Chap 15 Flashcards
What are some reasons why CFO’s cant make decisions and do analysis?
- Time
- Design of a capital investment project involves investment decisions that top managers do not see
- many capital investments don’t appear in the capital budget
- small decisions add up
- the CFO may be subject to the same kinds of temptations that afflict lower layers of management
What is the first step in creating a business?
Preparation of a business plan:
-Plan describing the proposed product, its potential market, the underlying technology, and the resources (time, money, employees, and plant and equipment) needed for success.
When venture capitalists invest in a start-up, what else do they often demand?
spots on the board of directors, NOT always the majority of seats though
-whether they do depends, for example, on how mature the business is and on what fraction they own. A common compromise gives an equal number of seats to the founders and to outside investors
What do start ups often do to raise venture capital?
- give themselves modest salaries
- recognize that in the case of failure, venture capitalists would be first to salvage all assets and they would get nothing
How do venture capitalists provide money to start ups?
Multiple stages of financing
What are mezzaine investors?
Mezzanine financing does not necessarily come in the third stage; there may be four or five stages.
The point is that mezzanine investors come in late, in contrast to venture capitalists who get in on the ground floor.
How do most companies initially raise equity?
- family funds and bank loans
- then move to wealthy individuals called angel investors
How do more adolescent companies raise capital?
Venture Capital firms: which pool funds from a variety of investors, seek out fledgling companies to invest in, and then work with these companies as they try to grow
What is crowdfunding?
- young companies have also used the Web to raise the money from small investors
- crowdfunded projects simply offer samples of the product in return for investment.
How are most venture capital funds organized?
as limited private partnerships with a fixed life of about 10 years
Who are limited partners? Who is the general partner?
Pension funds =limited
Management = general
What is carried interest?
When management receives a fixed fee and a share of the profits
What is private equity investing?
You will find that these venture capital partnerships are often lumped together with similar partnerships that provide funds for companies in distress or that buy out whole companies or divisions of public companies and then take them private
Are venture capital firms passive investors?
NO
For every 10 first stage venture capital investments, how many survive?
only about 2 or 3
What are the two rules for success for venture capitalism ?
- Don’t shy away from uncertainty; accept a low probability of success. But don’t buy into a business unless you can see the chance of a big, public company in a profitable market.
- Cut your losses; identify losers early, and if you can’t fix the problem—by replacing management, for example—throw no good money after bad.
What is a primary offering vs secondary offering (IPO’s)?
- Primary offering: new shares are sold to raise additional cash for the company
- Secondary offering: the existing shareholders decide to cash in by selling part of their holdings.
- many IPO’s are a mixture
Other than raising cash, why else might a company decide to go public?
- stock options
- reduce its borrowing cost.
- to create public shares for use in future acquisitions (MOST COMMON)
- to establish a market price/value for our firm
- to enhance the reputation of our company
- to broaden the base of ownership
- To allow one or more principals to diversify personal holdings
- To minimize our cost of capital
- To allow venture capitalists to cash out
- to attract analysts’ attention
- Our company has run out of private equity
- Debt is becoming too expensive
What is a consequence of SOX?
-an increased reporting burden on small public companies and an apparent increase in their readiness to go private.
Explain the procedure “going dark”
Companies can alleviate the reporting burden by reducing the number of shareholders to less than 300 and delisting their stock from the exchange.
The first step of an IPO is to select underwriters. Explain what their job is.
Usually they play a triple role:
- they provide the company with procedural and financial advice
- then they buy the issue
- finally they resell it to the public.
What is a registration statement?
document that presents information about the proposed financing and the firm’s history, existing business, and plans for the future
What is a red herring?
The company is allowed to circulate a preliminary version of the prospectus (known as a red herring) before the SEC has approved the registration statement.
Who is the book runner?
The managing underwriter
What is an all or nothing arrangement?
In this case, either the entire issue is sold at the offering price or the deal is called off and the issuing company receives nothing.
What is an all or nothing arrangement?
- In this case, either the entire issue is sold at the offering price or the deal is called off and the issuing company receives nothing
- Occasionally, where the sale of common stock is regarded as particularly risky, the underwriters may be prepared to handle the sale only on a best-efforts basis. In this case the underwriters promise to sell as much of the issue as possible, but they do not guarantee to sell the entire amount
What is a greenshoe offer?
This ensured that the underwriters were able to sell the extra shares to investors without fear of loss
What do underwriters get in return?
-receive payment in the form of a spread; that is, they were allowed to buy the shares for less than the offering price at which the shares were sold to investors
Since many of the costs incurred by underwriters are fixed, would expect that the percentage spread would decline with issue size?
Yes
What happens if a stock is underpriced at an IPO?
-Since the offering price was less than the true value of the issued securities, investors who bought the issue got a bargain at the expense of the firm’s original shareholders.
What does research say about investors who buy at the issue price?
on average they realize very high gains within the next few days
Why do investment bankers say underpricing is in the interest of the issuing firm?
They say that a low offering price on an IPO raises the price when it is subsequently traded in the market and enhances the firm’s ability to raise further capital.
What is the winners curse?
The highest bidder in an auction is most likely to have overestimated the object’s value and, unless bidders recognize this in their bids, the buyer will on average overpay. If bidders are aware of the danger, they are likely to adjust their bids down correspondingly.
-Uninformed investors who cannot distinguish which issues are attractive are exposed to the winner’s curse. Companies and their underwriters are aware of this and need to underprice on average to attract the uninformed investors
What is the gray market?
- where the winner’s curse would disappear
- only investors knew what the market price was going to be
- one response is to allow trading in a security before it has been issued.
what is “the money left on the table”?
the difference between the value placed by investors on the stocks and the amount that investors paid for the stocks.
What are the 8 steps to an IPO?
- Company appoints managing underwriter (bookrunner) and co-manager(s). Underwriting syndicate formed.
- Arrangement with underwriters includes agreement on spread (typically 7% for medium-sized IPOs) and on greenshoe option (typically allowing the underwriters to increase the number of shares bought by 15%).
- Issue registered with SEC and preliminary prospectus (red herring) issued.
- Roadshow arranged to market the issue to potential investors. Managing underwriter builds book of
potential demand. - SEC approves registration. Company and underwriters agree on issue price.
- Underwriters allot stock (typically with overallotment).
- Trading starts. Underwriters cover short position by buying stock in the market or by exercising greenshoe
option. - Managing underwriter makes liquid market in stock and provides research coverage.
What is the book building method?
- potential buyers indicate how many shares they are prepared to buy at given prices.
- used only as a guide to fix the price of the issue.
- it allows underwriters to give preference to those investors whose bids are most helpful in setting the issue price and to offer them a reward in the shape of underpric-ing.
What is the book building method?
- potential buyers indicate how many shares they are prepared to buy at given prices.
- used only as a guide to fix the price of the issue.
- it allows underwriters to give preference to those investors whose bids are most helpful in setting the issue price and to offer them a reward in the shape of underpricing.
What happened when all IPO’s were auctioned? Then what happened when they went back to the bookbuilding method?
- underpricing went down
- then underpricing went back up
What is the difference between discriminatory auction and a uniform-price auction?
Discriminatory: every winner is required to pay the price that he or she bid
Uniform Price: bidders both (all) pay lower bid price
- provides better protection against the winner’s curse
- result in higher proceeds
Why do uniform price auctions result in higher proceeds?
because there is little cost to overbidding in a uniform-price auction, but there is potentially a very high cost to doing so in a discriminatory auction
How might a financial manager use shelf registration?
- shelf registration: the registration statement is “put on the shelf,” to be taken down and used as needed
- a financial manager uses this to issue debt as needed
shelf registration is less often used for issues of common stock or convertible securities than for garden-variety corporate bonds.
true. idk what this means
What are eurobonds? globalbonds?
- underwritten by a group of international banks and offered simultaneously to investors in a number of countries
- Very large debt issues may be sold as global bonds, with one part sold internationally in the eurobond market and the remainder sold in the company’s domestic market.
Do larger or smaller issues haver lower spreads?
larger issues have lower spreads
How much do announcements of stock issues actually affect stock price?
fall in market value is nearly a third of the new money raised by the issue
What may happen if the company decides its stock price is too low?
- could scale back or delay expansion until stock price recovers
What may happen if a companys stock is over valued?
- if the firm sells shares at a new high price, it will help existing shareholders at the expense of the new ones
Why do companys mark down the price of their stock when an equity issue is announced?
because investors are not stupid and know the company will issue more stocks when they think its share price is higher than it should be
Do voluntary or involuntary issues cause a larger drop in stock price?
voluntary because the issue is outside the managers discretion
How do financial eonomists interpret the stock price drop on equity issue announcements?
- it is an informational effect
- NOT a result of the additional supply
Do pessimistic managers have greater incentive to issue equity or preferred stock/debt?
pessimistic = issue equity
Does an announcement of a debt issuance also result in a fall in stock price?
no
What is a rights issue?
Offering stock to existing shareholders before issuing to investors at large
When is the issue price of a rights offer irrelevant?
When the company successfully sells the new shares
General cash offers are typically sold at….?
a discount of about 3% on the previous days closing price
- underpricing is not a major worry
- this cost can be avoided by using a right issue?
What is a private placement?
When a company sells securities privately and therefore avoids the costs of registering with the sec
-sold to no more than 35 knowledgeable investors
What is a drawback of a private placement?
the investor cannot easily resell the secu- rity. However, institutions such as life insurance companies invest huge amounts in corporate debt for the long haul and are less concerned about its marketability.
