Equity Financing Flashcards
Raising equity finance
Methods for obtaining a listing and raising equity finance at the same time.
Methods for raising equity after the initial offering.
IPO- initial public offering
Offer for sale
From private to public.
Most popular method of raising finance in an IPO.
Issuing company they offer shares to the general public at a fixed price.
Both institutional and individual shareholders are invited to subscribe.
The sponsor = an underwriter, underwrites the share price.
Underwriting process
Within offer for sale
The sponsor or underwriter agrees to buy all the shares from the issuing company at a fixed price. Then they sell the shares to the general public on behalf of the issuing company.
But they take on a huge risk, as they are left with shares that the general public doesn’t want to buy. In this instance, the sponsor has to buy these shares in effect. Usually they insist that the company offers the shares at a low price in order to ensure heavy demand. Typically underwriters charge an approx 2% fee.
Offer for sale by tender - IPO
E.g google 2004 IPO
Went for the auction process where investors submit bids.
Investors can submit multiple bids
Company invites investors to make bids for shares. Announce a public share issue. And they invite institutional investors to buy shares.
Investors specify the price they are willing to pay.
Sponsor determines the strike price.
There still is an underwriter who the bids go through.
Those who offered a bid above the strike price get to buy at the strike price. = strike price
is the lowest possible successful bid.
Everyone pays the strike price.
Sponsor categories them in terms of the highest bid first: until the go down the list to get specified number of shares.
Risk that investors might undervalue the company.
Advantage = useful when it is difficult to value a company as the market determines the value. Moreover, where there is uncertain demand - share price will fluctuate in accordance with demand.
The lowest successful bid becomes the clearing price:strike price which all investors pay.
$108 per share.
But they overestimated the demand for shares but in practice it was only $85. Google wanted to raise $3 billion dollars but only raised $1.6 billion.
The strike price was this low because offer for sale by tender method was misunderstood as people bid near the minimum.
Also industry weakness in 2004 may have caused the underbidding.
Offer for subscription
Listing and raising capital - IPO
Partially underwritten as they can be stopped meaning it is a lot cheaper.
Share price can be aborted if not enough money is raised by the company.
Very attractive to growth companies.
Placings
Listing and raising capital
Shares are placed with clients of the issuing house.
Becoming more popular as it is cheaper way of issuing equity because there is no advertising costs involved.
Seasoned equity offerings
These are companies that are already listed on the stock market.
Rights issues
Key features
The most dominant method on the UK in terms of seasoned equity offerings
1) shareholders have pre-emption rights
2) Shares are offered to existing shareholders based on the %age they currently hold
3) shareholders can either buy the shares or sell the rights to the shares prior to everyone else - if they don’t buy, their overall shareholding is reduced. Of shareholder is entitled 3% of shares they don’t have to buy the full price
4) shares are offered at a discount different from the market value. -20% - 50%
5) most rights issues are underwritten
Very common for rights issues to be:
Deep discounted = shares are offered to existing shareholders at a massive discount to the market value.
Suggests less need for an underwriter meaning cheaper
Rights sued vs underwriter offerings
Rights issue paradox
Even though rights issues are cheaper, underwritten offerings are more popular
The company selects the more expensive way of issuing rights because:
(Smith, 1997)
Rights issue = deep discounted then the share price lowers but shareholder wealth is unaffected.
Underwriter offers increase the share price because the underwriter has certified information about the company mending shareholders are willing to pay more.
Insurance = if you use underwriter then it reduces the uncertainty of the offerings success but if deep discounted then the shares are cheap and attractive.
Timing aspect or element = proceeds of an underwritten issue are available sooner.
Distribution of ownership = underwriters provide a wider distribution of shares sold.
Consulting advice = from investment bankers then they have more expertise which is valuable advice needed.
Smiths hypothesis
Smith, 1997
Known as the monitoring cost hypothesis
= managers gain personal benefits from the use of underwriters
A week trip to london to get the deal sorted
= bigger argument = expensive for shareholders to monitor managers = free rider problem, rely on others to monitor managers. So shareholders are happy to pay an underwriter to monitor the company.
Other seasoned equity offerings
Placings- shares are sold at fixed price to small group of investors e.g clients of the underwriters
No pre-emotion rights
First rule = max discount is 5%
Can’t place more than 5% os share capital to ensure dilution doesn’t occur
Open offers
= a combination of rights issues and placings
= clawback entitlement cannot be sold nil paid as in rights issue
No limit on offer size as existing shareholders have the first bid opportunity
Maximum is 10%
Value of Pre-emotion rights
Myners 2005
Viewed as major strength of UK/EU law
Protect existing shareholders from a dilution of monetary value
Protect shareholders from a dilution of control
Rights issues could be cheaper than other equity issuance methods
Potentially with rights issues you can avoid underwriting fees through deep discounted rights issues.
Existing shareholders are prepared to finance company at lower cost than new investors as they know more about the company than outsiders.
Current issues with pre-emption rights
Rights issues process viewed as unnecessarily cumbersome and lengthy without an underwriter.
Guildlines suggest that generally where a company is seeking to raise more than 5% of share capital has been viewed as a rule which constraints a company as companies have had to forgo opportunities.
