[5] Equity Flashcards
What is venture capital?
What do most initially rely on?
What are those who invest in venture capital called?
Venture capital: Equity investment in new private companies(i.e., money invested to finance a new firm)
Most new companies rely initially on family funds and bank loans.
Some of them continue to grow with the aid of equity investment provided by wealthy individuals known as angel investors.
However, many adolescent companies raise capital from specialist venture-capital firms.
3 ways venture capital firms raise money to grow?
Venture capital firms:
→ pool funds from a variety of investors
→ seek out promising start-up companies
→ finance the firm’s operation (in exchange for a large share of the firm’s stock)
→ and work with these companies as they try to grow.
Sometimes other established companies also provide equity investment to new innovative firms; they act as corporate ventures.
Recently crowdfunding has been used to raise money from small investors via the web.
Venture capital firms characteristics:
Are they passive investors?
What type of firms do they specialise in?
What else do they provide apart from capital? x3
Venture capital firms are not passive investors;
they tend to specialize in young high-tech firms;
they monitor these firms closely;
they provide ongoing advice;
major role in recruiting senior management team;
their contacts are valuable to the business;
they can help the firm to bring its products more quickly to market.
Most venture capital funds are organized as ___ ___ ___ with a fixed life of about ___ ___.
___ and ___ funds and other wealthy private investors are the limited partners.
The management company of the venture capital firm is the ___ ___.
The general partner is responsible for:
making and overseeing the ___; receiving a ___ fee plus a ___ of ___ (called __ ___).
limited private partnerships, 10 years
Pension, mutual
general partner
investments
fixed, share of profits, carried interest
What is the Investment Policy of Venture Capitalist firms?
x2
What is the success of a new firm dependant on?
What does the Venture Capital firm do to encourage progress?
Investment policy:
accept high uncertainty if there is even a small chance that the company will become big/successful (returns can be significant)
identify failed investments early and accept the loss rather than trying to fix the problems.
Since the success of a new firm is highly dependent on the effort of the managers, some restrictions are placed on management by the venture capital company, and the funds are usually dispersed in stages, after a certain level of success is achieved.
Venture capitalists may cash in on their investment in 2 ways?
When the new business establishes itself, venture capitalists can sell their shares to a larger firm.
alternatively, the firm may become public;
its stocks can be traded in the capital market;
so, ventures have the opportunity to sell their stock and cash-in on their initial investment;
and entrepreneurs can retain control of the company.
What does the success of a venture capital firm require?
eg
an active stock exchange that specialises in trading the shares of young and rapidly expanding firms (e.g. Nasdaq in the US).
2 types of IPOs?
What type are most IPOs usually?
When do they usually occur?
Primary offering: new shares are sold to raise additional cash.
Secondary offering: existing shareholders cash in by selling part of their equity holdings (e.g., when governments sell their shareholdings in companies).
Many IPOs are a mix of primary and secondary offerings.
It occurs at a later stage of a company’s ‘lifetime’ (mainly, after it has established itself).
2 main reasons for an IPO?
raise new capital OR
enable shareholders to cash out
What are they main stages of an IPO? 6
Selection of an underwritter
Preparing a registration statement [for approval by the authority responsible for the operation of the stock exchange]
Publishing a prospectus
Arrange a roadshow
Book building
Selecting an appropriate issue price from this info
Define the following:
Underwritter registration statement Prospectus Road show Book building Issue price
underwriters: firms that buy an issue of securities from a company and resell it to the public; they also provide procedural and financial advice.
registration statement: a document with information about: the firm’s history and the proposed projects intended to be financed with the funds raised.
prospectus: a formal summary of the most important information from the registration statement.
Road show: talk to potential investors (e.g. pension and mutual funds) to get idea of how much stock they wish to but and for how much.
Book building: build a book of likely orders and use this information to set issue price.
Issue price: the initial price per share at which investors will buy the company’s stock.
3 main ways an IPO can be costly? jexplain
Spread: the payment of the underwriter - the difference between the price at which the underwriter buys the new issue and the issue price at which it is offered to the public (offering price).
Administrative costs: management of the process; legal counsels; financial advisers; accountants; fee for registration of new equity with the Stock Exchange Commission (SEC) /Financial Conduct Authority (FCA).
Other direct costs: printing; mailing, etc
Underpricing is a type of ‘hidden cost’ in the IPOs -Since the offering price is usually less than the true value of the issued securities, investors who buy the issue got a bargain at the expense of the firm’s original shareholders
Example: Assume that the issuing company incurs £1 million in expenses to sell 3 million shares at £40 each to an underwriter; the underwriter sells the shares at £43 each.
Q: What is the spread for this deal?
3 million x (£43 - £40) = £9 million
Example: Assume the issuer incurs £1 million in other expenses to sell 3 million shares at £40 each to an underwriter and the underwriter sells the shares at £43 each. By the end of the first day’s trading, the issuing company’s stock price is worth £70.
Q: What is the total cost of underpricing?
3 million x (£70 - £43) = £81 million
Explain how underpricing can actually generate higher returns?
Good example?
What do use to obtain a ‘fair’ valuation of a company?
The evidence shows that investors who buy at the IPO (low) issue price, on average, realize very high returns over the following days (when those shares started to be traded in the stock market).
↓
the price reaches and, many times, exceeds its true valuation
↓
excessive returns make the specific share desirable
↓
enhances firm’s ability to raise further equity capital in future
EG: eBay IPO issue price $18, The stock closed the day at a price of $47.375.
use Stock market to obtain a ‘fair’ valuation of a company
