18

Issuing Capital and

the Investment
Banking Process
Finance 3rd Edition

Cornett, Adair, and Nofsinger

Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education

Introduction
Firms finance assets with capital
Retained earnings
Debt
Equity

18-2

Sources of Capital for New and Small Firms

Debt
Borrowing from friends and relatives
Bank loans
Venture capitalists
Equity
Venture capitalists

18-3

Debt Financing
Bank Loans
New and small firms rely on banks
Availability of small-business loans was heavily

affected by the 2008 financial crisis

18-4

Bank Loans
Small Business Loans
Risky for commercial banks
Banks use small-business scoring models

18-5

Bank Loans
Mid-market firms
Sales between $5 million and $100 million per

year
Rely on banks for funding

18-6

Credit Process Flow Chart

18-7

Loan Commitments
Loan commitment agreements specify
Maximum loan amount
Interest rate terms
Length of loan

18-8

Fixed versus Floating Rate Loans

Interest rates for variable-rate loans

change over the life of the loan

Floating rate loans are set at a fixed

spread over a prevailing benchmark rate

18-9

Small Business Administration

Created to help small businesses
Basic loan guarantee program
For qualified new firms that cannot get

reasonable long-term financing from other

financial institutions

18-10

Equity Financing and Expertise

New and high-risk firms use venture capital

(VC) for financing

Professionally managed
VC firm takes an equity stake in the firm

financed
VC firms are actively involved in the business

18-11

Venture Capital Firms

Institutional venture capital firm types
Venture capital limited partnerships
Financial venture capital firms
Corporate venture capital firms
Small Business Investment Companies

18-12

Angel Venture Capitalists

Majority of VC equity investments from

wealthy individuals (angels), not institutions

Angel VCs want
High return
Easy exit

18-13

The Choice to Go Public

Choice made when firms capital needs

exceed its ability to raise capital

Initial public offering (IPO) of firms stock
Equity is publicly traded in stock markets for the

first time

18-14

The Choice to Go Public

Benefits of being a public firm
Access to a larger pool of equity capital
Stock market provides a market value for the

firms stock

18-15

The Choice to Go Public

Benefits of being a public firm
Firms managers can be rewarded with firms

stock
Original owners can diversify their holdings

18-16

The Choice to Go Public

Disadvantages of being a public firm
Costs of an IPO
Public disclosure of information required may

be valuable to competitors
Shareholders demand a great deal of

information

18-17

Public Firms Capital Sources

Debt Financing
Commercial Paper
Unsecured, short-term promissory note
Used to raise short-term cash, often working capital

18-18

Commercial Paper
Trading process
Can be sold directly to investors or through

broker dealer
Firms credit rating critical because commercial

paper is unsecured debt

18-19

Long-Term Debt
Corporate bonds
Minimum denomination on publicly traded

bonds is $1,000
Most coupon-paying bonds pay interest

semiannually

18-20

Trading Process for Corporate Bonds

Initial sale made by public offering or

private placement to institutional investors

Large firms use large investment banks
Smaller firms use small regional investment

banks

18-21

Trading Process for Corporate Bonds

Investment banks
Firm commitment underwriting
Entire issue bought by bank at fixed price (discount

from par) and resold at higher price

Issuing firm has price guarantee investment bank

has risk

18-22

Firm Commitment Underwriting Corporate Bond Issue

18-23

Trading Process for Corporate Bonds

Competitive sale highest bid from group

of underwriters wins
Negotiated sale issuing firm negotiates
with single investment bank

18-24

Trading Process for Corporate Bonds

Best efforts underwriting
Underwriter does not buy issue but instead acts

as a placing or distribution agent for a fee

Price risk remains with issuing firm

18-25

Equity Financing
Majority of both the board of directors and

the firms existing stockholders must

approve any new stock issue

18-26

The Trading Process for Corporate Equity

Primary market
IPO
Seasoned offering is when the firm already has

publicly-traded shares

18-27

Primary Market Stock Transaction

18-28

The Trading Process for Corporate Equity

The Securities and Exchange Commission

(SEC) must approve any new issues to the

public

18-29

The Trading Process for Corporate Equity

Stock issues
Firm commitment underwriting
Best-efforts basis

Registration statement
Full disclosure of firm information, risks,

management background and securities to be

issued

18-30

The Trading Process for Corporate Equity

Prospectus
Red herring prospectus is preliminary version of

the public offering prospectus

Official prospectus describes issue
Shelf registration allows multiple stock issues for two

years under one registration

18-31