Equity Financing

Question 1

What is venture capital?

Answer 1

Capital invested in a project in which there is a substantial element of risk, typically a new or expanding business.

Equity investment in new private companies.

Question 2

How do new companies raise capital?

Answer 2

Most rely initially on bank loans and family funds.

Some grow with aid of equity investment from wealthy individuals (angel investors).

Many young companies raise from specialist venture-capital firms

Question 3

What is a venture capital firm?

Answer 3

A venture capital firm is an investment company that provides funding to startups and small businesses with high growth potential in exchange for equity.

Question 4

What types of companies do venture capital firms typically invest in?

Answer 4

Invest in early-stage, high-growth potential companies, often in technology, healthcare, and other innovative sectors.

Question 5

What kind of investors are venture capital firms and what does this mean?

Answer 5

Not passive investors meaning;

Monitor firms closely.
Provide ongoing advice.
Major role in recruitment for senior positions.
Their contacts are valuable for business.
Can help firm bring its products to market quickly.

Question 6

What is due diligence in venture capital?

Answer 6

Thorough investigation and evaluation of a potential investment to assess its viability and risk.

Question 7

How long does it typically take for a VC firm to make an investment decision?

Answer 7

Often takes several weeks to a few months.

Question 8

What is a venture capital fund?

Answer 8

Pool of capital collected from various investors (limited partners) to invest in early-stage and high-growth companies.

Question 9

What are the two main types of partners in a venture capital fund?

Answer 9

General Partners (GPs) and Limited Partners (LPs).

Question 10

Who are general partners (GPs) and who are limited partners (LPs)?

Answer 10

GPs - The managers of the venture capital firm (fund) who make investment decisions and actively manage the portfolio.

LPs - Investors who provide the capital but do not manage the investments. Pension and mutual funds and other wealthy investors.

Question 11

What is portfolio diversification in venture capital?

Answer 11

The practice of investing in a variety of companies to spread risk.

Question 12

What is the typical lifecycle of a venture capital fund?

Answer 12

7-10 years, including fundraising, investing, and exiting.

Question 13

What is the purpose of the “harvest period” in a venture capital fund’s lifecycle?

Answer 13

The phase where the fund focuses on exiting investments and returning capital to LPs.

Question 14

What is the process of fundraising for a venture capital fund?

Answer 14

GPs raise capital from LPs by pitching their investment strategy and track record.

Question 15

Why do venture capital funds impose restrictions on the management of new firms?

Answer 15

To protect their investment and maximise chances of success.

To align interests between investors and management.

To ensure corporate governance and oversight.

Question 16

What are the benefits of implementing restrictions on management for new firms?

Answer 16

Enhanced investor confidence and trust.

Improved operational efficiency and financial management.

Greater alignment of interests and accountability.

Question 17

What is an IPO and how does it work?

Answer 17

The process by which a private company offers shares to public for first time.

The company will decide how many shares it wants to offer, and an investment bank will suggest an initial price for the shares based on the predicted demand for them.

Question 18

Why do companies go public?

Answer 18

Raising capital or boosting a company’s public profile or enabling shareholders to cash out.

Question 19

How do IPOs benefit companies and venture capitalists?

Answer 19

For companies:
Provides access to public capital markets.
Enhances visibility and credibility.
Facilitates liquidity for shareholders.

For VCs:
Allows VCs to sell their shares to the public.
Provides liquidity and a profitable exit opportunity.

Question 20

What is the IPO price?

Answer 20

The price at which shares are initially offered to the public.

Determined through a process of valuation and pricing by underwriters.

Question 21

What are underwriters in the context of IPOs?

Answer 21

Financial institutions that help companies navigate the IPO process.

Assist with pricing, marketing, and distribution of shares to investors.

Question 22

What are the two types of offerings with IPOs?

Answer 22

Primary offering - new shares sold to raise additional cash.

Secondary offering - existing shareholders cash in by selling part of their equity.

Many IPOs are a mix of these offerings.

Question 23

What is the purpose of a prospectus in an IPO?

Answer 23

A legal document providing detailed information about the company, including financial statements, risk factors, and business operations.

Question 24

What happens during the “roadshow” phase of an IPO?

Answer 24

The company’s management and underwriters present the investment opportunity to potential institutional investors to generate interest and gauge demand.

Question 25

What is the lock-up period in an IPO?

Answer 25

A period (usually 90-180 days) after the IPO during which insiders and early investors are restricted from selling their shares.

Question 26

Why is the post-IPO performance monitoring important?

Answer 26

Ensures the company meets its projections and continues to provide value to new shareholders, impacting the stock’s performance and investor confidence.

Question 27

How does the IPO process affect company management?

Answer 27

Management must adapt to public company responsibilities, including regular financial reporting, investor relations, and governance.

Question 28

What is the main costs associated with an IPO?

Answer 28

Spread - the payment of the underwriter = difference between price which underwriter buys new issue and the issue price at which it was offered to public (offering price).

Administrative costs - management of the process; legal counsels; financial advisers.

Under-pricing IPOs

Question 29

What is underpricing in the context of IPOs?

Answer 29

Underpricing occurs when the initial offering price of an IPO is set lower than the price at which the shares trade once they hit the public market.

Question 30

Why does underpricing occur in IPOs?

Answer 30

Risk Mitigation: Underwriters price IPOs conservatively to reduce the risk of the offering failing (where demand for shares is lower than expected).

Market Attraction: A lower price can generate more interest and demand from investors, ensuring a successful launch.

Reputation of Underwriters: Successful IPOs (those that rise post-offering) bolster the reputation of the underwriters, attracting future business.

Investor Satisfaction: Ensures that initial investors (usually institutional investors) see immediate gains, creating positive sentiment and future investment opportunities.

Question 31

What are the benefits of underpricing an IPO?

Answer 31

Successful Launch.

Market Momentum: A significant price jump can create positive news and market buzz, attracting more investors.

Reduced Risk.

Question 32

What are the drawbacks of underpricing an IPO?

Answer 32

Lost Capital: The company raises less money than it potentially could have if the shares were priced higher.

Equity Dilution: More shares need to be issued to raise the same amount of capital, diluting existing shareholders’ equity.

Perceived Value: Can give the impression that the company’s shares are undervalued or that the company lacked confidence in its valuation.

Question 33

How can companies minimize underpricing?

Answer 33

Accurate Valuation: Conducting thorough valuations and understanding market conditions.

Experienced Underwriters:

Investor Communication: Effective communication during the roadshow can better gauge demand and set a fair price.