling stock to the public for first
time.

Advantages: Disadvantages:
•Greater liquidity •Loss of control
•Better access to •Stringent financial
capital disclosure,
•Ability to diversify accountability and
requirement for public
companies
Initial Public Offering

 Primary Offering
New shares available in a public offering that raise new capital
 Secondary Offering

Equity offering of shares sold by existing shareholders

 Underwriter

Investment banking firm that manages a security issuance and

designs its structure
 Syndicate

Group of underwriters who jointly underwrite and distribute

security issuance
Process of IPO
 Preliminary prospectus (red herring)
Part of registration statement prepared by a company prior to an IPO that is
circulated to investors before the stock is offered.
 Final prospectus

Part of final registration statement prepared by a company prior to an IPO that

contains all the details of the offering, including number of shares offered and
the offer price.
 Road show

When a company senior management and its lead underwriter travel to

promote the company to underwriters’ largest customer (institutional investor)
 Book building

Process used by underwriters for coming up with an offer price based on

customers’ expression of interest.
Valuing an IPO

 Wagner Inc is a private companies that designs,

manufactures and distributes branded consumer product.
During it most recent fiscal year, Wagner had revenues of
$325 million and earnings of $15 million. Wagner has
filed a registration statement with the SEC for its IPO.
Before the stock is offered, Wagner’s investment banker
would like to estimate the value of the company using
comparable companies. The investment banker has
gathered the following information based on data of
companies in same industry that recently gone public. In
each case, the ratios are based on the IPO price.
Valuing an IPO

Company Price / Earnings Price / Revenues

Ray Products Corp 18.8 x 1.2 x
Byce-Frasier Inc 19.5 x 0.9 x
Fashion Industries 24.1 x 0.8 x
Group
Recreation Int 22.4 x 0.7 x
Average 21.2 x 0.9 x

After the IPO, Wagner will have 20 million shares

outstanding. Estimate the IPO price for Wagner using
the Price / Earnings Ratio and Price / Revenues ratio.
Valuing an IPO - Solution
 IPO price based on the Price / Earnings Ratio

Average P/E ratio for recent deals is 21.2 x

Based on earning of $15 million, the total market value
of Wagner’s stock will be $15 million x 21.2 = $318
million.
With 20 million shares outstanding, the IPO price per
share should be $318 million / 20 million shares =
$15.90 / share.
Valuing an IPO - Solution
 IPO price based on Price / Revenues ratio.

Average P/R ratio for recent deals is 0.9 x

Using Wagner’s revenue of $325 million, total market
value of Wagner’s stock will be $325 million x 0.9 =
$292.5 million.
The IPO price per share should be $292.5 million / 20
million shares = $14.63 / share.
 IPO Methods

• Agreement between underwriter and issuing

Firm Commitments firm in which the underwriter guarantees that it
will sell all of the stock at the offer price.

• For smaller IPOs, Underwriter does not

guarantee that the stock will be sold, but makes
Best-efforts Basis its ‘best effort’ to sell the issue to investors at an
agreed price.

• An online method for selling new issues directly

Auction IPO to the public that lets the market determine the
price through bids from potential investors.
Seasoned Equity Offering
 When a public company returns to the equity
markets and offers new shares for sales.
 This is because a firm’s need for outside capital
rarely end at the IPO.
 Usually, profitable growth opportunities occur
throughout the life of the firm, and in some cases it
is not feasible to finance this opportunities out of
retained earnings.
Types of Seasoned Equity Offering

Cash Offer Rights Offer

• Firms offer the • Firms offer the

new shares to new shares only
investors at large. to existing
shareholders.
• Protect existing
shareholders from
underpricing.
SEO – Cash Offer
 Supposed a company holds $100 in cash as its sole
asset and has 50 shares outstanding. Each share is
therefore worth $2.
 The company announce a cash offer for 50 shares at $1
per shares.
 Once the offer is complete, the company will have
$150 in cash and 100 shares outstanding.
 Price per share is now $1.50 (as the new shares were
sold at discount). New shareholder received $0.50
windfall at the expense of old shareholder.
SEO – Rights Offer
 Instead of cash offer, the same company make an
announcement for a rights offer.
 Every shareholder receive rights to purchase additional
share @ $1 per share.
 Once the rights offer is complete, the company will
also have $150 in cash and 100 shares outstanding,
with price per share is now $1.50.
 However, the $0.50 windfall accrues to the existing
shareholders.
 By using a rights offer, firm can continue to issue
equity without imposing a loss on current shareholders.
SEO – Rights Offer (Problem)
 You are the CFO of a company that has market
capitalization of $1 billion. The firm has 100 million shares
outstanding, so the shares are at $10 per share. You need to
raise $200 million and have announced a rights issue. Each
existing shareholder is sent one right for every share he or
she owns. You have not decided how many rights you will
require to purchase a new stock.
 You have the following choices:
i. Four rights to purchase one share at a price of $8/ share
ii. Five rights to purchase two shares at a price of $5/ share

Which approach will raise more money?

SEO – Rights Offer (Solution)
 Four rights case:
100 million shares / 4 rights = 25 million new shares
25 million new shares x $8.00/share = $200 million

Value of firm after issue: $1.2 billion

Share outstanding after issue: 125 million
Price per share after issue: $1.2 billion / 125 million = $9.60 per share.

Since the price exceeds the issue price of $8.00/share, shareholder will
exercise their rights. It will yield profit of ($9.60 - $8.00 = $1.60 /4 =
$0.40 per right).

Total value per share to each shareholder is $9.60 + $0.40 = $10 per
share.
SEO – Rights Offer (Solution)
 Five rights case:
(100 million shares / 5 rights) x 2 = 40 million new shares
40 million new shares x $5.00/share = $200 million

Value of firm after issue: $1.2 billion

Share outstanding after issue: 140 million
Price per share after issue: $1.2 billion / 140 million = $8.57 per share.

Since the price also exceeds the issue price of $5.00/share, shareholder
will exercise their rights. It will yield profit of [($8.57 - $5.00)/5)x2 ]
= $1.428 per right).

Total value per share to each shareholder is $8.57 + $1.428 = $10 per
share.
SEO – Rights Offer (Solution)
 In both case the same amount of money is raised
and shareholders are equally well off.