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Chapter 15: How Corporations Issue Securities - Coggle Diagram
Chapter 15: How Corporations Issue Securities
VENTURE CAPITAL
Equity investment in a young private company
Venture capital firms pool funds from a variety of investors, seek out fledgling companies and work with these companies
Success of the private company is dependent on the effort of the managers and owners of the company.
STAGES OF VC FINANCING
ZERO STAGE INVESTMENT: When you start the business at a low level with no external capital from other parties. e.g Using your own savings and working from a garage
.
FIRST STAGE FINANCING: When a external VC firm works/partners with you take your business to the next level.
.
SECOND STAGE FINANCING: When you receive an additional capital investment in order to expand your business. e.g capital to expand to all provinces in SA
.
MEZZANINE FINANCING: When you receive another capital injection to expand your business further using the skills of another entity. e.g getting an international VC firm to help you expand to the rest of Africa.
.
INITIAL PUBLIC OFFERING: When your partners at VC firms want to cash out on their shares in your company, they will sell them on the market through an IPO
Venture capital firms are not passive, they offer managerial advice and play a major role in the appoinment of senior management
It is very unlikely for a company to do extremely well, there is a 20-30% success rate
WHATS IN IT FOR VENTURE CAPITALISTS?
They may cash out by selling out to larger firms or by going public through an IPO
INITIAL PUBLIC OFFERING (IPO)
IPO is the first offering of a stock to the general public. Usually done through the
primary
or
secondary
market
.
Primary market is the market for the creation of new securities
Secondary market facilities the transfer of share from one party to another party e.g when one sells their shares
THERE ARE MANY MOTIVES WHEN GOING PUBLIC:
To create public shares for use in future acquisitions
To establish a market price/ value for the firm
To minmise the cost of capital
To enhance the reputation of the company
ARRANGING AN IPO:
Select underwriters
Underwriters play 3 roles:
financial advice, buying the stock and reselling it to public
↑ when they are buying and reselling to public, underwriters make a profit called the
underwriters spread
Prepares a registration statement - containing info on firms history, existing business & future plans
Prepare a prospectus to market the IPO to potential investors
Arranges for shares to be traded on a stock exchange
Determine the issue price by analysing PE ratios of competitors and DCF techniques (block 1!!)
Arrange a roadshow to determine potential investor's reactions to the issue
Build a book of potential orders
UNDERWRITERS ACT BASED ON A:
FIRM COMMITMENT:
underwriters buy the securities from the firm and then resell them to public
OR
BEST-EFFORTS COMMITMENT:
underwriters agree to sell as much of the issue as possible but do not guarantee the sale of the entire issue
UNDERPRICING OF IPOs
Underpricing is when you issue securities at an offering price set below the true value of the security
An IPO is determined to be underpriced if the offer price is lower than the price at close of the first trading day of the IPO
Cost of underpricing: Number of shares issued (Close price - Open price)
REASONS FOR UNDERPRICING:
it is difficult to judge how much investors are prepared to pay for the stock
underwriters underprice to generate demand
raises price of a stock and enhances ability to raise further capital
OTHER NEW ISSUE PROCEDURES
BOOK BUILDING VS. AUCTION
Bookbuilding allows the underwriter to set the offering price from information obtained during the roadshow
.
Auction allows the underwriter to invite investors to submit their bids. The investors decides how many shares they want to buy and the price they want to buy them.
DISCRIMINATORY AUCTION:
e.g Say a company wants to issue 10 million shares. Investor A offers to buy 5m shares @ R10, Investor B offers to buy 4m shares @ R9, Investor C offers to buy 1m shares @ R7.5 and Investor D offfers to buy 0.5m shares @ R7. The company would accept the offers from Investors A,B & C because their offerings satisfy the amount of shares that need to be bought (10m shares) even though they're offering different prices. Investor D's offer would be rejected.
UNIFORM PRICE AUCTION:
Similar to discriminatory auction except that the price offered by each investor would pay the same price based on the lowest qualifying bid. i.e Investor A, B & C would be accepted and price they'd all have to pay is R7.5 as that is the price of the lowest qualifying bid
A company will list through an
IPO
. Through their business life, they can decide to raise more money through a
SEASONED CASH OFFERING
. The
SEASONED CASH OFFERING
is executed through a
RIGHTS ISSUE
or
GENERAL CASH OFFER
Seasoned offering: issue of securities from established company whose existing shares have shown stable movements
.
General cash offer: sale of securities open to all investors by an already public company
.
Rights issue: Issue of securities offered only to current stockholders
↑ see notes on how to calculate prices of rights issue
Value of a right
= (Stock price - Subscription Price)/ (Number of rights required to buy one share + 1)
MARKET REACTION TO STOCK ISSUES:
Decline in stock prices after a debt issue is negligible
Issue stock when firm is overvalued
Issue debt when firm is undervalued
Value may be depressed by additional supply