Class 6 - Choice of financing Flashcards
What is M&M’s theory on optimal capital structure
The capital structure has no impact on the value of the firm Assumptions Perfect information No taxes No transaction fees
paper published saying the capital structure has no value : we cant create value with the capital structure
obviously cest pas realiste comme assumptions
what is interesting cest que sil y a des taxes, la il y a un impact : si cest taxes deductible ca a un impact
The capital structure only serves to redirect cash flows to the various capital providers of the firm
however sil y a des taxes, cest plus avantageux detre avec de la dette pcq ca va etre déductible dimpot
What is Myer’s theory : oecking order
The pecking order theory :
Firms will prefer to use their internal sources of capital first before drawing on external sources
“Pecking order” theory
pecking order
tres realiste : les gens sont reticents a se diluer. they prefer to keep the ownership of their company
This phenomenon of “pecking order” would be more pronounced for SMEs
What is Jensen & Meckling theory : théorie de lagence
The agency theory
The firm must take into account conflicts
Between shareholders and managers
Between lenders and shareholders
agency theory : the firm as to take into account the different conflict : managers vs owners of the company.
even if they were transparent about what they do, we would need someone that know evreything of the sector
vc funds solve this issue by getting access to all information they can get to reduce the information gap to nothing, one way of reducing the agency costs.
another way is to involve themselves
they give themselves rights to interven in the company in which they invest
as they progress in the company, they will create informaiton and create informaiton about the technology. when they reach a certain level of information, they go to the stock market because they want the investors to assess the commercial success and potential
Agency conflicts impose an “agency cost” on the firm
for example, in the cost of debt, which reduces the positive impact of the leverage ; the agency theory discribes a conflict that creates agency cost.
cost of debt has cost created by the moral hazard : if theres self interest of management, debt lenders will put higher rates to cover the agency costs. if a company has a higher moral hazard, cost of debt will be higher
What is Berger and Udell’s theory : stages of the firm
The optimal capital structure varies according to the stages of development of the firm (age, size and transparency of the firm)
The more a firm ages, grows, and becomes more transparent, the more attractive its sources of capital become
the more a firm ages, the more its transparent and it become attractve for sources of capital.
capital markets are more attractive than vc funds because less expensive
so a firm that ages should have access to this source of capital and will grow and have better access to capital market : not every company has access to capital markets you have to grow in order to attain it. it also has to be transparent (publish reports, resuls etc) they have to disclose the nature of the activities to go to the capital market
vc funds invest with the intent to resell the company later on.
the better way to maximimze the value of the firm is by going to the stock market
the older the company, the better
SMEs must rely on internal sources of capital, accept a higher cost of funds, and finance themselves in the short term
What is Gregory, Rutherford, Oswald, Gardiner’ study’s response to Berger and Udell’s theory
younger firms have ebtter access to the capital markets than older firm
this is explained by the fact that younger firms represent better growth potential. public makrets look at companies in terms of growth potential. they want high returns and high growth
for an older large company going to market, it is less attractive to investors than a younger large company going to market because theres less growth potential so youger firms are more likely to use public markets, which invalidates burgers results.
example : st-hubert : has been around for a very long time (50 years) the company as demonstrated that over the course of the 50 years she already attained the maximum size. but if a company attain a big size after 5 years, theres more growth potential. it has to do with growth potential
“An Empirical Investigation of the Growth Cycle Theory of Small Firm Financing”
Younger firms are more likely to use public capital markets for financing than older firms
The results invalidate Berger and Udell’s theory on the relationship between the age of the firm and its access to the capital market
aspect of the burger theory as been studied by gregory ruthford
it quesitons the fact that as the firm becomes older and transparent, does it have better sources of capital. it tests the growth cycle model. the results partially support the growth cycle model. it says that the larger size the companies do tend to use public equity funds
as firm size grows, we should have better sources of capital
the study tests the relationship between firm age, growth and transparency.
the results werent totally in line with the theroy
What are Gazelles
“Gazelles” attract VCs and investors in the stock markets
They are more likely to go public and raise capital to finance their growth
gazelle : attain big size in a short period of time (ex : IT companies).
gazelle : speed of growth
What are some main sources of financing
Founders’ capital Angels Venture capital Bank loans Internal cash flows Mezzanine funds Capital markets - equity Capital markets - debt Private equity
What are some problems of start up financing and their source of funding
a typical problem of innovative companies is that there are start ups so a lot of uncertainty relative to the futur of the company
at that point in time, founders capital is typically the only source of capital and are very limited in amount
when a comapny grows and establishes itself, they attract angels investors
they are typically those who have been successful in companies and have a lot of net worth. they invest with the motivation that they have been successful and theyll be able to identify successfull companies
angels : Limited availability and variable depending on geographic markets
Subject to the economic situation
Many called, few chosen
What is the source of funding of innovative compagnies
when the company has reach a few investors, it becomes officially a company and starts attracting venture capital, it becomes an innovative company
venture capital : Expensive (40% - 75% and more)
More complicated (complex contractual relationships)
More “invasive” (investor activism)
But often unavoidable
vc will be invasive in the company.
vc is for may of the companies at that stage are the only source of management
What is the source of funding of SME
Internal cash flows : Often non-existent, or
Often insufficient
- use of bank loans : Banks do not lend to companies that do not have
tangible assets, or
relatively stable and predictable cash flow
Bank debt being short-term constitutes a significant risk of bankruptcy for the company
Bank debt is more expensive for SMEs - capital markets - equity : Variable appetite for “small caps” depending on the state of the market
High “governance” requirements
Strong competition on the stock market
as it grows, attain a size and attracts outside shareholders
the larger the company, the more access it has to equity market
to go to the equity market, you have to have a certain goernance stnadards : transparance, board of governance
- mazzanine funds : Debt + warrants (call options)
Requires increasing cash flow and an “out”
its available for companies already profitable that would need to acquire another company. not large anough to be on the equity market.
debt financing + upside of the company
What is the source of funding of large caps
- Capital markets - debt
Reserved for large companies… and governments
smaller compagny can have access but there not investment grade - Private Equity
Only intended for companies that can sustain significant financial leverage and access to the stock market
they want to buy out public comany, restructuer them and make them public again
What is the need for adequacy
there needs to be an addequacy between the type of financing you choose for a specific project
Shareholder / promoter preferences
Sources / types of funds
What is a typical project that is of interest for venture capital
R&D Investments in intangible assets Negative cash flow for a few years High technological risk High business risk Risk of “Hold-Up” on the part of entrepreneurs
What are the Shareholder / promoter preferences
Desire to maximize the effect of operational leverage through innovation
Willingness to maximize financial leverage
Willingness to maximize participation in value creation by minimizing ownership dilution
they want to benefit from the operationnal leverage that the company represents. they want to maximie the financial leveral (can be offered by the public euiqyt makrets : PE buys out and then put back on market where its cheaper so so they benefit from the financial leverage of the public equity makret)
What are some Constraints of shareholders / promoters
Impossibility of diversifying technological risk
Little or no choice in funding sources
when a founder finances its company through VC, they have little choice of sources of capital : theres only VC for funding
they are forced to concentrate on core business and they cant diversify their comapny
