Raising Capital - Chapter 15
A new equity issue by a publicly traded firm is known as ____.
seasoned equity offering
Which one of the following types of offerings tends to have the lowest direct costs?
straight bond offering
The market for venture capital refers to:
the private financial marketplace for new, high-risk firms.
When average investors in an IPO receive their full allocation of new shares because the smart money avoided the isue, they fall victim to ____.
the winner's curse
ade published in financial news such as Wall Street Journal used during and after the registration waiting period is called a
tombstone
In the 1999-2000 time period, companies missed out on $63 billion because of ____.
underpricing
Which new issue cost results from the stock being sold for less than its true value?
underpricing
When a firm ultimately prices its IPO above its targeted "file price range", the usual result is that _____.
underpricing is much more severe
Entrepreneurs seeking start-up capital must usually rely on ____.
venture capital
shelf registration
- SEC Rule 415 -- permits firm to register a large issue with the SEC and sell it in small portions - Reduces flotation costs - allows company more flexibility to raise money quickly - requirements: -- company must be rated investment grade -- cannot have defaulted on debt within last three years -- market value of stock must be greater than $150 million -- no violations of the Securities Act of 1934 in the preceding three years
types of long-term debt
- bonds: public isue of long-term debt - private issues: - term loans: - direct business loans from commerical banks, insurance companies, etc. - maturities 1-5 years - repayable during the life of the loan - private placements: - similar to term loans with longer maturity - easier to renegotiate than public issues - lower costs than public issues - no SEC registration
Private equity firms provide financing for firms that otherwise would have difficulty raising capital such as:
- closely held private firms - distressed firms - start-up firms
firm commitment underwriting
- issuer sells entire issue to underwriting syndicate - syndicate resales issue to the public - underwriter makes money on the spread between the price paid to the issuer and the price received from investors when the stock is sold - syndicate bears the risk of not being able to sell the entire issue for more than the cost - most common type of underwriting in the US
green shoe provision
- overallotment option - allows syndicate to purchase an additional 15% of the issue from the issuer - allows the issue to be oversubscribed - provides some protection for the lead underwriter as they perform their price stabilization function - provision found in all IPO and SEO offerings but not in ordinary debt offerings
venture capital (private equity)
- private financing for new, high risk businesses in exchange for stocks (individual investors and venture capital firms) - usually involves active participation by VC - ultimate goal: take company public; the VC will benefit from the capital raised in the IPO - VC financing is hard to find - expensive method of financing
Underwriters of an IPO may do which of following for the issuing client?
- sell the securities - price the securities - assist with the SEC registration process
A firm can use a shelf registration if ____.
- the firm's aggregate market value is more than $150 million - it is rated investment grade - it hasn't defaulted on debt in the past 3 years
A risk to the issuing firm of a "best efforts" underwriting agreement is:
- the issuing firm will not raise the needed capital - all the shares won't be sold
Whether a firm obtains capital by debt or equity financing depends on:
- the size of the firm - the firm's growth prospects - the firm's life-cycle stage
Which of the following are costs of issuing new securities?
- underpricing - The Green Shoe option - the spread
Flotation costs for issuing securities include which of the following?
- underpricing - management time - underwriter's spread - legal fees and taxes
best efforts underwriting
- underwriter makes best effort to sell the securities at an agreed-upon offering price - issuing company bears the risk of the issue not being sold - offer may be pulled if not enough interest at the offer price - if this happens, the issuing company does not get the capital and they have still incurred substantial flotation costs - not as common as it used to be
underwriters
- underwriting services: - formulate method to issue securities - price securities - sell the securities - price stabilization by lead underwriter in the aftermarket - syndicate = group of investment bankers that market the securities and share the risk associated with selling the issue - spread = difference between what the syndicate pays the company and what the security sells for in the market
selling securities to the public
1. management obtains permission from the Board of Directors 2. Firm files a registration statement with the SEC 3. SEC examines the registration during a 20-day waiting period 4. Securities may not be sold during the waiting period 5. a preliminary prospectus, called a red herring, is distributed during the waiting period. If problems arise, the company amends the registration, and the waiting period starts over 6. Price per share determined on the effective date of the registration and the selling effort begins
cost of issuing securities
1. spread - consists of direct fees paid by the issuer to the underwriting syndicate - the difference between the price the issuer receives and the offer price. 2. other direct expenses - direct costs incurred by the issuer that are not part of the compensation to underwritiers. These costs include filing fees, legal fees, and taxes - all reported on the prospectus. 3. indirect expenses - are not reported on the prospectus and include the cost of management time spend working on the new issue 4. abnormal returns - in a seasoned issue of stock, the price of the existing stock drops on average by 3% upon the announcement of the issue. This drop is called the abnormal return. 5. underpricing - for initial public offerings, losses arise from selling the stock below the true value. 6. green shoe option - gives the underwriter the right to buy additional shares at the offer price to cover overallotments
Private offerings must be limited to a maximum of how many investors?
35
best efforts cash offer
Company has investment bankers sell as many of the new shares as possible at the agreed-upon price. There is no guarantee concerning how much cash will be raised. Some best efforts offerings do not use an underwriter.
A firm's registration statement to issue securities will typically include all of the following except:
Details of the existing business, plans for the future, financial information but not the proposed price for the security.
With the ____ method of selecting a syndicate, the issuing firm offers its securities to the highest bidding underwriter.
competitive offer
Rita owns 500 shares of ABC stock. ABC has decided to issue additional shares and has offered these shares to Rita and the other shareholders. The new shares have not yet been offered to the general public. What type of offering is this?
rights offer
The compensation a firm pays to its underwriters is called the:
spread
The fee the underwriter receives for managing a securities issue is typically term the ____.
spread
The degree to which a venture capitalist becomes involved in the day-to-day operations of a firm is referred to as the venture capitalist's:
style.
IPO Underpricing
- IPO pricing = very difficult -- no current market price available - Dutch Auctions designed to eliminate first day IPO price pop - Underpricing causes the issuer to "leave money on the table" - Degree of underpricing varies over time
Issue methods
- Public Issue: - registration with SEC required - general cash offer = offered to general public - rights offer = offered only to current shareholders - IPO = Initial Public Offering = unseasoned new issue - SEO = seasoned equity offering - Private Issue: - sold to fewer than 35 investors - SEC registration not required
Which of the following are true about the venture capital (VC) market?
- access to venture capital is very limited - personal contacts are important in gaining access to the VC market
In return for early stage financing, venture capitalists will frequently receive which of the following?
- convertible preferred stock - ability to name some management - seats on the board
Private equity firms provide financing for firms that otherwise would have difficulty raising capital such as:
- distressed firms - start-up firms - closely held private firms
Which of the following are important considerations when choosing between venture capitalists?
- financial strength - style - exit strategy
venture capital stage financing
- funding provided in several stages - contingent upon specified goals at each stage - first stage: ground floor or seed money and fund prototype and manufacturing plan - second stage: mezanine financing - begin manufacturing, marketing & distribution
the quiet period
- legally required by SEC - limits company communication to the public to ordinary announcements - all relevant information should be found in the prospectus prior to this period - quiet period = 40 calendar days
lockup agreements
- not legally required but common - restricts insiders from selling IPO shares for a specified time period - common lockup period = 180 days - stock price tends to drop when the lockup period expires due to market anticipation of additional shares hitting the Street
Seasoned Equity Offerings (SEO)
- stock prices tend to decline when new equity is issued - signaling explanations: -- equity overvalued: if managment believes equity is overvalued, they would choose to issue stock shares -- debt usuage: issuing stock may indicate firm has too much debt and can not issue more debt - issue costs - issue costs for equity, both direct and indirect, are significantly more than for debt
The available evidence indicates that there are pronounced cycles in which of the following?
- the degree of IPO underpricing - the number of IPOs
Possible explanations for the drop in a stock's price after an announcement of a new equity issue are that the announcement is an indication that____.
- the firm has too much debt - management believes the firm is overvalued
Private placements of debt have the following advantages:
1. easier to renegotiate in case of financial distress of the issuer 2. avoids SEC registration 3. distribution costs are lower
What are the steps involved in issuing securities to the public?
1. obtain approval from the firm's board of directors 2. prepare and file a registraiton statement 3. prepare and distribute preliminary prospectus copies 4. determine a selling price 5. prepare and distribute a final prospectus
Which of the following are explanations of underpricing?
1. underpricing occurs with smaller issues in order to attract investors 2. underpricing occurs to the reward institutional investos who helped underwriters price the issue. 3. underpricing is a kind of insurance for underwriters.
Shelf registration allows firms to sell the registered shares within which one of the following time periods?
24 months
dutch or uniform price auction
Buyers: - bid a price and number of shares Seller: - work down the list of bidders - determine the highest price at which they can sell the desired number of shres -- All successful bidders pay the same price per share -- encourages aggressive bidding
competitive firm cash offer
Company can elect to award the underwriting contract through a public auction instead of negotiation.
firm commitment cash offer
Company negotiates an agreement with an investment banker to underwrite and distribute the new stocks. A specified number of shares are bought by underwriters and sold at a higher price.
direct rights offer
Company offers the new stock directly to its existing shareholders.
choosing a venture capitalist
Important considerations: - financial strength - compatible managment style - obtain and check references - contacts - exit strategy
standby rights offer
Like the direct rights offer, this contains a privileged subscription arrangement with existing shareholders. The new proceeds are guaranteed by the underwriters.
Which one of the following statements is correct?
Pension funds and life-insurance companies are large suppliers of private debt financing
shelf cash offer
Qualifying companies can authorize all the shares they expect to sell over a two-year period and sell them when needed.
direct placement
Securities are sold directly to the purchasures, well, at least until recently, generally cound not resell the securities for at least two years.
Which act sets forth the federal regulation for all new interstate securities issues?
The Securities Act of 1933
Which one of the following correctly states a requirement that must be met for a firm to use Rule 415?
The firm's bonds must be rated as investment grade
Which one of the following statements related to IPO underpricing is correct?
Underpricing rewards investors
IPO Underpricing reasons
Underwritiers want offerings to sell out: - reputation for successful IPOs is critical - underpricing = insurance for underwriters - oversubscription & allotment - winner's curse Smaller, riskier IPOs underprice to attract investors
An agreement in an underwriting contract that prohibits insider shares from being sold after an IPO is called _____ period
a lockup
A Dutch auction underwriting is also known as ___.
a uniform price auction.
The period after a new issue is initially sold to the public is referred to as the ___.
aftermarket
If a cash offer is a public offer, _______ is usually involved.
an underwriter
The difference between general cash offers and rights offers is that ____.
cash offers are offered to the general public and rights offers are offered first to exisiting shareholders
A Green Shoe provision is used to ___.
cover excess demand and oversubscriptions
Morris & Co. just announced that it will issue $30 million in new shares. What is the most expected reaction in the firm's stock price to this announcement?
decline in price
Which one of the following defines a term loan?
direct business loan for a period of one to five years
In additional to shelf registration, firms can also issue new equity securities using the ____ method.
dribble
Which one of the following parties generally suffers the greatest loss when newly-issued shares are underpriced?
existing shareholders
An investment bank that underwrites a security issue by buying the securities for less than the offering price and accepting the risk that the securities won't sell is using the ____ method.
firm commitment
Under the ___ method, the underwriter purchases all the shares to be offered.
firm commitment
The costs associated with new issues are known as ___.
flotation costs
According to a study by Lee, Lockhead, Ritter and Zhao, direct expenses across all offerings are ____ for equity offers than for debt offers.
greater
The first public equity issue made by a firm is called
initial public offering
new issue usually priced
last day of registration waiting period
The SEC's suggested changes to a registration statement are contained in which one of the following?
letter of comment
Paulette Stores just announced that it will issue $25 million in a new bond offering. What is the most expected reaction in the firm's stock price to this announcement?
little, if any, change in price
OPM
other ppl money
The most difficult job the underwriter of an IPO must perform for the issuing client is to....
price the issue.
Which one of the following terms best describes the broad area of equity financing for nonpublic companies?
private equity
The SEC's logic for requiring the "quiet period" is that all relevant information should already be publicly available in the ___.
prospectus
The preliminary prospectus, which contains much of the information found in the registration statement and is distributed to potential investors, is called a _____.
red herring
Which one of the following is given to potential investors during the period in which the SEC is reviewing the registration statement for a new securities issue?
red herring
A document required by the SEC for new public issues that contains the issuing firm's financial information, financial history, and details of the existing business is known as the ____.
registration statement