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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 to finance a new firm

Since success of a new firm is highly dependent on the effort of the managers, restrictions are placed on management by the venture capital company and funds are usually dispersed in stages, after a certain level of success is achieved.

Eight Stages of Venture Development and Financing (Please refer to the table distributed)
Stage 1 : Seed Financing efforts to formulate a vision based on the original concept. Financing provided by bootstraps & angels Stage 2 : Start Up this stage ensues only if the results of stage 1 is promising. A proper management team looks at a more detail business plan. Product developed, prototype tested and marketing potential is tested.

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Eight Stages of Venture Development and Financing Stage 3 : Early Development risk is greatly reduced, the firm secures initial property, plant and equipment(PP&E). Products or services are shipped in commercial quantities. Usually Angels will cash-out at this stage, and replaced by VC firm or even a bank (usually with government guarantee).

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Eight Stages of Venture Development and Financing Stage 4: Expansion firm accumulates experience in the market, though success is still questionable. Usually losses money on operations and requires additional financing for PP&E. Usually financed by VC and Banks Stage 5: Profitable but cash-poor The downside risk is substantially eliminated, retain earnings starts to become source of financing, besides VC and banks

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Eight Stages of Venture Development and Financing Stage 6: Rapid growth towards liquidity point. Stable and low risk. The potential of debt financing increases. Stage 7: Bridge Stage ( Mezzanine Financing) it is the final growth and preparation stage before the harvest takes place. The harvest alternative is already decided at this stage and all activities are tailored towards the harvest stage.

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Eight Stages of Venture Development and Financing Stage 8: Harvest Stage cashing-out and exit of short-term investors. The alternatives involves remaining private with long-term investors; being acquired; or go public (IPO).
What is the difference between VC firm and a Bank?
Equity shares (VC) and Debt (Banks) Early stage financing (VC) and stable stage (Banks) Involved in management (VC) Less regulated (VC)

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Initial Offering
Initial Public Offering (IPO) - First offering of stock to the general public. Underwriter - Firm that buys an issue of securities from a company and resells it to the public. Spread - Difference between public offer price and price paid by underwriter. Prospectus - Formal summary that provides information on an issue of securities. Underpricing - Issuing securities at an offering price set below the true value of the security.

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Motives For An IPO

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

To create public shares for use in future acquisitions To establish a market price/value for our firm To enhance the reputation of our company To broaden the base of ownership To allow one or more principals to diversify personal holdings To minimize our cost of capital 51.2 49.1 45.9 44.1 42.5 32.2 29.8 27.6 14.3 0 10 20 30 40 50

59.4

To allow venture capitalists to cash out

To attract analysts' attention Our company has run out of private equity Debt is becoming too expensive

60

70

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The Top Managing Underwriters

Underwriter Citigroup J.P. Morgan Deutsche Bank Morgan Stanley Lehman Brothers

Value of Issues ($billion) 667 506 475 455 477

Number of issues 1966 1738 1444 1419 1306

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Average Initial IPO Returns

Denmark Canada Netherlands Spain Turkey France Australia Norway Hong Kong UK USA Italy Japan Singapore Sweden Taiwan Germany Switzerland Korea Brazil India China

256 %

20

40

60

80

100

return (percent)

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Initial Offering
Average Expenses on 1767 IPOs from 1990-1994
Value of Issues ($mil) 2 - 9.99 10 - 19.99 20 - 39.99 40 - 59.99 60 - 79.99 80 - 99.99 100 - 199.99 200 - 499.99 500 and up All Issues Direct Avg First Day Costs (%) 16.96 11.63 9.7 8.72 8.2 7.91 7.06 6.53 5.72 11.00 16.36 9.65 12.48 13.65 11.31 8.91 7.16 5.70 7.53 12.05 Total 25 . 16 18. 15 18. 18 17.95 16.35 14. 14 12.78 11 . 10 10.36 18.69 Return (%) Costs (%)

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General Cash Offers

Seasoned Offering - Sale of securities by a firm that is already publicly traded. General Cash Offer - Sale of securities open to all investors by an already public company. Shelf Registration - A procedure that allows firms to file one registration statement for several issues of the same security. Private Placement - Sale of securities to a limited number of investors without a public offering.

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Underwriting Spreads (2006)

Type Common Stock: IPO IPO IPO IPO Company Mastercard Golfsmith International Luna Innovators Verigy Issue Amount ($ millions) 2,399 29 21 128 Underwriter's spread 4.70% 7.00% 7.00% 7.00%

Seasoned Seasoned Seasoned Seasoned Seasoned Debt (cupon rate, type, maturity) : 5.37% floating rate notes, 2009 5.75% debentures, 2036 5.2% senior global notes, 2011 7% senior notes, 2016 5% senior convertible notes, 2013

Nasdaq Stock Market Parker Drilling KFX, Inc. Walter Industries Natural Gas Services Group

556 101 131 149 50

4.00% 1.06% 4.00% 1.28% 5.77%

Honeywell International Boston Edison Home Depot Navigators Group BioMartin Pharma

300 200 1,000 125 125

0.25% 0.88% 0.35% 0.65% 3.00%

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IPOs
Benefits of going public:
- Reduce risk through diversification - Increase liquidity of the stocks - Lower costs of capital - Reduces debt Dilute voting power and the influence of preIPO shareholders

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IPOs
Costs of going public:
- Underpricing - Issuance costs (about 5-10%) -Loss of Control - Agency costs of managerial distress - Information asymmetry - Performance pressures -Distractions

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IPO Process
Choice of underwriter is based on:
- Size - Reputation - Specialization - After-market support - On going commitment - Costs (includes fees for service, greenshoe option and valuable warrants)

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Why are IPOs Underpriced?

Litigation Risk The Winners Curse Signaling Models
Is Underpricing related to the Firms stated use of the Proceeds of the IPO? -General corporate purposes or working capital - debt retirement or stock repurchase Unit IPOS? it consists of share of stock and one or more warrants that give the investor the right to purchase additional shares at a later date at a specified price.

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Unit IPOs
Rationale:
Unit IPOs mitigate the principal-agent problem in the sense that if the firm receives more proceeds than it needs in a normal IPO the management will squander the excess. In unit IPO, the management only gets what it needs with a promise that they can raise new funds later via the warrants. It is an effective signal of firms value under conditions of severe information asymmetry. This relates to different private valuations of the value of underlying warrants to the shares of the company. The insiders will assign lower private value (less costly) of the warrants of the firm that has higher risk and higher expected cash flows.

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Private Placement
It is a seasoned equity offering (SEO) that is an additional issuance of shares by publicly traded firm. Whereas IPO is an unseasoned equity. Rationale: When a firm has fixed its capital expenditure program and its debt equity structure to finance these investments, and internal funds are insufficient to support the investment program Then the firm will either resort to external equity (via SEO) or scale back its planned investments. One form of SEO is private placement. It is a private sale of equity, when the firm usually sells a block of shares to single or a group of investors.

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Private Placement
Usually the information effect of private placement announcements shows positive market reactions to the sales.because sales are usually made discount to market value could be explained by; The discounts are compensation for the expert advise and monitoring services provided by private investors The resolution of information asymmetries and anticipated effects of changes in the ownership structure are reflected in the positive market reaction to announcements. Information Hypothesis- reflects the changes in firm value around private placements due to market assessment of value of existing firm assets and investment opportunities. Ownership Structure Hypothesis implies that market revaluation can be the result of anticipated changes in managerial performance.

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Rights Issue
Rights Issue - Issue of securities offered only to current stockholders. Current shareholders are given the preemptive rights to purchase new shares on a pro-rata basis. The exercise price is usually at a deep discount to market price as to strongly encourage the shareholder to exercise the rights. However, the shareholder could also sell the rights in the secondary markets, if there is no wish to purchase additional shares of the company.

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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

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Rights Issue
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 each right?

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Rights Issue
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 each right?

Current Market Value = 17 x 60 = 1,020 Total Shares = 17 + 4 = 21 Amount of funds = 1,020 + (4x41) = 1,184 New Share Price = (1,184) / 21 = 56.38 Value of a Right = 56.38 41 = 15.38

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Case and Readings

Case:
Jet Blue Airways IPO evaluation (Refer to Pages 381-400 of the Book, Case Studies in Finance: Managing for Corporate Value Creation, by Robert F. Bruner, Kenneth M. Eades and Michael J. Schill, 6th Edition, McGraw-Hill International Edition, 2010). Articles: (Venture Capital) 1. KB Subhash, Venture Capital Financing and Corporate Governance: Role of Entrepreneurs in minimizing information/Incentive Asymmetry and Maximization of Wealth, Journal of portfolio Management, Fall 2009, Vol. 12, No. 2, pp: 113-129. 2. Carlos Marques DeSliva, Matej Janazic and R.D Hisrich, Five ways to operate and succeed as a venture capitalist in Southeast Europe, Journal of Private Equity, Spring 2012, Vol. 15, No. 2, pp: 84-89.

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Case & Readings

(IPOs)
1. Daniel Konku, Vivek Bhargava and DK Malhorta, Long-term performance of Penny Stock IPOs, The Journal of wealth Management, Summer 2012, Vol. 15. NO. 1, pp: 104-121. 2. Joseph W. Bartlett, Public or Private? A review of the Eclipse of the Public Company in the current Environment, The Journal of Private Equity, Summer 2011, Vol.14, NO. 3, pp: 7-15. (Private Placement) Normazia, M., M., Ariff, Taufiq, H., and Shamsher, M., Private Placements, Share Prices, Volume and Financial Crisis: An Emerging Market Study, Paper under review by the Global Finance Journal.