Topic 11: Raising Capital in Initial Public Offerings

What is Nasdaq? What type of exchange is Nasdaq?

Nasdaq is an over the counter market (OTC). They act as the MARKET MAKER for various stocks, assuming risk by holding a certain number of shares for a particular security, then facilitating the trading of that security. They compete for customer orders by displaying buy and sell quotations for a guaranteed amount of shares. They receive orders from buyers, then sell from their own inventory to offset the order.

What are the main benefits of holding stock? What are the downsides?

Price Appreciation or Dividend Yield. Price appreciation is when the price of the stock has grown higher than the amount which the investor had purchased the stock for. When the investor sells this stock that has experienced price appreciation, they will earn capital gains. Dividend Yield is the return of buying shares in the form of dividend payments. These are regular quarterly payments to shareholders - dividend smoothing here! Unlike debt, when you invest in equity, there are no guarantees to whether or not an investor will receive return from holding the stock. Furthermore, there is always a chance that the company may go bankrupt and all that the investor had put forth in the company is gone. Taking greater risks allows investors to be compensated even more! Historical returns on stocks range around on average of 10-12%.

What are the purposes of a stock market?

The purpose of a stock market is to facilitate the trade of stocks between buyers and sellers. These exchanges provide a location and means of technology in order for investors to easily trade with efficiency. Without a market, it would be very hard to buy or sell stocks! You would have to call your wife, your kids, your neighbors, what a mess!

What is Venture Capital?

Venture Capital is the financing that investors may provide to startup companies and small businesses that are believed to have growth potential. Venture capitalists provide money to these firms in return for earnings, etc. Venture capitalists assume a lot of risk because small companies may easily go bankrupt.

What are the specific specifications in order to be an ACCREDITED INVESTOR as stated by the SEC?

(1) A person must demonstrate an annual income of $200,000 or $300,000 for joint income, for the last two years with expectation of earning the same or higher income. (2) A net worth exceeding $1 Million individually or in combination with his spouse. (3) He must be a general partner, executive officer, or combination thereof for the issuer of the security.

Distinguish Primary Markets and Secondary Markets.

(1) Primary Markets are markets which shares are traded for the first time. This is facilitated by underwriters. (2) Secondary Markets occur after the IPO, these transactions of stock trade are between investors and other investors, the issuing company here is not involved.

What is a QIB, or Qualified Institutional Buyer?

A Qualified Institutional Buyer is an accredited corporation (investor) that can invest in securities which the general public can invest in. Can invest in privately issued securities. 1. QIB owns and invests a minimum of $100 million in securities on a discretionary basis. They must have a net worth of $25 million or over. 2. Qualified Institutional Buyers may include banks, investment and insurance companies, employee benefit plans, entities completely owned by accredited investors. It must be an institution that is domestic or foreign. 3. Individual may not be QIBs.

Who are accredited investors? Explain Regulation D of the SEC.

Accredited investors may be individuals or an entity (business firm) that can can purchase privately issued stocks. These investors are termed ACCREDITED because they have fulfilled requirements imposed by the SEC in areas such as: a. Net Worth b. Asset Size c. Income d. Governance Status (works within the company's board) e. Professional Experience. Common accredited investors include banks, insurance companies, employee benefit plans exceeding $5 Million, the right individual that means one of the three criteria set by the SEC. Regulation D of the SEC states that individuals and entities who are termed accredited are individuals with "a level of financial sophistication that would allow for a decreased need for protection provided by regulatory disclosure filings". These individuals are sophisticated enough to make wise investment choices in securities that do not follow all of the SEC requirements for public issuances of stocks.

What does it mean to be a holder of a company's stock?

Being an owner of stock means that you own a portion of the company's earnings and assets. Furthermore, holding a company's stock also means that you own any voting rights that come with the stock. You will be able to enjoy benefits of dividends and/or capital gains if the company is doing well.

About different classes of stock...

Companies have different classes of stock. Companies may customize different classes of stocks in any way which they want to. Why would they want to do that? Because certain people within the company may want even more voting rights per share that they own. For instance, the founders of a company. How are these stocks denoted by their class? BRKa BRKb Or BRK.A BRK.B Ex: Class A: Shares have 100 votes per share. Ex: Class B: Shares have 1 vote per share.

What are ways which firms are able to raise capital (through equity)?

Firms may be able to raise capital through private or public issuances. (1) A public issuance is the issuing of a stock to the public market. A company may raise money from the public if there is not enough internal funding that will sustain the firm's growth. Public issuances can only happen once the SEC approves of the firms, prior to this approval, a firm must provide financial statements, registration statement, etc. which may prove to be very costly. (2) A private issuance is when the company issues its own stocks to a select group of investors, called ACCREDITED INVESTORS. When a firm performs a private issuance, the firm may issue it without prior registration with the SEC.

As a stockholder, what happens if the company goes bankrupt?

If the issuing firm ever goes bankrupt, you do not lose any of your assets or earnings, instead, the largest amount that you could lose is the amount which you put down to purchase the stocks (known as limited liability) When a company is being liquidated, creditors as well as debt holders are paid back first, then preferred shareholders, then common shareholders.

What does it mean to raise capital?

Raising Capital means raising money through methods such as issuing debt or issuing equity. Capital raised is money raised for the firm which may be used towards completing positive NPV projects, or running daily operations of the company.

What is Regulation D?

Regulation contains three rules providing exemptions from a company needing to uphold all registration requirements, so it can legally perform a private issuance.

What is Rule 144(a) of the SEC?

Rule 144(a) is a rule within the SEC that provides a safe harbor (exempted) from certain requirements of the SEC 1933 for trading privately issued securities. It allows QIBS to trade privately issued securities among other QIBS, increasing the liquidity of securities. QIBS however are not allowed to trade these private issuances from the public.

What is SecondMarket / Nasdaq Private Market?

SecondMarket changed its name to Nasdaq Private Market. It provides a virtual exchange software for private companies. Also used to perform tender offers and share buybacks.

How do stocks trade?

Stocks are commonly traded on exchanges, which are places which buyers and sellers of stock get together to decide on a price to buy or sell the stock. Some exchanges may be physical locations, while sometimes stocks may be sold electronically (see virtual exchanges).

What is a stock?

Stocks represent a portion of ownership of a company's total assets and earnings. Acquiring more stock is equivalent to owning even more of a company.

What are the causes of a stock's price to change?

Supply and demand forces mostly, and what investors believe the underlying value of the stock is.

What is the New York Stock Exchange?

The New York Stock Exchange is the most prestigious exchange in the world. Stocks of the largest companies trade on this exchange. If you are listed on this exchange, that means you are one of the YUGEST companies.

What are the two main types of stocks that companies issue? Please explain the differences between these two types of stocks.

The two main types of stocks which companies issue are (1) Preferred Stocks, and (2) Common Stocks. (1) Preferred Stocks: stocks that represent a degree of ownership in the company. Usually does not come with the same voting rights as those of common stock. a. Preferred stock guarentees a fixed dividend into perpetuity. c. In the event of liquidation, preferred shareholders are paid before common shareholders. d. Preferred stock may be callable, meaning that the company will sell the preferred stock with a required option to allow the firm to repurchase the share back at any time for any reason. *Preferred shares are like the in between of common stock and debt (bonds). (2) Common Stock: represents ownership of a portion of a company's earnings and assets. a. Most popular type of shares out there. b. Investors get one vote per share of common stock that they own to elect board members of a company. c. Common stock yields higher returns than any other form of financial security due to its risk and volatility in price. d. If a company goes bankrupt, common shareholders are last on the list to have liquidation money allocated towards them. (after creditors, bondholders, preferred shareholders)

What is a company worth? What effects the valuation of a stock?

To value a company, you would use its Market Capitalization, which is the number of shares outstanding multiplied by the price per share. The earnings that a company has will affect the price of a stock, as well as other indicators which as investor's valuation. There is no one conclusion that explains the prices of stocks.

Explain what a public Issuance of Stock is and the different requirements.

When there is a public offering of stock (public issuance) securities are sold to investors in a process overseen by federal and state regulatory authorities. When a firm issues new shares, they usually have to use services from an investment banker underwriter. Once a firm is registered on a public exchange, they may be traded freely on an exchange.

Why would a company choose to issue debt versus equity?

When a company issues debt, it is legally obligated to pay back interest payments as well as the principle amount that they borrowed. If they do not pay back people who loaned the money, the company will face serious consequences. Issuing stock allows a company to raise capital without the obligation to pay back shareholders. Interest payments are also not required to be paid (Dividends are only legally required when they have already declared the dividend amount).