Accounting Exam lesson 2

Special dividend

A one-time payment to stockholders. Are larger than extra dividends and occur less frequently. -if they sell a division -want to get rid of excess cash -become a target if they have too much excess cash

Management has just declared a 3-for-1 stock split. If you own 12,000 shares before the split, how many shares will you own after the split?

36,000 36 thousand for 1 share you will get 3 (no calculations on final exam)

-Venture capitalists are not long-term investors in the companies, but usually exit after a period of three to seven years. -Every venture capital agreement includes provisions identifying who has the authority to make critical decisions concerning the exit process. Timing (when to exit) The method of exit What price is acceptable -all negotiated at year 3 upfront even if they stay until year 7

venture capital: exit strategy

Stock Splits

A stock split is quite similar to a stock dividend, but it involves the distribution of a larger multiple of the outstanding shares. We can often think of a stock split as an actual division of each share into more than one share. -2 for 1 stock split is 1 share is split into 2 shares -say you own 100 shares now you have 200 shares -a 3 for 1 stock split you now have 300 shares -SHARE CAPITAL REMAINS THE SAME -no effect on equity -stock split makes it easier for a company to buy its shares -if they think their share price is too high in the market they will do this and it can be risky, hoping that price will go up again. Will do this for investors to buy it because its too expensive but in hopes it will get so many buys you will make money back

Private Markets versus public markets

Cheapest source of external funding for smaller firms and firms of lower credit standing is often the private markets. --> private markets are cheaper because you dont need all the lawyer and consultants. A smaller company many not be able to afford to go public. Some companies have a low credit rating and may be harder to go public because investors do look at company debts When market conditions are unstable, some smaller firms that were previously able to sell securities in the public markets no longer can. Bootstrapping and venture capital financing are part of the private market as well.

Stock Dividend

Does not involve the distribution of value. When a company pays a stock dividend, it distributes new shares of stock on a pro-rata basis to existing stockholders. Value of company does not change. The stockholder is left with exactly the same value as before. 10% say you own 100 shares x 10% they will pay you 10 shares original 100 +stock dividend 10 you now own 100 shares of that company debiting dividends credited share capital by issuing more shares, and net effect is 0 and didn't change equity of the company - by having more shares allows for shareholder to benefit moreso

The dividend payment process advantages

It is easy to inform all stockholders of the decision to pay. It is easy to actually pay it. There is no public announcement. There is no need for an ex-dividend date. The record date and payable date can be any day on or after the day that the board approves the dividend.

Extra dividends

Management can afford to err on the side of setting the regular cash dividend too low because it always has the option of paying an extra dividend if earnings are higher than expected. Often paid at the same time as regular cash dividends. -ex: regular cash dividend is 10 cents EXTRA Q1 0.10 0.05 Q2 0.10 0 Q3 0.10 0.07 Q4 0.10 0.15 shareholder gets extra on top of regular. A company is doing well and adds extra.

Practical considerations in setting a dividend policy

Managers should consider several practical questions when selecting a dividend policy: 1. Over the long term, how much does the company's level of earnings (cash flows from operations) exceed its investment requirements? How certain is this level? 2. Does the firm have enough financial reserves to maintain the dividend payout in periods when earnings are down or investment requirements are up?--> do we have enough cash do we anticipate we will have enough cash on hand to cover the times of low profits or losses so we can continue paying out the dividend 3. Does the firm have sufficient financial flexibility to maintain dividends if unforeseen circumstances wipe out its financial reserves when earnings are down? 4. Can the firm quickly raise equity capital if necessary? 5. If the company chooses to finance dividends by selling equity, will the increased number of stockholders have implications for the control of the company?

Regular cash dividend

Most common form. Generally paid on a quarterly basis. (every 3 months) Common means by which firms return some of their profits to stockholders. Set at a level that management expects the company to be able to maintain in the long run, barring some major change in the fortunes of the company. regular dividend--> always same amount ex 10%

Stock Splits

One real benefit of stock splits is that they can send a positive signal to investors about the outlook that management has for the future and this, in turn, can lead to a higher stock price. Management is unlikely to want to split the stock of a company two-for-one or three-for-one if it expects the stock price to decline.

liquidating dividend

Paid to stockholders when a firm is liquidated -when a company is going bankrupted or closing all of the employees and supplies and bankers then the shareholders would get paid and would pay the shareholders with the liquidating dividend

Advantages of private placements

Private lenders are more willing to negotiate changes to a bond contract.--> not so much to consider If a firm suffers financial distress, the problems are more likely to be resolved without going to a bankruptcy court. --> can get financing from private equity firm Other advantages include the speed of private placement deals and flexibility in issue size.

Dividends

When a firm distributes value through a dividend, it reduces the value of the stockholders' claims against the firm. -example a companies balance sheet has cash $1000 -$1000 =0 assets $900 . total $10,000 . =9000 debt 0 share capital 10,000-1000=9000 total is 10,000=9000 this company pays a dividend of $1000 in total, debit dividends and credit cash $1000 A dividend reduces the stockholders' investment in a firm by returning some of that investment to them.

Dividends

-A dividend is something of value that is distributed to a firm's stockholders on a pro-rata basis.--> the number of shares you own determines the amount of dividends you get paid. A dividend can involve the distribution of cash, assets, or something else, such as discounts on the firm's products that are available only to stockholders.

Types of Dividends

-Regular cash dividend -special dividend -extra dividend -liquidating dividend

Dividend payment process

-board vote to pay off dividend -announcement is made (declaration date) means that you are obligated to pay dividend, liability on balance sheet -record date (anyone who owns a share by this date gets the dividend) take time too see who gets these shares -ex-dividend date (2 days before record date) gives them 2 days to compile that list, need to buy shares before ex-dividend date in order to get the dividend (record date becomes irrelevant and helps set ex-dividend date) -payable date --> actual day they pay out the dividends

how stocks are repurchased

1. open-market purchase--> right on stock exchange 2. tender offer: fixed price: where the company announces they buy back shares and announce how much they are willing to pay for shares and maximum amount of shares they will buy. then wait and let shareholders tell them how many shares they will sell dutch auction: management analyses how many shares they want to buy back and offer to buy back shares at DIFFERENT PRICES, higher than market price 3. Targeted stock repurchase --> where they negogiate directly with the shareholder because they might own a block of shares and negogiate with that shareholder directly to buy their block of shares. in order to take back and control (if you own your shares) price that is BELOW MARKET

-The process by which many entrepreneurs raise "seed" money and obtain other resources necessary to start their businesses -The initial "seed" money usually comes from the entrepreneur or other founders. -small businesses are the backbone of countries they employ over 50% of people. -"Pull yourself up by your bootstraps-do it yourself -all of bootstrapping is done in the private market

Bootstrapping

lead underwriter makes a recommendation of the price and management decides if they accept it or not -final prospectus gets filed with shares commission, are registered and sold the next day Once the due-diligence process is complete, the underwriters and the issuer determine the final offer price in a pricing call. The pricing call typically takes place after the market has closed for the day. By either accepting or rejecting the investment banker's recommendation, management ultimately makes the pricing decision.

Distribution

Dividend policy

Dividend policy: a firm's overall policy regarding distributions of value to stockholders. -if they do choose to pay dividents they will have a divident policy which is a guideline on how they will distribute their profits to the shareholders

-"seed money" Cash may come from personal savings, sale of personal assets, loans from family and friends, use of credit cards -ex: steve jobs selling his car -Airbnb selling cereal is seed money -seed money is used for developing a prototype of the product or service and a business plan -usually lasts 1-2 years

For funding of the firm, where does the money usually come from? What is it spent on?

-Individual venture capitalists or angel investors, are typically wealthy individuals who invest their own money in emerging businesses at the very early stages in small deals. -Venture capitalists are individuals or firms that help new businesses get started and provide much of their early-stage financing

Venture Capital: individual venture capitalists or angel investors

INVESTMENT-BANKING SERVICES -To complete an IPO, a firm will need the services of investment bankers, who are experts in bringing new securities to the market. 1. Origination--> giving them financial avdice and getting them ready to sell their shares 2. underwriting--> pricing of the shares 3. distribution--> actual selling of the share

Investment bankers provide three basic services when bringing securities to market-

The dividend payment process at private companies

It is not as well defined for private companies because shares are bought and sold less frequently, fewer stockholders, and no stock exchange is involved in the dividend payment process. easy much more straight forward

Private Equity Firms

Like venture capitalists, private equity firms pool money from wealthy investors, pension funds, insurance companies, and other sources to make investments. Private equity firms invest in more mature companies, and they often purchase 100 percent of a business. -look for businesses that have stable cash flows -used to only invest in small companies and now invest in bigger companies

-investment banker asks these questions and management must be able to answer yes to all of these questions 1. is the management team strong enough? Would they want the managing team managing their money? 2. Whats the companys historical performance? Would an investor consider this company based on their performance? 3. Whats their expected future performance? Would an investor invest in this company based on the future? Then... -Company needs to make sure that people approve it before they do it. Once the decision to sell stock is made, the firm's management must obtain a number of approvals. -File a registration statement with the SEC, prospectus--> info about the company, financials plus forecast, competitive analysis done -The investment banker helps the firm determine whether it is ready for an IPO.

Origination

Private Equity Firms

Private equity firm managers look to increase the value of the firms they acquire by closely monitoring their performance (they own 100% of the company and want to increase value of company so that when they sell shares they are worth a lot) Best possible management team --> May choose to replace someone Providing advice--> monitor performance Facilitating mergers and acquisitions--> help company buy other companies, or joining with other companies in order to be more competitive Once value is increased, they sell the firms for a profit. --> may sell to back original owners to another private investor or will go public Private equity firms generally hold investments for three to five years.

Private placements (not in textbook)

Private placement occurs when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals. -securities are shares or bonds -venture capitalist exits by selling their bonds or shares -these shares are not registered, because these shares are staying private, their is no registration with security exchange comission

Disadvantage of private placements

The biggest drawback of private placements involves restrictions on the resale of the securities. -restriction on the shares. only investors that have skills and knowledge to evaluate these shares can buy it, because it is skill risky because the company is private

-Sell to a strategic buyer in the private market --> sees similarities between the 2 businesses things that they can share (synergy) ex: loblaws joining with .. -Sell to financial buyer in the private market--> venture capitalist sells it to someone else who will provide financing -Initial Public Offering: selling common stock in an initial public offering (IPO).--> first time a company sells their shares out to the public -ontario securities and exchange commission needs to register to be allowed to sell their shares to the public on stock exchange

There are three principal ways in which venture capital firms exit venture-backed companies:

Underwriting spread-->Difference between the proceeds the issuer receives and the total amount raised in the offering. -Banker offers to pay $39 per share to the company, then sell to public at $42, 42-39:$3 per share is the underwriting spread -investment bankers profit Out-of-pocket expenses-->Includes: other investment banking fees, legal fees, accounting expenses, printing costs, travel expenses, SEC filing fees, consultant fees, and taxes. Underpricing-->Difference between the offering price and the closing price at the end of the first day of the IPO. -August 19 2004 Google did their IPO and put their stock onto the market at $85 per share. At the end of the day google stock was trading at $100.34 the difference is $15.34. This is underpricing this means the price they started with was too low and didnt value Google accordingly to what the public thought of it. They released 19.6 million shares that day. x 15.34 =300 million dollars google lost

Three basic costs are associated with issuing stock in an IPO

1. high degree of risk--> 50% of businesses fail in the first year, 1/3 of this percent fails in the second year 2. types of productive assets--> banks like to see real assets as collateral such as a house. When a company starts up they usually dont have any real assets or collateral to back up the loan 3. Informational asymmetry problems--> the parties dont have the same information. An entrepreneur they know their business and why it would be good or bad, but a banker does not know their business because they are not experts in industries. Venture capitalists are experts and will focus on one type of industry. banks wont lend them money

Three reasons exist as to why traditional sources of funding do not work for new or emerging businesses:

-The risk-bearing part of investment banking. -The securities can be underwritten in two ways: -Firm commitment basis--> where investment banker company guarantee a certain price for the shares. the banker will buy the shares from the company (fixed price) The banker sells those shares to the public. May turn out when sold to public may be a lower price that is the risk. -Best-Efforts basis --> investment banker makes no guarantee about the price. They promise to do their best. -Company sells their shares to the public which then sells them to the company. -No buying not as risky

Underwriting

-To share the underwriting risk and to sell a new security issue more efficiently, underwriters may combine to form a group called an underwriting syndicate. -Participating in the syndicate entitles each underwriter to receive a portion of the underwriting fee as well as an allocation of the securities to sell to its own customers. -spread the risk

Underwriting Syndicates

-One of the investment banker's most difficult tasks is to determine the highest price at which the bankers will be able to quickly sell all of the shares being offered and that will result in a stable secondary market for the shares. - if you price it too high you wont sell them but if you sell them too low you will lose out on money -looks at future cash flows of company, put a value on the company to put a price on the shares -May go on road shows--> visit potential investors such as insurance companies, pension funds, and will see how much are you willing to pay for a share of this company?

Underwriting the offer price

-transparent -Before the shares are sold, representatives from the underwriting syndicate hold a due-diligence meeting with representatives of the company. -Investment bankers hold due-diligence meetings to protect their reputations and to reduce the risk of investors' lawsuits in the event the investment goes sour later on. -last check before they decide to go and sell the shares

Underwriting: Due Diligence Meeting

-diversification of investments -venture capital firm will find other venture capitalist firms to invest in the company to spread the risk, so that if the company fails they wont lose all their money, just some. -Then reenforces the original venture capitalists of the company that it is a good investment if other venture capitals are interested -It is a common practice to syndicate seed- and earlystage venture capital investments. Syndication occurs when the originating venture capitalist sells a percentage of a deal to other venture capitalists.

Venture Capital: Syndication

Advantages of Going Public • Amount of equity is larger • Additional equity can be raised at a low cost • Can fund growing business without giving up control • Creates secondary market for trading--> where shares can be bought or sold • Easier to attract top management and motivate current managers--> CEO, CFO, usually because they can offer a better compensation plan such as higher salary. Giving management options to buy the company shares at a discounted price. Management is motivated to increase share price so they can buy them at a cheap price and sell them to the public to make money enables a company to raise money without losing control If dave owns 90% and his shares are 10% he can do what he wants -

What are the advantages of going public? (An initial public offering)

Disadvantages to Going Public • High cost of the IPO itself--> because of the amount of people involved and what needs to get filed, registered, lawyers • Costs of complying with ongoing SEC disclosure requirements--> need to be audited every year, need lawyers every year and costs associated with that • Transparency that results from this compliance can be costly for some firms--> they need to disclose info in their annual reports which can be risky because they will be disclosing more info than a private company and that can allow competitors to see their information

What are the disadvantages to going public?

-funding the ventures in stages--> stage financing, give a company some money and the company needs to perform to a certain level and once they reach that level they get more money -requiring entrepreneurs to make personal investments-> entrepreneurs need to put in their own money. The venture capitalists wont invest in a company that the entrepreneur wont invest in because that means they dont believe in their company -syndicating investments -in-depth knowledge about the industry --> because they specialize in industries thats one of the ways that helps them reduce risk 20% success rate for venture capitalists

What are the tactics that venture capitalists use to reduce their risk?

-The venture capitalists' investments give them an equity interest in the company. -Often in the form of preferred stock that is convertible into common stock at the discretion of the venture capitalist. -provide advice, they are advisors in marketing, branding, they always have access to the companies information to see how the company is performing - venture capitalists write a cheque and get preferred shares in exchange (preferred shares have more senior claim, they got the money first before any common shareholders if the company went under) -these preferred shares can be converted into common shares, if the company becomes successful you would want to convert it into common

What do venture capitalists investments give the company?

stock repurchases

companies buying back their shares They do not represent a pro-rata distribution of value to the stockholders, because not all stockholders participate. When a company repurchases its own shares, it removes them from circulation. Stock repurchases are taxed differently than dividends. -when shares are bought back your debiting share capital and crediting cash as supposed to when you issue shares you credit share capital - not all shareholders participate they get a choice if they want to sell their shares back -dividends are taxed higher and capital gain is taxed lower

You would like to own a common stock that has a record date of Friday, September 5, 2014. What is the last date that you can purchase the stock and still receive the dividend?

ex dividend date: september 3rd need to own shares as of september 2nd to get the dividend