RAISING CAPITAL

Chapter 15
 Introduction

 Definition of capital: borrowed sums or equity with

which the firm's assets are acquired and its operations are
funded.
 When does a firm need capital?
 New or start up companies
 Finance expansion
 Rapid growth
 Opening new market lines
 Mergers and acquisitions
 Introduction

 How can a firm raise money??

 1. Equity: selling a portion of the firm to investors so the
investor would be the owner of that portion of the firm in the
form of common stock or preferred stock.
 2. Debt: An amount owed to a person or organization for funds
borrowed. Debt can be represented by a loan note, bond,
mortgage or other form stating repayment terms and interest
requirements.
 How a firm raises capital depends on the size of the firm, the
life cycle stage, and the growth prospects of the firm.
 1- The Financing Life Cycle of a Firm:
Early-Stage Financing and the Importance of Venture Capital

 Venture Capital Financing for new, often high-risk

venture.

 Private Equity: is often used to label the rapidly

growing areas of equity financing for nonpublic
companies.
 Capital for new firms

 Can new start-up firms rely on bank loans for capital?

 Venture capital: general term for financing startup,
early stage, and "turn around" type businesses
 Sources of VC
 New business will be risky
 What does Venture capitalist do to avoid this risk?
 Why might Venture capitalist be willing to take this
risk?
 Venture capital firm often specialize in different stage.
Some specialize in very early “seed money or ground
floor” financing.
 Financing in the late stages might come from venture
capitalist specializing in so-called mezzanine-level
financing (mezzanine level refers to the level just
above the ground floor).
 Choosing a venture capital

1. Financing strength is important.

2. Style is important.
3. References are important.
4. Contacts are important.
5. Exit strategy is important.
2- SELLING SECURITIES TO THE PUBLIC

1. The first step is to obtain approval from the board of

directors
2. The second step is to prepare a registration statement
and file it with the SEO “Securities and Exchange
Commission” The registration statement is required for all
public, interstate issues of securities, with two exceptions:
a. Loan that mature within nine months.
b. Issue the involve less than $5 million.
3. The SEO examine the registration statement during a waiting
period. During this time, the firm may distribute copies of a
preliminary prospectus.
The prospectus: contain much of the information in the
registration statement, and it is given to potential investors by the
firm.
4. The company cannot sell these securities during the waiting
period.
While and after the waiting period, an advertisement announcing
a public offering is used by underwriters and called Tombstone.
3- ALTARNATIVE ISSUE METHODS

 When a company decides to issue a new security, it

can sell it as public issue or a private issue (less than
35 investor)
 In the case of a public issue, the firm is required to
register the issue with the SEC.
 For equity sale, there are two kinds of public issue
1. General cash offer.
2. Rights offer.
 With the cash offer, securities are offered to the
general public .
 With the rights offer, securities are initially offered
only to existing owners.
 The first public equity issue that is made by the
company is referred to as an initial public offering,
IPO.
This issue occurs when a company decides to go
public.
A seasoned equity offering (SEO) is new issue a
company with securities that have been previously
issued.
A seasoned equity offering of common stock can be
made by using a cash offer or a rights offer.
 4- UNDERWRITERS

 Definition: investment firms that act as intermediaries

between a company selling securities and the investing

capital
 Services provided by underwriters

 Formulate method used to issue securities

 Price the securities
 Sell the securities
 Price stabilization by lead underwriter
 Underwriters

 Syndicate – group of investment bankers that

market the securities and share the risk associated

with selling the issue
 Spread – difference between what the syndicate

pays the company and what the security sells for

initially in the market
 The underwriter buys the securities for less than the
offering price and accepts the risk of not being able to
sell them.
 Because underwriting involves risk, underwriters
usually combine to from an underwriting group called
a syndicate to share the risk and to help sell the issue.
 The difference batten the underwriter's buying price
and the offering price is called the Gross spread, or
underwriting discount.
 It is the basic compensation received by the
underwriter.
 Sometime, on smaller deals, the underwriter will get
noncash compensation in the form of warrants and
stock in addition to the spread.
 Types of underwriting

1. Firm Commitment Underwriting

 Issuer sells entire issue to underwriting syndicate

 The syndicate then resells the issue to the public

 The underwriter makes money on the spread between

the price paid to the issuer and the price received

from investors when the stock is sold
 The syndicate bears the risk of not being able to sell

the entire issue for more than the cost

 Types of underwriter

2. Best efforts underwriting

 Underwriter must make their “best effort” to sell

the securities at an agreed-upon offering price

 The company bears the risk of the issue not being

sold
 Not as common as it used to be
 Types of underwriter

3. Dutch auction underwriting:

 Underwriter accepts a series of bids that include

number of shares and price per share

 Google was the first large Dutch auction IPO
 IPOs & under pricing

 Initial Public Offering – IPO

 May be difficult to price an IPO because there isn’t

a current market price available

 Under pricing causes the issuer to “leave money on

the table”
Why Does Underwriting Exist??

 To attract investors for young firms

 To act as an Insurance for the investment bank
 A way that a bank can reward investors for reveling
what they think the stock worth and the numbers of
shares they would like to buy
THE COST OF ISSUING SECURITIES

1. Gross spread: The gross spread consists of direct

fees paid by the issuer to the underwriting
syndicate- the different between the price the issuer
receive and the offer price.
2. Other direct expenses: these are direct cost,
incurred by the issuer, that are not part of the
compensation underwriters. These cost include
filing fees, legal fees, and tax … etc.
THE COST OF ISSUING SECURITIES

3. Indirect expenses: these cost are not reported on the

prospectus and include the cost of management time
spent working on the new issue.

4. Abnormal return: in seasoned issue of stock, the price

of the existing stock drop on average by 3% on the
announcement of the issue. This drop is called the
abnormal return.
THE COST OF ISSUING SECURITIES

5. Under pricing: For initial public offering, losses arise

from selling the stock below the true value.

6. Green shoe option: It gives the underwriters the right

to buy additional shares at the offer price to cover
overallotment.
 Rights

 Definition: an issue of common stock offered to existing

stockholders
 “Rights” are given to the shareholders

 Specify number of shares that can be purchased

 Specify purchase price
 Specify time frame
 Why do companies offer Rights? (Advantages)

 Rights may be traded OTC or on an exchange

 Rights

 The mechanics of a rights offering

 Number of rights needed to purchase a share

 The value of a right
 Example:
 National Power current share price is 20$, there is 1,000,000 shares
outstanding. Suppose they want to raise 5,000,000$ in new equity
using a right offering (1 right for each 1 share) with a subscription
price of 10$. Calculate the following:
1. Number of new shares to be issued
2. Number of rights needed to buy a new share
3. The value of the right
4. Show in calculations the effects of the rights offering on
shareholders
 The value of a right
 Results

 The price specified in a rights offering is generally less

than the current market price
 The share price will adjust based on the number of
new shares issued
 The value of the right is the difference between the
old share price and the “new” share price
 Rights Offering Example

 Suppose a company wants to raise $10 million. The

subscription price is $20 and the current stock price is $25.
The firm currently has 5,000,000 shares outstanding.
 How many shares have to be issued?
 How many rights will it take to purchase one share?
 What is the value of a right?
 Dilution

 Dilution is a loss in value for existing shareholders that

occurs through the issuance of additional stocks
 Dilution kinds:
1. Percentage ownership – shares sold to the general public
without a rights offering
2. Market value – firm accepts negative NPV projects
3. Book value and EPS – occurs when market-to-book value is
less than one
 Issuing Long-term Debt
 Types of Long-term Debt

1. Public issue of long-term debt are usually in the form of bonds

2. Private issues
 Long-Term loans usually bank loans or could be from private firm which
has a history with the company
 Easier to renegotiate than public issues
 If bonds were issued to private investors costs would be lower than
public issues
 MORE THAN 50% OF ALL DEBT ARE ISSUED PRIVATELY
 Interest rates are higher in private issues when compared to public issues
 Ex 1 Page 505
 Big Time, Inc., is proposing a rights offering. Presently there
are 500,000 shares outstanding at 81$ each. There will be
60,000 new shares offered at 70$ each.

A. What is the new market value of the firm

B. How many rights are associated with one of the new

shares?

C. What is the value of a right?

D. Why might a company have a rights offering rather than a

general cash offer?