chapter 2- equity: the lifecycle of a company

Question 1

what is a company’s working capital?

Answer 1

their outgoings

Question 2

what is venture capital?

Answer 2

a source of equity funding for young and fast-growing companies

Question 3

once a company is listed, what it can it do with its shares?

Answer 3

• buy other companies through M&A

- these are either agreed bids (where the target agrees to be bought) or hostile (where the target’s directors resist)

Question 4

why is fixed capital needed for businesses?

Answer 4

• for long term funding
• e.g. to buy the shop, fit it out, buy a van for deliveries etc
• ^these are assets of the business that you need otherwise not in business at all

Question 5

why is a working capital and why is it needed for businesses?

Answer 5

• their outgoings
• paying for staff, electricity, water etc
• money that keeps the business going
• ensures cash flow, which without, would cause a cash flow crisis

Question 6

what are the 2 types of funding businesses need?

Answer 6

fixed capital

working capital

Question 7

what is equity finance and what is it used for?

Answer 7

• provided by investors
• professional equity investors are also known as venture capitalists/ VC’s
• this is because investing in a new business is risky

Question 8

what are the 3F’s in the city and what do they mean?

Answer 8

family, friends and fools
these are people who are more likely to invest as they don’t want to disappoint and believe you have a great business prospect

Question 9

how many businesses go bust in the first 5 years?

Answer 9

3 out of 5

Question 10

how much do venture capitalists seek to own of your business and why?

Answer 10

over half as it is high risk and they want to ensure that their return is adequate
eventually, they will sell their investment in order to receive profit and then invest back into future start-up businesses

Question 11

what are the 4 exit routes for venture capitalists?

Answer 11

1. recycling- selling their stake to another VC - this is because different VC’s provide different funding- some provide seedcorn or start-up funding, whereas others invest in businesses that have some heft, also known as late- stage equity.
2. MBO/ management buyout- happens in 2 circumstances:
3. founders of a business buying a stake back from an original VC backer
4. managers of an established business buying it off the parent company because it is non-core to the parent companies strategy
5. trade sale- VC will encourage the founder to sell the business to a bigger company who could help it get to the next stage
   this can beef it up or diversify the business
6. flotation- transfer from private to public- involves doing an Initial Public Offering (IPO)
   this means shares are listed and could be sold on the LSE

Question 12

what are some limitations of flotation?

Answer 12

• the company must consult shareholders with any decision
• need to provide financial details on a regular basis
• respond to pressure from biggest shareholders in terms of how you run your business

Question 13

what are the advantages of flotation?

Answer 13

more investors= shares will be in demand= price will go up= if you want to issue more shares, you will raise the capital more cheaply

Question 14

how is the LSE a business?

Answer 14

• can list itself
• charges companies to list
• charges investors a fee for buying and selling their shares
• sells information generated by the buying and selling activity

Question 15

what is insider dealing?

Answer 15

the trading of a public company’s stock or other securities based on material, nonpublic information about the company
it is a criminal offence

Question 16

what does the LSE want to ensure?

Answer 16

1) that companies are transparent about what they are doing and how
2) investors are operating on a level playing field and aren’t trying to gain unfair advantages over each other

Question 17

give 2 examples of markets for company’s to float on?

Answer 17

LSE- London stock exchange (businesses 3 years plus)
AIM- alternative investment market (owned and regulated by LSE) (companies less than 3 years of trading history and riskier)

Question 18

what are some requirements of listing on the LSE?

Answer 18

sponsor- these chaperone companies to ensure that they follow the listing process
publishing a prospectus- this explains what the business is about, how it has done and how well it is likely to do. It contains detailed financial information, for instance about cash flow
the company also agrees to regularly update information to notify its shareholders

Question 19

from the company’s perspective, what does the success of flotation depend on?

Answer 19

1) whether its the sort of business with good prospects that investors want to invest in
2) the state of the market in general

Question 20

what is involved in getting a share issue underwritten?

Answer 20

where a broker is sponsored and acts a bit like insurance- for a fee, the company knows that any shares not bought will still be bought

Question 21

what are the different types of listing on the LSE?

Answer 21

1. introduction- where no fresh capital is raised, 25% of their shares are in public hands, doesn’t require underwriting as there are no new shares, is only listed for its shares in issue to be publicly traded on the exchange, cheapest way
2. placing/ private offering- offered a sale on a selective basis, mainly to institutional investors, often used by smaller businesses where the placing is on behalf of VC’s or existing shareholders, cheap but the company ends up with a narrow shareholder base as the main aim is to increase the number of investors without a full blown public offer
3. public offer- shares to anyone who wants them, issues that are underwritten and require a full-blown prospectus, most expensive route but widest spread of investors and raises the largest amount of fresh capital

Question 22

what does the term over-subscribed mean when referring to issues?

Answer 22

if the demand exceeds the number on offer

Question 23

what does the term under-subscribed mean when referring to issues?

Answer 23

when underwriters pick up the unallocated shares at the agreed price

Question 24

what is considered a premium and discount in relation to shares?

Answer 24

once shares are issued or sold and are traded, if they rise above the issue price then that is considered premium
if below issue price, then discount

Question 25

what is and when will a company publish a pathfinder prospectus?

Answer 25

it contains information in draft form
is used to market the issue to selected potential investors on a restricted basis
used if a company is coming to a market via a placing/ public offer
it is sometimes known as a red herring as it contains text in red indicating that some information is still not fully finalised

Question 26

what is a book-building process and when would it be best used?

Answer 26

it is the process by which an underwriter attempts to determine the price at which an initial public offering (IPO) will be offered
would be used when there are big issues

Question 27

what are secondary issues/ rights issues?

Answer 27

where existing shareholders are given the opportunity to buy a set number of new shares in the company they own
this prevents dilution

Question 28

what are rights issues called in the US?

Answer 28

seasoned equity offerings

Question 29

what are listed companies requirements based around?

Answer 29

disclosure of price sensitive information (any information about the company that might affect its share price)
and
significant transaction disclosure

Question 30

why do some multinational companies be listed in more than one country on the LSE?

Answer 30

to gain the benefit of interest from international investors

Question 31

what are 2 ways in which when entering M&A, companies get taken over?

Answer 31

consolidation or diversification

Question 32

what is consolidation in M&A?

Answer 32

where you acquire a business in the same sector as you or one that is part of a supply chain (also known as vertical integration)

Question 33

what is diversification in M&A?

Answer 33

moving into a different business sector to spread risk and potentially increase returns
can do this in 2 ways:
1. starting up another business
2. taking over an established business

Question 34

what are recommended vs hostile bids?

Answer 34

recommended- directors of the target recommend the bid to their shareholders. advise them to accept the bidder’s offer
hostile- if this is rejected, then the bid becomes contested

Question 35

what is a fiduciary duty?

Answer 35

a duty of trust

directors are under a duty to recommend a bid if it is in the shareholders’ interest

Question 36

what do activist shareholders do?

Answer 36

• buy shares cheaply
• demand the company does something to change and then wait for shares to go up
• sell out at a profit

Question 37

what are dawn raids?

Answer 37

where a bidder would swoop on a target’s shares and buy them up early in the day before anyone knew what was happening

Question 38

what is in place to prevent dawn raids?

Answer 38

rules that require stakeholders to discuss their stake building if above a certain limit
to make a full offer for all the shares once they hold a significant stake

Question 39

what happens when a bidder has 90% of the shares of a company?

Answer 39

they are forced to buy the remaining 10% for the same terms as the original offer

Question 40

what is mezzanine finance?

Answer 40

lies midway between equity and debt

Question 41

when is something considered a quick flip?

Answer 41

where companies are taken over, broken up, bits are sold and then the rest is re-listed
it is considered a quick flip if done within the space of 3 years
when selling off bits and re floating the company, this creates much more than the initial buying of the company, which is how they make profit