IPO

Question 1

For example, if the face value of the bond is $1,000 and the conversion price is $50? what is the conversion ratio?

Answer 1

the conversion ratio would be 20 shares ($1,000 / $50).

Question 2

WHEN WE WILL WE CONVERT OUR BOND?

Answer 2

Vfirm - (final payment) x contracts / shares = P

When the value of the firm (minus the value of the bond repayment) divided by the number of shares you’d get upon conversion (which is the bond number times conversion ratio) is higher than the current market price of the share (P), it would make financial sense to convert the bond into shares, because the implied share price from conversion is higher than the market price.

Question 3

How to work out shares issued when using convertible bond?

Answer 3

To calculate the number of shares to be issued upon conversion, you multiply the number of bonds being converted by the conversion ratio. For example, if you have 10 convertible bonds and the conversion ratio is 50, you would receive 500 shares (10 bonds x 50 shares per bond).

Question 4

How does stock dilution work as a function of company value

Answer 4

• When converting a convertible to shares, we issue shares
• Bondholders now own a % of the company
• Bond holders only convert when their stake in the company is greater than the final payment

Question 5

How to work out stock value with and without conversion

Answer 5

Without conversion= look at equity after debt/Number of shares

• With conversion= Equity/new number of shares

Question 6

What does the decline in stock price after dilution represent

Answer 6

• Loss to old shareholders
• Gain to new shareholders

Question 7

How do small firms raise investment capital

Answer 7

• retained earnings
• Banks
• Venture capital

Question 8

What is venture capital?

Answer 8

Venture capital (VC) is a type of private equity financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential.

Question 9

How do you calculate the ownership for each investor after a new funding round?

Answer 9

Suppose a VC contributes $X to a startup.
After contribution, the startup is worth $V (‘post-money valuation’).
Assume an original investor (OI, e.g. owner) holds a fraction s (0 < s ≤ 1) of the pre-contribution firm.

What fraction of the post-contribution company do the VC and OI own?

VC → X/V
OI→ (1−X/V)×s

Question 10

How does VC monitoring overcome the free-rider problem of small shareholders mointoring companies?

Answer 10

The free-rider problem occurs when many small shareholders avoid the cost of monitoring a company’s management, expecting others to do it. However, venture capital firms, owning significant stakes in companies, are motivated to actively monitor management due to the substantial benefits they receive from it, thus overcoming the free-rider problem.

Question 11

How are VC’s compensated?

Answer 11

VC compensation usually has two parts:
Fixed fees:
a.k.a ‘Management fee’: a fraction (usually 2%) of the committed capital annually, regardless of performance

Incentive fees:
a.k.a ‘Carry’: a fraction (typically 20%) of any profit made above some promised return (hurdle rate)
Compared to GPs contribution, these are big numbers.

Question 12

How do VCs exit the portfolio firms?

Answer 12

M&A: The start-up is bought by another company.

IPO: Initial public offering
A company’s equity is available for the public for the first time.

Question 13

What are the benefits of an IPO for a firm?

Answer 13

Benefits:

1) Funds for investment

2) Diversify the initial investors.
Founders can cash out and use the money for other ventures. Current equity holders usually sell a fraction of their shares, but not a large fraction. Why not?

3) Exit strategy for VCs and other investors.
Founders want VCs and banks out (would rather have dispersed shareholders)
VCs and other early investors want out. Typically have a 5-10 year timeframe, want to realize return and move on.

Question 14

What are the disadvantages of an IPO for a firm?

Answer 14

Costs:
1) Monetary costs

Administrative costs
At IPO, 2–10%: there are big economies of scale in IPOs After IPO, expensive to comply with regulatory filing requirements after becoming a publicly traded company

Underwriting costs (7–11%): This is the fee that Investment Bankers charge for their services
Underpricing: IPO price &laquo_space;day 1 closing price
2) Disclosure requirements
3) Loss of control
4) Loss of freedom: there is now oversight by the regulator

Question 15

What are underwriting costs?

Answer 15

Underwriting costs (7–11%): This is the fee that Investment Bankers charge for their services

Question 16

What is underpricing?

Answer 16

Underpricing for an Initial Public Offering (IPO) is when a company sells its shares at a lower price than what they’re actually worth during the IPO. This often leads to a “pop” or price increase when the shares start trading on the open market. Companies might do this to attract more investors, make sure all the shares are sold, and create a positive buzz around the IPO. But it also means they might not raise as much money as they could have.

Question 17

What is the post issue stock price and how many shares should be issued at this price?
How much equity did the original stockholders give up?

Answer 17

Question 18

Post-IPO firm description:
What is the value of founders’ shares after the IPO?
What is the value of (new) investors’ shares after the IPO?

Answer 18

The Bottom line: As long as the issue is fairly priced, existing shareholders only lose issuing costs ($9.8M in this case)

Question 19

5 Suppose the issue was underpriced at $28/share. How much equity was sold?

How much did existing shareholders give away?

Answer 19

Question 20

What is a seasoned offering?

Answer 20

In other words, a seasoned offering is any additional issuance of stock by a company that is already publicly traded.

The term “seasoned” implies that the company has been around long enough to have gone through the IPO process and has decided to issue additional shares. These offerings can be used to raise new capital for the company, to reduce existing debt, or for a variety of other corporate purposes.

Question 21

What is a rights issue?

Answer 21

A rights issue is a way for companies to raise additional capital by offering existing shareholders the opportunity to purchase more shares, often at a discount to the current market price. These new shares are issued proportionally to the shareholders’ existing holdings.
An ‘X for Y’ rights offer means for every Y shares you own, you have the option to buy X more shares from the company.

Question 22

What is the value of right formula?

Answer 22

Question 23

Answer 23

Question 24

what does this mean? Day 1 closing price is on average 16% higher than the IPO price ( empirical evidence of IPO’s?

Answer 24

Indicates underpricing: Firms could have sold the shares for 16% more.

Question 25

If an IPO is fairly priced what do existing shareholders lose?

Answer 25

The Bottom line: As long as the issue is fairly priced, existing shareholders only lose issuing costs. (Underwriting costs)

Question 26

Which are bigger underwriting or underpricing costs?

Answer 26

Underpricing costs are much larger than the
direct costs.

Underpricing varies with uncertainty about the stocks value Larger firms are underpriced less. Underpricing is smaller for older firms.

Long run returns are abnormally small.

Question 27

What is the inuition behind the winner’s curse theory for why IPO’s are underpriced?

Answer 27

The winner’s curse theory for IPO underpricing is based on the idea that some investors have better information about a company’s true value than others. When a company goes public, investors with higher valuations are more likely to get the shares, but they might be overpaying for them if their valuations are too optimistic.

To reduce this risk, companies often underprice their IPOs. This encourages more investors to participate, helping to balance out overly optimistic investors. The underpricing can also create a positive initial performance for the stock, generating interest and momentum.

Question 28

How much money do we raise from an IPO

Answer 28

We raise the equity wanted + the underwriting costs

Question 29

Imagine you’re at an auction bidding on a mysterious sealed box. You don’t know exactly what’s inside, but you believe it’s worth $100. Some other people at the auction might think it’s worth $80, some might think it’s worth $120.

Now, if you win the auction, that means you likely had the highest estimate, so maybe you paid $120 for the box. But once you open the box, you discover that it’s really only worth $100 - this is the “winner’s curse,” the tendency for the winning bidder to overpay.

Now, let’s apply this to IPOs. When a company goes public, investors are like bidders at an auction. But unlike an auction, the company wants to make sure that whoever ‘wins’ (i.e., gets the shares) doesn’t feel like they overpaid.

So, the company might set the IPO price a bit lower, say at $80. This way, even those who estimated lower are more likely to bid. It also ensures that those who estimated higher don’t feel cursed for overpaying.

In summary, the winner’s curse theory suggests that IPOs are underpriced to make sure a wide range of investors participate and that they feel good about their investment after the IPO.
do you understand this ?

Answer 29

yes