Chapter 15

underpricing

- If the issue is priced below the true market value, the issuer's existing shareholders will experience an opportunity loss when the issuer sells shares for less than they are worth. - helps new shareholders earn a higher return on the shares they buy - exists due to young firms, insurance for the IBs, reward to investors that offered info about price and number of stocks

VC benefits

- from proceeds (sale in case the company is sold) - from IPO ( if they take company public)

Underwriters perform services:

1. Formulating the method used to issue the securities. 2. Pricing the new securities. 3. Selling the new securities.

Process of issuing securities to the public

1. Management obtains approval from the board of directors 2.The firm must prepare a registration statement and file it with the SEC 3. The SEC examines the registration statement during a waiting period. Firm may distribute copies of a preliminary prospectus . 4. The company cannot sell these securities during the waiting period. Oral offers can be made. 5.On the effective date of the registration statement, a price is determined and a fullfl edged selling effort gets under way.

Stock prices tend to decline following the announcement of a new equity issue - indirect cost of selling securities

1. Managerial information ( shareholders will anticipate this superior information and discount it in lower market prices at the new-issue date) 2. Debt usage (too much debt or too little liquidity) 3. Issue costs

DILUTION OF VALUE: BOOK VERSUS MARKET VALUES

1. market-to book ratio is less than 1, due to decrease in EPS ( accounting dilution) 2. negative NPV

NUMBER OF RIGHTS NEEDED TO PURCHASE A SHARE

1. number of new shares= Funds to be raised/ subscription price 2. number of rights needed to buy a share of stock = old shares/new shares

execute a rights offering

1. price per share be for the new stock? 2. How many shares will have to be sold? 3. How many shares will each shareholder be allowed to buy?4. What is likely to be the effect of the rights offering on the per-share value of the existing stock?

initial public offering

A company's first equity issue made available to the public. Also called an unseasoned new issue or an IPO . - made in cash

Green Shoe provision

A contract provision giving the underwriter the option to purchase additional shares from the issuer at the offering price. Also called the overallotment option . - 30 days -15% of newly issued shares

syndicate

A group of underwriters formed to share the risk and to help sell an issue.

prospectus

A legal document describing details of the issuing corporation and the proposed offering to potential investors

seasoned equity offering

A new equity issue of securities by a company that has previously issued securities to the public.

red herring

A preliminary prospectus distributed to prospective investors in a new issue of securities.

rights offer

A public issue of securities in which securities are first offered to existing shareholders. Also called a rights offering .

registration statement

A statement discloses all material information concerning the corporation making a public offering.

rights offering

An issue of common stock offered to existing stockholders - set time, price, expiration - more advantages over cash offers ( no need for underwriter)

general cash offer

An issue of securities offered for sale to the general public on a cash basis.

Term loans ( LT Debt)

Direct business loans of typically one to fi ve years.

underwriters

Investment firms that act as intermediaries between a company selling securities and the investing public. - buys the securities for less than the offering price and accepts the risk of not being able to sell them. - needs to be a cash offer

Private placements

Loans (usually long-term) provided directly by a limited number of investors. - maturity is longer

Difference btw direct private vs public issues of debt

Private: 1. avoids the cost of SEC registration 2. more restrictive covenants 3. easy to renegotiante in the event of a default 4. life insurance companies dominate 5. low distributing costs

lockup agreements

The part of the underwriting contract that specifi es how long insiders must wait after an IPO before they can sell stock. - 180 days until allowed to cash out -

post money

V+I I/% investing ownership -about % ownership: = Investment/% - about new shares: = new shares/(new +old shares) -about existing shares: = investment/(existing/old)

pre - money valuation (V)

agreed value of company prior to the round of investment (I)

Dilution of percentage ownership.

arise whenever a fi rm sells shares to the general public - the value of shares is unaffected; a decrease in percentage of the ownership of the firm - can be avoided by using a rights offering.

gross spread

basic compensation received by the underwriter. = Offering price - buying price =underwriter discount

The Securities Exchange Act of 1934

basis for regulating securities already outstanding

Value of a right

difference between the old share price and the new share price

Cash vs Rights offering

difference lies in how the shares are sold. rights offer - shareholders are informed that they own one right for each share of stock they own, then specify how many rights a shareholder needs to buy one additional share at a specified price

venture capital

financing for new, often high-risk ventures.

"angels"

individual VC investors, specializing in smaller deals

dilution

loss in existing shareholders' value kinds: 1. Dilution of percentage ownership. 2. Dilution of market value. 3. Dilution of book value and earnings per share.

Securities Act of 1933

origin of federal regulations for all new interstate securities issues

Shelf registration

permits a corporation to register an offering that it reasonably expects to sell within the next two years and then sell the issue whenever it wants during that two-year period.

Firm Commitment Underwriting

the issuer sells the entire issue to the underwriters, who then attempt to resell it. - purchase-resale arrangement - risk associated with selling the issue is transferred to the underwriter.

Dutch Auction Underwriting

the underwriter does not set a fixed price for the shares to be sold

Best Efforts Underwriting

the underwriter is legally bound to use "best efforts" to sell the securities at the agreed-upon offering price - the underwriter can return any unsold shares without financial responsibility