Financing Decisions and the Enterprise Value - Equity Instruments

Question 1

What are equity financing instruments?

Answer 1

Are represented by shares, available for trading in secondary markets (when previous IPO) and have a set of rights associated to them.

Question 2

What are the fundamental rights associated with the equity financing instruments (shares)?

Answer 2

-Ownership - claim over cash-flows
-Management and control rights - like voting rights
-Right to dividends
-Preference rights in future stock issues - in the same proportion of the shares already owned

Question 3

What are the main classes of shares?

Answer 3

-Common or ordinary shares
-Special shares
-Preferred stock

Question 4

What do ordinary shares consist in?

Answer 4

Proportional voting rights, no prefferenc in dividend distribution but control rights, and returns in the form of dividends and capital gains. One-Share-One-Vote type of shares

Question 5

Why are special shares previleged?

Answer 5

They offer non-proportional voting rights - special power in decisions. Dividends are the same as in common shares. - Golden shares type

Question 6

What are the main differences between common shares and preferred stock?

Answer 6

Common shares give proportional rights in terms of voting, and returns in form of dividends and capital gains. Also, investors don’t have priority dividend in case of bankruptcy, while preferred stock usually gives no voting rights, but have priority of dividend and asset claims and the dividend rigts aren’t proportional.

Question 7

What other equity instruments were presented?

Answer 7

-Warrants - call options over company shares
-Tracking stocks - shares issued by holdings where the dividends given are according to only one of the companies holded
-Contingent Value Rights - put options

Question 8

How can we get equity financing through equity crowdfunding?

Answer 8

Companies can raise shares and sell them to the crowd; it allows to reach a larger audience.

Question 8

What are the different sources of Equity financing?

Answer 8

1) Four F’s
2) Equity Crowdfunding
3) Retained Earnings
4) Venture Capital and private equity
5) IPOs
6) Seasoned equity offering

Question 9

What are the main reasons for profit retention?

Answer 9

-Financing of new projects
-Existence of market frictions
-Share placement risks
-Capital dilution
-Lower cost of capital

Question 10

What is a benefit of equity financing through retained earnings?

Answer 10

The cost of retained earnings is lower than the cost of new share capital.

Question 11

How does equity financing through venture capital works?

Answer 11

Venture capital pulls money from people and puts it in a fund to latter invest in all the companies they think will be profitable

Question 12

How does raising equity through an IPO works?

Answer 12

The companies shares are sold in the market for the first time , and the company can sell new or standing shares, although only new shares will raise capital - in standing shares, only the share holders will get money.

Question 13

What are the phases of an IPO?

Answer 13

1) Find support of an investment bank
2) Company valuation, price and number of shares to sell, and method of sale
3) Register of preliminary prospects of the offer through the regulator - CMVM em Portugal
4) Roadshow
5) Final registration and definition of price and ofering price
6) Distribution of shares
7) Start of trading
8) The day after

Question 14

Why do companies need the support of an investment bank to proceed with an IPO?

Answer 14

They need advising, need some of the investment bank activities like the underwiting of shares (help selling the shares and if there are some left, the inv estment bank will buy them), and their reputation as a garantee for the future shareholders - to assure they’ll get the real information

Question 15

What are the 3 presented methods of sale for an IPO?

Answer 15

• Fixed price - if the demand is higher than the issuing, the investors will get a certain percentage of the shares they want to buy pro rata
• Bookbuilding - investors need to downplay their expectations because the investment bank will based the share price on them, but they can’t do that too much since the investment bank will promise more shares to the best offers.
• Auction - the offers from the investors are lined from highest to lowest, the company will distribute the shares and their price will be the offer where the last share “falls”.

Question 16

What is the purpose of the road show previously to an IPO?

Answer 16

To present the operation to investors and stimulate their interest in buying shares

Question 17

Between overpricing or underpricing, what is the best for the company on an IPO?

Answer 17

If underpricing, even if there is a transaction of value from the existing shareholders to the new ones, and the bearing of opportunity costs, with overpricing investors will be disappointed after and that will be bad for the company and its reputation.

Question 18

Shareholders most likely would be able to benefit from selling their shares, however, that would bring the share price down and due to perception might stop investors from buying, so what can be done to stop that?

Answer 18

Shareholders may sign a deal to not sell there shares during a certain period after the IPO - lockup period

Question 19

What are some of the adantages of market listing?

Answer 19

-Alternative sources of financing
-Prestige
-Risk diversification
-Induces the adoption of better corporate governance

Question 20

What are some of the disadvantages involved in market listing?

Answer 20

-Issuing costs
-Listing fees
-Agency costs
-Loss of confidentiality

Question 21

What is the Greenshoe?

Answer 21

Option for the company to increase the number of shares offered - if the price after the IPO is higher than the offering price (overpricing) -> exerts the option

Question 22

What are some possible explanations for underpricing?

Answer 22

-Winner’s curse - uninformed investors always expect underpricing
-Signalling
-Cascade effect
-Compensate investors for information costs
-Looking for a greater ownership dispersion
-Motivate the lead manager to act in the interest of the company
-Market innefficiency

Question 23

What forms may the new shares issued by listed companies take? Forms of Season Equity Offering

Answer 23

-General Cash Offers
-Private Placement
-Rights Offerings

Question 24

In what consists General cash offers?

Answer 24

Shares are offered to the general public, but for this, current shareholders have to give up their right to buy new shares in the same proportion of the ones theu already own. In this, there is a reference price, that should be lower than the market price, or investors would just buy the shares in the secondary market - there will be a transfer of value from existing shareholders to new shareholders.

Question 25

What is a private placement and how does it work?

Answer 25

Shares are sold directly to one or small number of investors. The price can’t be higher than the market price, or investors can get the shares in the secondary market cheaper - transfer of value from existing shareholders to new shareholders. this method presents lower costs but is directed to a smaller number of investors.

Question 26

What is rights offerings and how does it work?

Answer 26

Existing shareholders have a preference in buying the new shares pro-rata of shares held and can exercise it or trade - shares have rights and those rights can be traded, and because of this call option, the lower price than the market price doesn’t affect the shareholders. Shareholders who don’t exercise the rights nor trade them will loose wealth. Shareholders may wave their right to buy by a majority decision.