Corporate issuance Flashcards
Types of ownership structure
Sole Proprietorship no legal identity, extension of owner
owner-operated business
owner retains all return and assumes all risk
profits taxed as personal income
financed personally/family/friends
General Partnership no legal identity, extension of partners
partner-operated business (two or more)
partners share all returns and assume all risks
profits taxed as personal income
financed personally/family/friends
Limited Partnership LP - limited partner - limited liabilies.
Corporation - limited liability for all owners
Life cycle of corporations
What is a SPAC and a direct listing
Special Purpose Acquisition Company (SPAC) - capital raise through IPO
- then SPAC conducts an acquisition within a specified
time period or funds returned to investors
Direct listing: No capital raised existing shares can be listed and begin trading.
Equity vs debt conflicts of interest
equity holders - limited downside, unlimited upside - prefer higher risk,
higher return investments by company
-
bondholders - limited upside ➞ prefer company investments that are
less risky that increase cash flow certainty
Share holder vs stakeholder theory?
Shareholder: interests of shareholders
is primary
other interests are
important only to the
extent that they benefit
shareholders
Stakeholder: interests
of all
stakeholders
gives more
prominence
to ESG
What is the principal- agent relationship and how asymmetric information arises and when it is higher?
Principal-agent relationship - created when a principal hires an agent
- the agent is expected to act in the best interests of the principal
asymmetric information: an unequal distribution of information - managers have more information than is made available to outsiders (owners/creditors) - decreases ability to assess performance.
higher info. asym. exists: complex products little transparency in financial accounting low levels of institutional ownership
Issues with using compensation to align interest
entrenchment - when BOD or mgmt. compensation is excessive,
may lead to risk avoidance - interested in keeping
empire building - if compensation is tied to size of business (e.g. assets) may lead to growth for growth’s sake
excessive risk taking - too much equity-based compensation may lead to too much risk-taking
but/ not enough - become more risk-averse
Describe the principal-agent relationships
Shareholder mechanisms
- Corporate reporting and transparency
- Shareholder meetings
- Shareholder activism
- Shareholder lawsuits
- Corporate takeover - proxy contest, hostile takeover
Creditor mechanisms
- Bond indenture - covenants
- Corporate reporting/transparency
- Creditor committees
Employee mechanisms
Labour Laws - describes standards for employee rights and responsibilities
- most countries - employees have the right to form unions
Employment Contracts - specify specific rights/responsibilities
Employee Stock Ownership Plan (ESOP)
Customer/supplier mechanisms
Contractual agreements
Govt mechanisms and common vs civil law
1/ Regulations - laws that companies must follow - compliance is monitored
2/ Corporate governance codes - companies may be required to
disclose their adoption of corp. gov. practices or explain why they have not.
Common law: generally considered to offer superior protection of shareholder or creditor interests
creditor actions generally more successful than shareholder actions.
Civil Law: aws created by statutes/codes
- judges just apply the law
- common law - judge can
follow/apply or create law
Responsible investing, Sustainable, and Socially responsible.
Responsible investing - the practice of considering ESG approaches in the
investment process
Sustainable investing - select investments based on positive ESG practices that may enhance returns (value-based)
Socially responsible investing - exclude undesirable/include desirable activities
in the investment decision (values-based)
ESG investment approaches
1/ Negative screening - exclude investments based on values/ethics or
(i.e. no alcohol/tobacco)
2/ Positive screening - include investments based on values/ethics/preferences
3/ ESG Integration - ESG factors are explicitly included in asset allocation,
security selection, and portfolio construction decisions
4/ Thematic Investing - investing in assets related to ESG factors/themes
5/ Engagement/active ownership - use of shareholder or bondholder power
to influence corporate behavior through direct engagement
- seeks targeted ESG objectives + financial returns
6/ Impact investing - investing to promote an ESG cause foremost, financial
return as well
Board mechanisms
What topics come under ESG?
What is a business model?
Business model - describes how a business is organized to deliver
value to its customers
- no universal definition, but widely accepted key elements
What are the components of the value proposition?
Customers/markets (who), firm offering (what) the product or service, Where - sales and delivery channels, pricing (how much) -
Types of pricing?
Differentiation
low - price takes
high - price setters
Price discrimination - different prices to different customers though :
tiered pricing - most commonly based on volume
dynamic pricing - different prices at different times
Auction/reverse auction - prices established through bidding
Pricing for multiple products
bundling - combining multiple products/services
razors-and-blades pricing - low price (or free) on a product and high margin pricing on repeat-purchase consumables
Pricing for rapid growth
penetration pricing - sacrifice margin in order to build scale
and market share
freemium pricing - allows a certain level of usage or functionality
at no charge - widely used with digital content
hidden revenue business model - free for users but generates
revenue elsewhere
Alternatives to ownership
Alternatives to ownership:
recurring revenue/subscription pricing
fractionalization - selling an asset in small fractions
- co-locating/co-ownership
leasing - tangible assets
licensing - intangible assets
- typically minimum volume or % of sales
franchising
Business organisation capabalities,
how the firm is structured to deliver value
- also called the ‘value chain
Profitability and unit economics
margins, BEPs, per unit revenue/costs
What are the business model types and how have they changed.
Business model types/ goods: manufacturer to retail
service: B2C, B2B
- digital technology has changed the economics of many
- traditional business models
location matters less
- outsourcing is easier
- digital marketing is more precise
Business model variations?
Variations:
Private label or ‘contract’ manufactures
- produce goods to be marketed by others
licensing arrangements - produce something using someone else’s brand name in return for a royalty
value-added resellers - not only sell but add value with
layered services or customization
franchise models - typical in service intensive business
E-commerce models
E-commerce models:
affiliate marketing - generate commission revenue for sales
generated on other’s websites
marketplace businesses - create a network (platform) of
buyers and sellers without taking ownership of the goods
aggregators - re-market products/services under its own
brand
Network effects and Platform business models, Crowd sourcing models, Hybrid
Network effects and Platform business models/ - produce an increase in
value to users as more users join
one-sided - FB
two-sided - Ebay
Linear business - value is added by the firm
platform business - value is added by users
Crowdsourcing business models/ users contribute directly to a product,
service, or online content
Hybrid business models/ combines linear + platform models
Summarising Business model
Macro and business risk
Macro risk ➞ risk from external environment (econ., legal, pol., reg.)
higher for cyclical sectors
Business risk ➞ how the business is managed/operated affects results
- captured by EBIT (pre-financing, pre-tax
Industry and company specific risk
Competetive, product market and execution risk
competitive risk - heightened due to a lack of competitive advantage
- the risk of a loss of market share
- higher when both market share and pricing power are low
- disruption introduces risk to even strong incumbents
product market risk - risk that market size is actually smaller
(i.e. market does not really value what you offer)
- highest pre-revenue
- existing markets may also shrink due to changing
consumer preferences, technological obsolescence, et
Execution risk: mgmt. may be unable to execute the strategy
- the more unproven or distant the strategy or mgmt. team,
the higher the risk
Components of business risk and what is the impact
Competitive intensity/ rivalry ➞ higher, profitability ➞ lower
- lower ROIC, lower margins, lower EBIT
Competitive dynamics in the value chain/ power of buyers/suppliers
threat of substitute products
Long-term growth and demand outlook/ slowdowns introduce excess
capacity and possible price competition
- risk to profitability
Others/ exogeneous shocks (geopolitical, natural disasters, etc.)
regulatory/tax
Business risk is captured impacts to EBIT or bottom line performance
What is operating leverage and financial risk
Operating leverage is FC/TC measures the degree a buiness can increase operating income by increasing revenue.
Financial risk refers to capital risk, mainly the level of debt in a company. Can be financing risk - cost gets higher or default risks
Financial leverage * operating leverage = total leverage.
Types of projects under Business maintenance and business growth
Capital allocation defiintion and process
Capital allocation principles
What are this issues with IRR and when may it not work
IRR assumes reinvestment at IRR - may not be realistic
IRR issue/ non-conventional CFs may produce multiple IRRs (as many
as there are sign changes)
What are the common capital allocation pitfalls
What are the types of real options relevant to capital investment
What are the key features in business models vp,vc and p
Net working capital definition and sources
CA - CL
Types of Financing structures
Pros and cons of each financing structure
Types of lines of credit
Working capital and liquidity profile will be a function of what?
Function of the business cycle, likely with seasonal/variable components
Liquidity and liquidity management definitions
Sources of liquidity
Pulls and drags on liquidity
Objectives of short term borrowing strategy and and factors influencing these strategies
What do 1/10 net xx mean?
1/10 net 30 means there is a 1% discount if paid within 10 days otherwise payment is due in 30 days.
Numerator gives the discount rate.
Limitations of CAPM
Issues with estimating cost of debt and methods
Yield to maturity method and Debt rating approach (when reliable bond prices are not available)
Methods of estimating equity risk premium?
Survey method (asking finance experts), Capm, Peer company analysis , Bond yield plus risk premium approach
Unlevered beta formula and method estimating beta of thinly traded company
Find peer company with similair business risk then delever and relever to the company you are valuing
What are floatation costs and the methods of incorporating them
Issue with method 1 is that the present value of the difference doesnt equal the cost of raising capital
Cost of equity using dividend discount model
Compare the business life cycle stages with their capital structures
What are the unique circumstances to the usual business cycle and capital structures?
Modgliani miller and its assumptions
What are MM prop 1 and 2 without taxes and is the effect of leverage
under MM Prop. I/II, leverage does not affect the value of a firm
or wacc, but does cause the risk of equity to
increase and therefore
MM propositions with taxes
Summary of MM with and without taxes for Value, cost of equity and cost of capital
What is optimal capital structure with debt in theory versus reality?
at the extreme, optimal capital structure = 100% Debt
wacc = 𝐫𝐝 (𝟏 − 𝐭)
- counterpoint ➞ personal taxes
- since interest is taxed higher than dividends or
capital gains, investors will begin to demand a
higher pre-tax return to debt (as equity availability
➞ Costs of Financial Distress (more likely)
- operating/financial leverage magnifies losses
- financial distress adds costs ➞ implicit and explicit
lost customers bankruptcy costs
employees
suppliers
agency costs of debt
- greater probability of default raises costs of debt
Factors affecting capital structure decisions: Capital structure policies and target capital structures
Financing capital invetsments
Financing capital investments - key financing decisions
typically tied to a specific investment or acquisition
- nature of the investment may be well or poorly suited to leverage
- well suited ➞ marketable, cash-generative, considered strong
- asset/liability mgmt. - short-term projects should
use short-term financing (ret. earn, s.t. debt)
- foreign investments typically financed substantially with debt
- hedges currency risk by borrowing in the same currency
as revenues earned
Market conditions
financings are often opportunistic
- borrow when rates are low, sell equity when share
prices are elevated
Information Asymettries and signalling
Signalling
- issuing equity seen as a negative signal
- mgmt. believes shares are overvalued or they
had no other alternative
Describe agency costs and Jensens hypothesis
Shareholder versus stakeholder theory
Describe the debt versus equity conflict
How does debt versus equity impact preferred shareholders, PE/controlling shareholders, Banks and private lenders
How capital structure decisions affect Banks and private lenders (continued) and other stakeholders
iii) Management & Directors
Issues b) when compensation is tied to the size of the business
- can lead to ‘empire building’ ➞ M&A that increases
size but not shareholder value
c) reliance on stock options can motivate
risk-taking behavior (only participate in the upside)
iv) Regulators/Government
- capital structure may be a regulatory issue
- capital structure may be influenced by global tax
rates
Describe what affects beta
What are the components of finance and business risk
Break even point formula
FC / contribution margin per unit, gives net income equal 0
Operating break even point
Operating fixed costs (no interest)/ contribution margin, gives operating income equal 0
Breakdown of total leverage in terms of contribution margin (P-VC)per unit financial costs FC
