How Firms Issue Securities (ElementsOfInvestments) Flashcards
When a company issues new shares or bonds for the FIRST TIME, it does so in the ——. Once that has been done, the stocks and bonds can be bought and sold between investors in the ——
Primary Market
Secondary Market
company does not receive money from the secondary market
bonds are the most common type of fixed income
Some bond issues are launched directly to institutional investors, rather than being offered broadly to the public or through retail markets. What is the name of the market (where the bonds are issued)?
Institutional Market
Under U.S. federal law, companies must register all securities offerings with the — unless they qualify for an exemption (does not have to register its securities before selling them).
SEC (Securities and Exchange Commission)
What are private placements?
A way for private companies to sell securities (stocks or bonds) directly to a small group of institutional investors or wealthy individuals without going through the expensive SEC registration process.
This is regulated under SEC Rules 144, 144A, and 145
Since private firms can’t sell shares on the stock market, they raise money through private placements instead of public offerings.
What does SEC Rule 144A allow?
Large institutional investors (Qualified Institutional Buyers or QIBs) to trade “restricted securities” privately.
What is the main priblem with private placements?
Lack of Liquidity
Trading in these restricted securities is severely limited compared to a listed security, both for legal and operational issues.
Definition of Liquidity
“Ability to transact a “normal” trading amount of a security (each market has a defined minimum size, for
example in the US equity markets 100 or 500 shares, in the US Treasury market $10mn is the regular quote size)
without materially affecting the price”.
Liquidity is defined by
Market Depth → The number and size of buy/sell orders waiting to be executed.
Bid-Ask Spread → The gap between the highest price a buyer is willing to pay (bid) and the lowest price a seller is asking (ask).
Daily Trading Volume → The total number of shares or contracts traded per day
JOBS (Jump-start our business start-ups) Act of 2012
Since 2007, new laws and several amendments to existing legislation and SEC regulations have been introduced to improve liquidity in restricted securities and make capital raising for private firms more efficient. Amongst there are the JOBS.
- increased the number of shareholders a company must have to register with the SEC from 500 to 2,000.
- exempted smaller public companies with less than $1bn annual gross revenues from Section 404 of the Sarbanes-Oxley Act, regulating reporting on a firm´s financial controls.
Initial Public Offering (IPO)
When a company sells its shares to the public for the first time.
Seasoned Equity Offering (SEO)
If a company is already public but wants to raise more money, it sells additional shares in the primary market.
IPO Process
1) Investment bank (who takes the lead in pricing and marketing the securities) forms a syndicate (group of bankers and brokers) to help sell the securities.
2) Lead investment bank wins a “mandate”: company selects an investment bank (lead manager) based on factors (deal terms) like
* Pricing of the stock/bond issue
* Size of the offering
* Maturity (for bonds)
3) A preliminary registration statement (called a “red herring”) is submitted to the SEC. This document describes the company, potential risks, and financial statements. SEC reads it.
4) When the final offering document (the prospectus) is approved by the SEC, the final issue price and size are announced.
When a company issues new securities, it does not sell them directly to investors. Instead, an ————, made up of investment banks and brokers, manages the sale.
underwriting syndicate
The company sells the securities to the syndicate, which then resells them to investors at the new issue price.
What does the underwriting syndicate get in return of reselling securities from company to investors?
a spread
which serves as their fee for managing the sale. So the issuing firm sells the securities at the
new issue price minus a spread, which serves as compensation to the underwriters.
2 types of underwriting agreements
1) Firm commitment underwriting: senior members of the syndicate (underwriters) purchase all the securities of a new issue and
take on the inventory risk, meaning they bear the loss if they cannot sell all the securities.
2) Best efforts underwriting: underwriters commit only to make their best effort to sell as much as possible of the securities offering.
A Shelf Registration
under SEC Rule 415
allows a well-known, seasoned issuer to register a new securities offering without selling all the securities immediately. Instead, the company can gradually sell the securities over a three-year period when market conditions are favorable, without needing to re-register each time.
IPOs
Once the SEC clears the registration statement and the preliminary prospectus is sent to investors, the lead managers organize —
roadshows to market the offering
This marketing process is crucial because it helps determine the final issue price and size of the securities.
What happens during roadshows?
after SEC approves and prospectus is sent to investors, the lead managers organise roadshows
large institutional investors provide feedback, which helps investment banks gauge demand and start building a book of orders (at this stage, these are just expressions of interest, not firm commitments)
What are the explicit costs of an IPO and what percentage of the funds raised do they typically represent?
These are the direct costs associated with going public and generally amount to around 7% of the funds raised through the IPO.
Why are IPOs often underpriced?
compared to actual demand
due to negotiations between investment banks and institutional investors
In a bull market, where investor sentiment and market trends are positive, —-—can see significant price increases once they begin trading on the public market.
“hot” IPOs
those highly anticipated due to the company’s potential
the statistical record for US IPOs suggests they are…
relatively poor long-term investments
What happens in a Direct Listing?
A direct listing is a method companies use to become publicly traded without raising new capital through a traditional IPO. Instead of issuing new shares, a company directly lists its existing private shares on a stock exchange, allowing current shareholders to sell their shares directly to the public.
This contrasts with a traditional IPO, where new shares are created, underwriters are involved, and capital is raised.
What companies use Direct Listings?
companies who do not need capital but want to become public so that early investors can cash out.
Spotify
it’s choosing a way to become publicly traded without raising new money by selling additional shares
primary goal of a direct listing is to allow the company’s early investors and employees to sell their shares directly on the stock market, which provides them an opportunity to easily “cash out” or convert their shares into cash
