Equity Finance

Question 1

Discuss the stages involved in floating a company on the LSE.

Answer 1

Pre launch publicity
Decide technicalities (method price, underwriting)
Pathfinder prospectus
Launch of public offer
Close of offer
Allotment of shares
Announcement of price and first trading

Question 2

What are the different methods of floating a company on the new issue market of the main market?

Answer 2

Offer for sale
Offer for sale by tender
Introduction
Offer for sale by subscription
Placing
Intermediaries offer
Reverse takeover

Question 3

Explain offer for sale as a method of floating a company.

Answer 3

This is a public invitation by a sponsoring intermediary such as an investment bank.

Question 4

Explain offer for sale by tender as a method of floating a company.

Answer 4

This is where investors state the price they are willing to pay. A strike price is established by the sponsors after receiving all the bids.

Question 5

Explain introduction as a method of floating a company

Answer 5

In an introduction, a company joins the market without raising any capital. A company can do this if over 25% of shares are already public and there is fair spread of shareholders. Introductions involve no underwriting fees and little requirement for advertising, however opportunities for boosting company profile and visibility are limited.

Question 6

Explain offer for sale by subscription as a method of floating a company.

Answer 6

This can be called direct offer and is a public invitation by the issuing company itself. The issue is aborted if the offer does not raise sufficient interest from investors.

Question 7

Explain placing as a method of floating a company.

Answer 7

This is where new shares are sold directly to a group of external investors. Usually involves offering to a selected base of institutional investors. Allows capital to be raised at a lower cost and with more freedom also more discretion to choose investors. This results however in a narrow shareholder base and as such there may be lower liquidity in the shares once your company has been admitted to market.

Question 8

Explain intermediaries offer as a method of floating a company.

Answer 8

Shares are offered to financial institutions such as stockbrokers. Clients of those intermediaries can then apply to buy shares from them.

Question 9

Explain reverse takeover as a method of floating a company.

Answer 9

Instead of conducting an IPO the private company buys enough shares to control a publicly traded company, thereby becoming listed. It is simpler, shorter and less expensive.

Question 10

What are the advantages of ordinary shares/ equity?

Answer 10

No obligation to pay dividends
Capital does not have to be repaid
Greater flexibility (no covenants like debt)

Question 11

What are the disadvantages of ordinary shares/ equity?

Answer 11

High cost - direct costs of issue (administration, market pricing and costs of equity) and cost of return requires to satisfy shareholders.
Loss of control (dilution of existing shareholders, especially when issued at a discount)
Dividends cannot be used to reduce taxable profit (loss of interest tax shield)

Question 12

What are the advantages of debt?

Answer 12

Lower cost than equity finance - lower transaction costs and lower rate of return
Debt holders generally do not have votes
Interest is tax deductible

Question 13

What are the disadvantages of debt?

Answer 13

Committing to repayments and interest can be risky for a firm, ultimately the debt holders can force liquidation to retrieve payment
Use of secured assets for borrowing can be an onerous constraint on managerial action
Covenants may further restrict managerial action

Question 14

What are the advantages of preference shares?

Answer 14

Dividend optional
Influence over management
Extraordinary profits
Financial gearing considerations

Question 15

What are the disadvantages of preference shares?

Answer 15

High cost of capital
Dividends are not tax deductible

Question 16

What are the advantages of floating on AIM in preference to the main market of the LSE?

Answer 16

Sub market LSE allows smaller, high growth or less viable companies to float shares with a more flexible regulatory system than the LSE. AIM also has lower regulatory burdens as rules are kept relaxed to keep costs of membership and capital raising to a minimum.

Has nominated advisers not sponsors
Lower costs
No minimum capitalisation, trading history or percentage of shares in public hands needed
More accessible to small and medium sized enterprises
Lower on going costs
Do not have to disclose as much information

Question 17

Discuss the three main costs associated with gaining floatation of new shares on the stock exchange.

Answer 17

Market pricing costs
- IPOs normally under priced as companies eager to get full subscription rather than face the backlash associated with under subscription. This gives a bad image for shares.

The equity cost of capital
- an opportunity cost incurred by investors when they hold shares of one company (forgo return from other investments). Therefore firm need to generate a return that exceeds or is equivalent to the opportunity cost.

Transaction/ administration costs
- underwriting costs, stock market listing fee (the initial charge) for new securities, fees of the issuing house, solicitors, auditors, and public relations consultant, charges for printing and distributing the prospectus, advertising in national newspapers.

Question 18

What are the advantages and disadvantages of share issues?

Answer 18

Ads
- No obligation to pay dividends
- Capital does not have to be repaid

Disads
- High costs (direct costs + return requires to satisfy shareholders)
- Loss of control
- Dividends cannot be used to reduce taxable profit

Question 19

How to calculate the premium on a share?

Answer 19

Original share price - par value

Question 20

Which dividend gets paid first of shares?

Answer 20

The dividend on preference shares is paid before anything is paid out to ordinary shareholders. Dividends on preference shares can be reduced to 0 tho if needed.

Question 21

What are the advantages and disadvantages of preference shares?

Answer 21

Ads
- dividend optional
- influence over management
- extraordinary profits
- financial gearing considerations

Disads
- High cost of capital
- Dividends not tax deductible

Question 22

What is a cumulative preference share?

Answer 22

If dividends are missed the right to eventually receive a dividend is carried forward.

Question 23

What is a participating preference share?

Answer 23

As well as fixed payment, the dividend may be increase of the company has high profits.

Question 24

What is a redeemable preference share?

Answer 24

These have a finite life, at the end of which the initial capital investment will be repaid.

Question 25

What are convertibles preference shares?

Answer 25

These can be converted at the holder’s request into ordinary shares at specific dates and on present terms.

Question 26

What is a rights issue?

Answer 26

An invitation to existing shareholders to purchase additional shares in the company.

Question 27

What is debt finance?

Answer 27

It is something that has to be repaid, it is less expensive than equity.