Fin Mgt Ch. 15 Raising Capital Hoffman Rutgers
Six costs of issuing securities
(1) the gross spread, (2) other direct expenses, (3) indirect expenses, (4) abnormal returns, (5) underpricing, and (6) the Green Shoe option.
Important points of Dutch auction
1. All successful bidders pay the same price to encourage aggressive bidding 2. Compute the ratio of shares offered to shares bid at the offer price or better and allocate bidders that percentage
Costs of debt issues
1. Economies of scale (large fixed costs) 2. Investment grade have much lower direct costs
Key considerations for choosing a VC
1. Financial strength 2. Firm style (hands on or off, boutique or large) 3. References and previous success 4. Contacts and their network 5. Exit strategy
Reasons for stock decline following announcement of new equity issue
1. Managerial information: management has superior information and know when the firm is overvalued thus will attempt to issue new shares when market value exceeds the correct value 2. Debt usage: may reveal company has too much debt or too little liquidity 3. Issue costs
Four patterns of costs of issuing equity
1. Substantial economies of scale. The underwriter spreads are smaller on larger issues, and the other direct costs fall sharply as a percentage of the amount raised—a reflection of the mostly fixed nature of such costs. 2. The costs associated with selling debt are substantially less than the costs of selling equity. 3. IPOs have higher expenses than SEOs, but the difference is not as great as might originally be guessed. 4. Straight bonds are cheaper to float than convertible bonds.
Typical IPO costs
10% direct, 19% underpricing
Initial Public Offering (IPO)
A company's first equity issue made available to the public. Also called an unseasoned new issue or an IPO.
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. The stated reason for the Green Shoe option is to cover excess demand and oversubscriptions. Green Shoe options usually last for 30 days and involve 15 percent of the 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 (SEO)
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.
Oversubscription privilege
A privilege that allows shareholders to purchase unsubscribed shares in a rights offering at the subscription price.
Rights offer
A public issue of securities in which securities are first offered to existing shareholders. Also called a rights offering or a privileged subscription.
Registration statement
A statement filed with the SEC that discloses all material information concerning the corporation making a public offering. Required for all public companies with the exception that they're raising loans that mature within 270 days or issues less than $5 million
Regulation A
An SEC regulation that exempts public issues of less than $5 million from most registration requirements
Tombstone
An advertisement announcing a public offering.
Standby fee
An amount paid to an underwriter participating in a standby underwriting agreement.
General cash offer
An issue of securities offered for sale to the general public on a cash basis.
Winner's curse
Another reason why IPOs have such a large average return. When the average investor "wins" and gets the entire allocation, it may be because those who knew better avoided the issue. The only way underwriters can counteract the winner's curse and attract the average investor is to underprice new issues (on average) so that the average investor still makes a profit.
Gross spread
Compensation to the underwriter, determined by the difference between the underwriter's buying price and offering price.
Other direct expenses
Filing fees, legal fees, taxes - all reported on prospectus
Venture capital
Financing for new, often high-risk ventures.
Underpricing
For initial public offerings, losses arise from selling the stock below the true value. (Indirect)
Abnormal returns
In a seasoned issue of stock, the price of the existing stock drops on average by 3 percent on the announcement of the issue. This drop is called the abnormal return.
Underwriters
Investment firms that act as intermediaries between a company selling securities and the investing public.
Dilution
Loss in existing shareholders' value in terms of ownership, market value, book value, or EPS.
Indirect expenses
Not reported on prospectus - cost of management time spent working on new issue
Crowdfunding
The JOBS Act allows a company to issue up to $1 million in securities in a 12-month period, and investors are permitted to invest up to $100,000 in crowdfunding issues per 12 months.
Ex-rights date
The beginning of the period when stock is sold without a recently declared right, normally two trading days before the holder-of-record date.
Holder-of-record date
The date on which existing shareholders on company records are designated as the recipients of stock rights. Also, the date of record.
Lockup agreement
The part of the underwriting contract that specifies how long insiders must wait after an IPO before they can sell stock. Fairly standardized at 180 days.
Bookbuilding
The process of soliciting information about buyers and the prices and quantities they would demand
Dutch auction underwriting
The type of underwriting in which the offer price is set based on competitive bidding by investors. Also known as a uniform price auction. Very common in bond market and sole procedure used by US Treasury
Standby underwriting
The type of underwriting in which the underwriter agrees to purchase the unsubscribed portion of the issue.
Firm commitment underwriting
The type of underwriting in which the underwriter buys the entire issue, assuming full financial responsibility for any unsold shares. Most prevalent type in U.S. (95%+ of new issues)
Best efforts underwriting
The type of underwriting in which the underwriter sells as much of the issue as possible, but can return any unsold shares to the issuer without financial responsibility. (Uncommon)
Accounting dilution
When the market-to-book ratio is less than 1, increasing the number of shares will always cause EPS to go down.
Gross spread
direct fees paid by the issuer to the underwriting syndicate—the difference between the price the issuer receives and the offer price