MOS 1023 Lecture #7

Practical considerations in setting a dividend policy

-a company's dividend policy is about how the excess value in a company is distributed to its stockholders -It is extremely important that managers choose their firm's dividend policies in a way that enables them to continue to make the investments necessary for the firm to compete in its product markets

Bootstrapping

-Initial funding of the firm -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 -Other cash may come from personal savings, the sale of personal assets, loans from family and friends, use of credit cards -The seed money in most cases, is spent on developing a prototype of the product or service and a business plan -Usually lasts 1 to 2 years

Liquidating dividend

-A dividend that is paid to stockholders when a firm is liquidated

Special dividend

-A special dividend, like an extra dividend, is a one-time payment to stockholders -Larger than extra dividends and to occur less frequently

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 -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

Private versus Public Markets

-Because many smaller firms and firms of lower credit standing have limited access, or no access, to the public markets, the cheapest source of external funding is often the private markets -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

Tactics venture capitalists uses to reduce risk

-Funding the ventures in stages -Requiring entrepreneurs to make personal investments -Syndicating investments -In-depth knowledge about the industry

Disadvantages of going public

-High cost of the IPO itself -The costs of complying with ongoing SEC disclosure requirements -The transparency that results from this compliance can be costly for some firms

Origination

-Includes giving the firm financial advice and getting the issue ready to sell -The investment banker helps the firm determine whether it is ready for an IPO -Once the decision to sell stock is made, the firm's management must obtain a number of approvals -File a registration statement with the Securities Exchange Commission

Syndication reduces risk in two ways:

-It increases the diversification of the originating venture capitalist's investment portfolio -The willingness of other venture capitalists to share in the investment provides independent corroboration that the investment is a reasonable decision

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 -Private equity firm managers look to increase the value of the firms they acquire by closely monitoring their performance and providing better management -Once value is increased, they sell the firms for a profit. Private equity firms generally hold investments for three to five years

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 -Extra dividends are often paid at the same time as regular cash dividends

Distribution

-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

Underwriting— Determining the offer price

-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

Stock dividends

-One type of "dividend" that does not involve distribution of value is known as a stock dividend -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

3 ways stock is repurchased

-Open market repurchase -Tender offer (fixed price or dutch auction) -Targeted stock repurchase

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

-Sell to a strategic buyer in the private market -Sell to financial buyer in the private market -Initial Public Offering: selling common stock in an initial public offering (IPO)

Dividend

-Something of value that is distributed to a firm's stockholders on a pro-rata -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 -When a firm distributes value through a dividend, it reduces the value of the stockholders' claims against the firm -A dividend reduces the stockholders' investment in a firm by returning some of that investment to them

Advantages Going Public with IPO

-The amount of equity capital that can be raised in the public equity markets is typically larger than the amount that can be raised through private sources -Once an IPO has been completed, additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost -Going public can enable an entrepreneur to fund a growing business without giving up control -After the IPO, there is an active secondary market in which stockholders can buy and sell its shares -Publicly traded firms find it easier to attract top management talent and to better motivate current managers if a firm's stock is publicly traded

Venture capitalists provide more than financing

-The extent of the venture capitalists' involvement depends on the experience of the management team -One of their most important roles is to provide advice -Because of their industry and general knowledge about what it takes for a business to succeed, they provide counsel for entrepreneurs when a business is being started and during early stages of operation

Regular cash dividend

-The most common form, it is the cash dividend that is paid on a regular basis -Are generally paid on a quarterly basis and are a common means by which firms return some of their profits to stockholders -The size of a firm's regular cash dividend is typically 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

Underwriting

-The risk-bearing part of investment banking -The securities can be underwritten in two ways: on a firm-commitment basis and on a best-efforts basis

Stock repurchases

-They do not represent a pro-rate 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

IPO 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

Underwriting Syndicates

-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

Three basic costs are associated with issuing stock in an IPO

-Underwriting spread -Out of pocket expenses -Underpricing

Venture capital

-Venture capitalists are individuals or firms that help new businesses get started and provide much of their early-stage financing -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 -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

The exit strategy for venture capitalists

-Venture capitalists are not long-term investors in the companies, but usually exit over 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, the method of exit, what price is acceptable)

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? 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?

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

1. The high degree of risk 2. Types of productive assets 3. Informational asymmetry problems

Dividend policy

A firm's overall policy regarding distributions of value to stockholders

Underwriting— due diligence meeting

Before the shares are sold, representatives from the underwriting syndicate hold a due-diligence meeting with representatives of the issuer -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

Initial Public Offering (IPO)

One way to raise larger sums of cash or to facilitate the exit of a venture capitalist is through an IPO of the company's common stock First time stock are given a special name because the marketing and pricing of these issues are distinctly different from those of seasoned offerings

Reverse stock splits

Opposite of stock split

Out of pocket expenses

Include other investment banking fees, legal fees, accounting expenses, printing costs, travel expenses, SEC filing fees, consultant fees and taxes

The dividend payment process at private companies

It is not as well defined for private companies because: -Shares are bough and sold less frequently -Fewer stockholders -No stock exchange is involved in the dividend payment process It is easy to inform all stockholders of the decision to pay It is easy to actually pay it There is no public announcement 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

Private Markets

Many private companies that are owned by entrepreneurs, families, or family foundations, and are sizeable companies of high credit quality, prefer to sell their securities in the private markets even though they can access public markets

Investment bankers provide three basic services when bringing securities to market

Origination Underwriting Distribution

Private placements

Private placement occurs when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals -Private lenders are more willing to negotiate changes to a bond contract -If a firm suffers financial distress, the problems are more likely to be resolved without going to a bankruptcy court -Other advantages include the speed of private placement deals and flexibility in issue size -The biggest drawback of private placements involves restrictions on the resale of the securities

Underpricing

The difference between the offering price and the closing price at the end of the first day of the IPO

Underwriting spread

The difference between the proceeds the issuer receives and the total amount raised in the offering