raising capital
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CHAPTER 15
Raising Capital
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
How can a firm raise money??
1. Equity: the value of an ownership interest in property or interest in a corporation in the form of common stock or preferred stocks
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.
Introduction
Can new start-up firms rely on bank loans for capital?Venture capital: general term for financing startup,
early stage, and "turn around" type businessesSources of VCNew business will be riskyWhat does Venture capitalist do to avoid this risk?Why might Venture capitalist be willing to take this
risk?
Capital for new firms
Capital for existing firms
How can a company finance its investments?1. Selling securities to the public
A. PublicB. Private
2. General cash offer3. Rights offer4. Initial public offering (IPO)5. Seasoned equity offering (SEO)
Refer to table 15.1
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
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
Underwriters
Types of underwriter
1. Firm Commitment UnderwritingIssuer sells entire issue to underwriting syndicateThe syndicate then resells the issue to the publicThe 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
2. Best efforts underwritingUnderwriter must make their “best effort” to sell
the securities at an agreed-upon offering priceThe company bears the risk of the issue not being
soldNot 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
Types of underwriter
IPOs & under pricing
Initial Public Offering – IPOMay be difficult to price an IPO because there isn’t
a current market price availableUnder pricing causes the issuer to “leave money on
the table”
Why does under pricing exist?
To attract investors for young firmsTo act as an Insurance for the investment bankA 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 costs of issuing securities
1. Gross spread
2. Other direct expenses
3. Indirect expenses
4. Abnormal returns
5. Under pricing
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
The mechanics of a rights offeringNumber of rights needed to purchase a share
Rights
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
Effects on share holders
The case of buying a new share using rightsThe case of selling rights
ResultsThe price specified in a rights offering is generally
less than the current market priceThe share price will adjust based on the number of
new shares issuedThe value of the right is the difference between the
old share price and the “new” share price
The value of a right
Suppose a company wants to raise $10 million. The subscription price is $20 and the current stock price is $25. The firm currently has 5,000,000 shares outstanding. How many shares have to be issued? How many rights will it take to purchase one share? What is the value of a right?
Rights Offering Example
Dilution
Dilution is a loss in value for existing shareholders that occurs through the issuance of additional stocks
Dilution kinds:1. Percentage ownership – shares sold to the general
public without a rights offering
2. Market value – firm accepts negative NPV projects
3. Book value and EPS – occurs when market-to-book value is less than one
Types of Long-term Debt
1. Public issue of long-term debt are usually in the form of bonds
2. Private issues Long-Term loans usually bank loans or could be from private firm which
has a history with the company Easier to renegotiate than public issues If bonds were issued to private investors costs would be lower than
public issues MORE THAN 50% OF ALL DEBT ARE ISSUED PRIVATELY Interest rates are higher in private issues when compared to public
issues
Issuing Long-term Debt
Ex 1 Page 505
Big Time, Inc., is proposing a rights offering. Presently there are 500,000 shares outstanding at 81$ 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?
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