Equity based financing Flashcards
What are the types of equity-based finance?
- stock market
- preference shares
- ordinary shares
- IPO
- venture capital
- Business angels
- Rights issues
- Placings
Discuss the stock market
consists of 2 roles
primary: enable business to access capital
secondary: allow investors to sell secuirties with ease (incl shares + loan notes)
Being “Listed” confers status on companies (implies that they are large and financially secure) and on managers (implies experience and importance)
Discuss venture capitalism
used by small and medium firms that need access to capital but cant access the stock market (prehaps due to insuffcient funds or unable to comply with regulations)
assosiated with high risk and high returns
venture capitalists seek out motivated oweners to increase security of a return on their investment
Discuss ordinary shares
a share entitling its holder to dividends which vary in amount and may even be missed, depending on the fortunes of the company.
paid last after debt instituions like banks and preference shareholders
entitled to residual profits after this - so if business succesful, could see higher return
investors are only liable for losses to the amount that they initally invested
ordinary shareholders control the company with their voting rights
Concentrated ownership: most shares are held by institutions, and so a few large investors can be very influential in voting strength
Discuss IPO
firm invites public to buy shares
broader range of people - better chance of aquiring LT finance
going public triggers the securities exchange act of 1934 which requires intense finacial reporting
the cost of complying with the SEC is costly
discuss placings
no invitation to public to purchase shares
shares are placed with selcted investors such as financial instituions
good for raising secondary capital
used for smaller fund raisings
cheap, simpler and less administration than rights issues
discuss rights issues
business obliged to to offer shares to current shareholders before being put on the market (pre-emption rights)
shareholders are offered a discount on the shares
motivates shareholders to buy more
control of the company not diluted
succesful way of rasing capital
• Rights issues usually succeed - so the “committed costs” of the issue are rarely wasted
disadvantages to rights issues from investor perspective
investor doesnt always get a bargain
should calculate the theoriteical excersize (TERP)
need to understand context behind the additional shares
If shareholders do not take up their rights, then their shareholding will be diluted.
discuss preference shares
a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends.
Fixed dividend = no growth on returns
Quasi-equity”: - fills the gap between debt and equity and aims to reflect some of the characteristics of both.
firm has ability to buy back shares
lower risk than ordinary shareholders shown by a lower rate of return
What are the issues with debt based finance
loan interest is a deduction from taxable profit
loans are classed as legally binding contracts
What are the issues with equity based finance
dividends are paid out of taxed income
dividend payouts are voluntary based on company profits
More equity = a dilution of existing shareholder base and of earnings
Permanent capital = a permanent drain on resources through dividends (and, long-term, a higher return is expected from equity than loans)
Issue with obtaining new finance from the stock market
(loss/reduction of control; compliance/corporate governance; disclosure)
investors dont want to invest in a bear market (market which shares are falling, encouraging selling)
what must an investor consider regarding the stock market
- Level and type of return desired (high initial income; growing income; capital growth?)
- Level of risk involved in obtaining the return
- Disposal potential (through secondary market or repayment by the issuing company)
- Investor’s tax position (beneficial tax treatment may influence the investment chosen)
- Influence or control gained (expect to pay a premium to obtain control)
- Market situations (investors are often just as reluctant to buy equities “cheap” in depressed markets as companies are to float new equities at low market levels)
