Lecture 7: Financing and Distributing Flashcards
What is bootstrapping?
how entrepreneurs raise seed money to start their business
What is seed money from bootstrapping used for?
Is spent on developing a prototype of the product and also a business plan.
How long does bootstrapping usually last?
lasts 1-2 years
Who are venture capitalists?
are the people that help new businesses get started especially with early-sage financing. They are wealthy people who invest their own money.
What is another name for venture capitalists?
angel investors
What firms are the primary sources of funds for venture capital firms?
Financial and insurance firms
What are the 3 reasons as to why traditional funding does not work?
- High degree of risk - don’t know if the business will be successful
- Types of Productive Assets- they have more intangible assets
- Info asymmetry problems- the investor does not know as much about the product
What does venture capitalists investments give them?
equity investment, often in the form of stock that is convertible into common stocks
What is the most important role of venture capitalists?
to provide advice and council to entrepreneurs because they fall short on skills that are needed for growth
What are some tactics to reduce risk for venture capitalists?
- Fund in stages (3-7)- not all at once
- Make entrepreneurs make personal investments to prove their confidence in the business
- Syndicating investments
- in-depth knowledge about the industry
What is syndication?
when a venture capitalists sells a % of a deal to other venture capitalists
(splitting into 2 creates less risk)
What are 2 ways that syndication reduces risk?
- increases diversification
2. sharing of investment shows that the investment is a good decision
What is the exit strategy of venture capitalists?
They are not long-term investors. They exit by selling their equity position.
How many years does it usually take for a venture capitalist to exit?
3-7 years
What are the 3 important details venture capitalists need to agree on in their exit strategy?
- Time (when to exit)
- The method of exit
- What price is acceptable
What are the 3 types of buyers venture capitalists can sell to?
- strategic buyer in a private market (create value through synergies)
- Sell to a financial buyer (buying with the intention of holding it for 3-5 years then selling for profit)
- IPO: selling a common stock in the initial public offering - does not sell all of the shares
What way do venture capitalists usually exit through?
strategic or financial buyers
How many new businesses are usually successful?
1-2/10
What is the usual annual return percentage venture capitalists receive back?
15-25%
What does an initial public offering do?
- A way to raise money
2. Gives an opening of a venture capitalist to exit
What are the 5 advantages of going public?
- Equity can be raised higher in public equity is larger
- More equity can be raised after the IPO
- give entrepreneur ability to fund a business without giving up control
- stockholders can buy and sell in a secondary market after IPO
- easier to attract top management team in public firm
What are the 4 disadvantages of going public?
- High cost of IPO
- Out of pocket costs
- Cost of complying with SEC disclosure
-> transparency (provide detail about firm)
4.
How do you complete an IPO?
through the service of bankers who bring new securities to the market
What are the 3 service of bringing securities to market?
- Origination- big businesses provide this for themselves
- Underwriting
- Distribution
What is origination?
- Banker gives the firm advice prior to selling it - then states if it is ready and get approvals for doing so
- then file a registration with SEC
What is preliminary prospectus?
allows investors to make intelligent decisions about investing a security issue
What is underwriting?
the risky part of investment banking
What two ways can securities be underwritten?
- Firm commitment basis
- > investment banker promises the issuer a fixed amount of money even if the resell price is slower - Best effort basis
How much compensation does the investment banker get usually?
7%
What is best effort underwriting?
there is not guarantee from the investment banker to sell the securities at a fixed rate
What is compensation based on in best effort underwriting?
number of shares sold
What are underwriting syndicates?
when underwriters combine to form a group which entitles them to receive a portion of the underwriting fee and allocation of securities
what is a selling group?
when you enlist other investment banking firms in a syndicate
What is one of the most difficult tasks of being an investment banker in IPO?
to determine the highest price that bankers will be able to sell all of the shares
- consider value of cash flow
- consider stock price
- Conduct a road show
What is a road show?
A road show is when a manager makes presentations about the firm to potential investors
What are due diligence meetings?
before shares are sold when investment bankers have meetings to protect their reputation to reduce risk of lawsuits
What is a pricing call?
when the due diligence meetings are over, the issuer determines the final offer price
Who makes the pricing decision?
Management- rejection or acceptance
What 3 costs are associated with issuing stock in an IPO?
- underwriting spread -> difference between proceeds an issuer receives and total amount raised
- Out-of-pocket expenses: other investment fees
- Underpricing: difference between offering price and the closing price at the end of the first day
What is the syndicates (the group formed) primary concern?
sell securities as quick as possible because conditions can change
What happens if securities are not sold within a few days?
the underwriting syndicate disbands and members sell the securities at whatever price
What happens in the closing?
the issuing firms delivers the security certificates and the underwriter delivers the payments
When does the closing usually take place?
The third day
What is the cheapest source of external funding?
private markets (bootstrapping and venture capital)
When does private placement occur?
when firms sell unregistered securities directly to investors
What are advantages of a private placement?
- lenders are more willing to negotiate
- solve financial issues without bankruptcy court
- faster and more flexible
what is the disadvantage to private placements?
restrictions on resale of securities
What do private equity firms do?
pool money but invest in more mature companies and purchase 100% of the business
What is the goal of private equity firms?
to increase value of the firm for about 3-5 years then sell it for profit
What is a dividend policy?
policy regarding distributions of value to stockholders - when dividends are given out equity is reduced
A dividend
reduces the stockholders investment in a firm by returning some of the investment back to them
What is a pro-rata basis
in proportion to the firms shares
that they own
What is a regular cash dividend?
cash dividend that is paid out on a regular basis/ quarterly basis
What is an extra dividend?
management can afford to set the dividend low because it has the option to pay out extra
What is a special dividend
one time payment to stockholders that is larger then an extra and less frequent
What is a liquidating dividend?
a dividend that is paid to stockholders when a firm is liquidated (firm ceases to exist)
-> stockholder being the last to receive
What is the order of the dividend payment process?
PREPB <-
- Board vote- to pay a dividend
- Public announcement- announces to pay it
- Ex-dividend date- the first date that the stock will trade without rights to dividend
- Record Date- 2 days after ex-dividend-> investor becomes a stock holder of record
- Payable date - the stockholders receive the dividend 2 weeks after record date
Why is the dividend payment process not the same for private companies?
- shares are bought and sold less
- fewer stockholders
- no stock exchange
What are stock repurchases?
when a company repurchases its own shares not in proportion to the shares that they own
Do stockholders have to participate in a repurchase?
No they do not and then can choose when they pay taxes
What are the 3 ways that stock can be repurchased?
- Open-market Repurchase
- Tender Offer
- Targeted Stock Repurchase
What is the most common way that stock can be repurchased?
Open-market repurchase
What happens in the open-market repurchase?
when companies have a large amount to distribute they use this because there is a limited # of shares per day
What is a tender offer repurchases?
large amounts of cash distributes without special dividends
What are the two kinds in tender offer repurchases?
- Fixed Price: management announces price and the amount of shares
- Dutch Action: price is lowered until it receives a bid
What happens in Targeted Stock Repurchase?
there is direct negotiation with a stockholder and used to buy blocks of shares
What is the reaction to targeted stock repurchases?
Negative. Because it may insist pessimism towards company driving down stock price
What are stock dividends?
frequent
when a company distributes new stock to existing stockholders – no value change
What are stock splits?
infrequent
the distributions of a larger outstanding shares - actual division of stocks into more then one share
What is the benefit of stock splits?
send a positive signal to investors about the future of the business
What is a reverse stock split?
number of stock shares of the shareholder is reduced
Trading Range Argument
successful companies use stock dividends or stock splits to make their company more attractive to investors
What is a round lot?
100 shares
What is a odd lot?
<100 shares
After a stock trade, does the stock dollar appear to be higher then before?
No
