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Raising capital
Chapter 15
Key concepts and skills
• Understand the venture capital market and
its role in financing new businesses
• Understand how securities are sold to the
public and the role of investment bankers
• Understand initial public offerings and the
costs of going public
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-2
Chapter outline
• The financing life cycle of a firm: Early-stage
financing and venture capital
• Selling securities to the public: The basic
procedure
• Alternative issue methods
• Underwriters
• IPOs and underpricing
• New equity sales and the value of the firm
• The cost of issuing securities
• Issuing long-term debt
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-3
Venture capital
• Private financing for relatively new businesses in
exchange for shares in the firm
– Individual investors
– Venture capital firms
• Usually involves active participation by VC
• Ultimate goal to take company public; the VC will
benefit from the capital raised in the IPO
• Many VC firms are formed from a group of
investors that pool capital and then have partners
in the firm decide which companies will receive
financing
• Some large corporations have a VC division
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-4
Venture capital stage financing
• Funding provided in several stages
• Contingent upon specified goals at each
stage
• First stage
– ‘Ground floor’ financing or ‘seed money’
– Fund prototype and manufacturing plan
• Second stage
– ‘Mezzanine’ financing
– Begin manufacturing, marketing and
distribution
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-5
Choosing a venture capitalist
• Look for financial strength.
• Choose a VC that has a management style
that is compatible with your own.
• Obtain and check references.
• What contacts does the VC have?
• What is the exit strategy?
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-6
Selling securities to the public: The
basic procedure
• Management must obtain permission from the Board
of Directors.
• Appoint an underwriter.
• Firm must file a prospectus with ASIC or NZSC.
• ASIC or NZSC examines the prospectus and approves it.
– The period between filing and approval is called the
registration period.
• Securities may not be sold during the registration
period.
• The price is usually determined on the effective date of
the registration.
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-7
Issue methods
• Public issue—Initial public offering (IPO)
– General cash offer = offered to general public
– Usually open for six to eight weeks
– Only cash offers
• Private issue—Rights issue
– Opportunity for existing share holders to buy
more shares
– A new issue by a company with shares issued
already
– Existing shareholders can sell their entitlement if
issue is renounceable
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-8
Total equity raised and bank lending
1999–2008 (A$ in billions)
Table 15.1
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-9
The methods of issuing new securities
Table 15.2
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-10
Underwriters
• Services provided by underwriters:
– Formulate method used to issue securities
– Price securities
– Sell securities
• Syndicate—group of investment bankers
(underwriters) that market securities and
share the risk associated with selling the
issue
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-11
Standby underwriting
• At the end of the issue, the issuer buys any
shares not bought by the public.
• The underwriter charges a fee for this
service.
• The underwriter bears the risk of not being
able to sell the entire issue to the public.
• Most common type of underwriting in
Australia.
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-12
Best efforts underwriting
• Underwriter must make their ‘best effort’ to
sell the securities at an agreed-upon offer
price.
• The company bears the risk of the issue not
being sold.
• The offer may be pulled if there is not enough
interest at the offer price and the company
does not get the capital while still incurring
substantial flotation costs.
• Not as common as it used to be.
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-13
IPO underpricing
• Initial public offering – IPO.
• May be difficult to price an IPO because there
is not a current market price available.
• Additional asymmetric information associated
with companies going public.
• Underwriters want to ensure that their clients
earn a good return on IPOs on average.
• Underpricing causes the issuer to ‘leave
money on the table’.
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-14
Average first-day returns
Figure 15.1
Average first-day returns by month for ASX initial public offerings:
February 1993–December 2009
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-15
Number of offerings by month
Figure 15.2
Number of offerings by month for ASX-listed initial public offerings:
February 1993–December 2009
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-16
IPO underpricing reasons
• Underwriters want offerings to sell out
– Reputation for successful IPOs is critical
– Underpricing = insurance for underwriters
– Oversubscription and allotment
– ‘Winner’s curse’
• Smaller, riskier IPOs underprice to attract
investors.
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-17
New equity issues and price
• Private placement
– An exclusive issue of new securities to an investor or group of
investors who may or may not be current investors in the firm.
• Share prices tend to decline when new equity is issued
• Possible explanations for this phenomenon:
– Signalling and managerial information
– Signalling and debt usage
– Issue costs
• Since the drop in price can be significant and much of the drop
may be attributable to negative signals, it is important for
management to understand the signals that are being sent and
try to reduce the effect when possible.
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-18
The cost of issuing securities
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-19
Types of long-term debt
• Bonds/Debentures—public issue of long-term debt
• Private issues
– Term loans
• Direct business loans from commercial banks, insurance
companies, etc.
• Maturities 1–5 years
• Repayable during life of the loan
– Private placements
• Similar to term loans with longer maturity
– Easier to renegotiate than public issues
– Lower costs than public issues
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-20
Quick quiz
• What is venture capital and what types of
firms receive it?
• What are some of the important services
provided by underwriters?
• What type of underwriting is the most
common in Australia and how does it work?
• What is IPO underpricing and why might it
persist?
• What are some of the costs associated with
issuing securities?
• What are some of the characteristics of
private placement debt?
Copyright © 2011 McGraw-Hill Australia Pty Ltd
PPTs t/a Essentials of Corporate Finance 2e by Ross et al.
Slides prepared by David E. Allen and Abhay K. Singh
15-21
Chapter 15
END
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