Lecture 5: Exits & IPOs Flashcards

1
Q

What is an exit?

A

An event that allows institutional investors to monetize the investment into a venture

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2
Q

What are the types of exits?

A

1) IPO
2) Acquisition (trade sale)
3) Entrepreneurs buyout
4) Liquidation

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3
Q

What is an IPO?

A

Shares are sold to the public on the stock market.

Usually this is a partial exit, as VC retains some of the stake in the company, receiving both new shares and cash for the old shares.

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4
Q

What is an acquisition (trade sale)?

A

A corporate buyer (e.g. Google) buys all the shares in the company.

Investors can receive cash and the corporate buyer’s shares in exchange.

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5
Q

What is an entrepreneur buyout?

A

The entrepreneur buys back the
company from the investors, usually with the use of debt.

This is usually a full exit and investors are compensated in cash.

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6
Q

What is liquidation?

A

When things go sour investors may decide to break up the company and sell individual assets to various buyers, in exchange of cash.

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7
Q

Most popular exit routes US?

A

Ranked:
1) IPO
2) Buyout
3) Acquisition

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8
Q

How are exits in Europe characterised?

A

1) Venture capitalists are better at investing than exiting and do not plan the exit at the time of investment
2) Venture capitalists regard the IPO as the ideal exit (and do not devote enough attention to trade sales)
3) Many exits are by buyback
4) Financial buyers are often not taken seriously
5) Most venture capitalists do not market their investments widely enough and do not make su cient use of intermediaries
6) Management often blocks an exit

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9
Q

What is the main obstacles in European VC?

A

Frictions in the exit market

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10
Q

What are the stylized fact of Exit Routes?

A

Venture capitalists prefer the IPO as the exit

Venture capitalist use trade sales to exit both successful and unsuccessful investments

Exiting unsuccessful companies is largely dependent on bankruptcy rules (stigma and cost of failure)

Exit types are similar across financing stages

Later stage investments are more likely to exit via IPO than expansion and early stage ventures

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11
Q

What are the stylized fact about Exit Timing?

A

Timing to exit depends on the industry of the start-up and the exit route chosen (average 6 years after 1st investment)

Investors are more likely to exit an investment as it moves to the cycle of early stage, expansion and later stage financing

For all types of exit routes the time to exit decreases as the number of rounds increases

Biotech and Internet companies have the fastest IPO exits

As time progresses venture capitalists are more likely to exit via IPO, but if not exited after 2.75-4 years the chance of IPO exit starts to decrease

As time progresses further, exit via acquisition becomes more likely, but if not exited after 6.8-11 years the chance of trade sale starts to decrease

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12
Q

Why to firms go public?

A
  • Access the public equity markets
  • Enhance reputation of company
  • Attract attention of analysts
  • Establish market price/valuation
  • Broaden ownership base
  • Allow pre-IPO owners to cash out
  • Create acquisition currency for future acquisitions
  • Debt is becoming too expensive
  • Private equity has run out
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13
Q

What are the costs of going public?

A

General costs: loss of proprietary information to competitors, meeting disclosure rules, loss of decision making control

Direct costs: Hiring an underwriter (7% of IPO proceeds), auditor, legal advisors, printing costs (10% of IPO proceeds)

Indirect costs: Underpricing (firms could have ex post sold their shares at this higher market price and therefore leave money on the table)

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14
Q

What are the pricing mechanism of IPOs?

A

Fixed price offering: one price is agreed for all interested parties

Auction: the stocks are auctioned to interested parties

Book building: Prepare prospectus, Establish pricing range Roadshow presentations to institutional investors, Underwriter collects information about investor demand
Underwriter sets final offer price that can be within range, Allocation of shares to investors is typically discretionary

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15
Q

What is the formula for underpricing

A

Underpricing = (P1c / PI) PI

P1c = closing price 1st day of trading
PI = issue price

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16
Q

What are explanations of underpricing?

A
  • Broaden ownership base and liquidity after IPO - Lawsuit avoidance (keep everybody happy)
  • Facilitate spinning and flipping (short term gains) by favoured investors such as friends and family programs
  • Asymmetric information between: issuers and underwriters, between issuers and investors, between informed and uninformed investors

==> Underpricing can also be a rational phenomenon

17
Q

What does the Winner’s Curse demonstrate?

A

Price must be determined by fairness condition for uninformed traders (they have to participate if all shares are to be sold):

Pr(high price) x (Fraction of shares received when price high) x (High price - Initial price)
+
Pr(Low price) x (Fraction of shares received when price low) x (Low price - Initial price)

18
Q

What does the Winner’s Curse demonstrate?

A

Price must be determined by fairness condition for uninformed traders (they have to participate if all shares are to be sold):

Pr(high price) x (Fraction of shares received when price high) x (High price - Initial price)
+
Pr(Low price) x (Fraction of shares received when price low) x (Low price - Initial price)
>=
0

==> Demonstrated undepricing is necessary to ensure participation of uninformed investor

19
Q

What is Flipping & Spinning in Underpricing?

A

Flipping: Investors that are allocated shares in the IPO sell these at the first day of trading at a significant profit

Spinning: Underwriters offer shares in hot IPOs to executives in companies, whose business the bank is looking to attract

20
Q

What are the critisicims of IPOs?

A
  • Underpricing
  • Concentration of Underwriters
  • Power of Large Institutional Investors
  • Lack of access for Investing Public
  • Lack of Transparency
  • Lack of Fairness
  • Potential for Abuses
21
Q

What is a solution to IPO problems?

A

Open IPOs

22
Q

What are the characteristics of an Open IPO?

A
  • Dutch Auction approach
  • Offering listed on Internet = accessible to all
  • Investors bid for shares (both number of shares and price per share)
  • Bids collected from Highest Price down, until you get enough shares for the offering.
  • The lowest price that clears the offering is the clearing price
  • Issuer has the right to set price below the clearing price.
  • All investors buy at the price set by the Issuer, regardless of their bid.
  • Oversubscription: Allocation by price, and by time priority
23
Q

What is the Quiet Period after an IPO?

A

During the first 25 days after the IPO the rm and its underwriters have to remain silent about the firm’s financial prospects

Reason: Prevent insiders from hyping up the price

After 25 days underwriters release their (usually favorable) reports about the firm

On average stock price rises at the end of the quiet period

24
Q

What is the Lock Up period after an IPO?

A

Underwriters require that initial pre-IPO shareholders do not sell their stock for a pre-determined period (usually 180 days)

Reasons: Keep incentives aligned (e.g. flipping, spinning), Prevent pressure on stock prices, if demand curves are downward sloping

Locked up investors sell at the expiration of the lock-up period

Stock price drops after the expiration of the lock-up period

25
Q

What is the long-run underperformance of IPOs?

A

IPO stocks underperform the market in the rst three to ve years after the IPO

On average, a buy and hold strategy of investing in IPO stocks would have left an investor with only 83 cents on every dollar invested

26
Q

What are explanations for the long-run underperformance of IPOs?

A

Clientele effects: Only optimistic investors buy at IPO (everyone thinks they found the next Amazon or Facebook), but believes converge when more information is released about the firm

Window of opportunity: Valuations of IPOs is subject to fads so issuers try to go public in hot markets (when investors tend to become overoptimistic about the prospects of a certain
industry, e.g. dot-cot bubble)

27
Q

What is the heterogeneity in the long-run underperformance of IPOs?

A

First-day return is inversely related to three-year stock price performance

VC-backed IPOs show much less underperformance than non-VC-backed IPOs

Most of the underperformance in the aggregate is driven by the smaller offerings

28
Q

What are some of the difference between US & EU IPO markets?

A

Companies that IPO in EU tend to be:
- older
- selling more secondary shares
- priced within price range
- less subject to class action suits
- subject to longer (mandatory) lock-ups
- characterized by more concentrated ownership by pre-IPO owners