long term finance: equity and debt Flashcards
(37 cards)
what are shareholders
considered the corporation’s owners
- normally have voting rights at the annual general meeting of the company
- protected by limited liability - (the most they can lose is the value of their investments
what are equity holders
residual claimants to the firm’s cash flows
- entitled to receive payments from after-tax profits (dividends) at the firm’s discretion
what are the 2 types of equity claim
- common stock
- preferred stock
- preferential claim to dividends and assets compared to common stockholders
- limited voting rights
what are the sources of financing
- angel investors
- generally wealthy ppl interested in funding businesses they believe will provide attractive returns - venture capital firms
- venture capitalists are individuals/ firms capable of making substantial investments in business that they view as having very high and rapid growth potential - institutional and corporate investors
- invest through an initial public offering
what industry do venture capital firms belong to
they belong to the private equity industry
what are features of private equity funds
- they are limited-duration (typically 7-10 years)
- closed-end funds that invest primarily in equity stakes in companies
they typically
- hold large stakes in private companies
- are active in the management of their portfolio firms
how are private equity funds structured as limited partnerships
- limited partnerships (investors, such as pension funds, endowments, investment funds) provide most (90+%) of the capital
- general partners are responsible for choosing and monitoring the funds investments
distinguish between venture capital funds and leveraged buyout funds
venture capital funds - specialise in financing new firms
leveraged buyout funds - specialise in buying mature firms
what happens in leveraged buyout funds
- a small group of investors acquires all of the company’s (private or public) capital
- the acquisition is financed mostly with debt backed by the target’s assets
- after the acquisition, the target becomes a private firm with a very high leverage
how do venture capital investors exit their investment in a firm
- mergers and acquisitions
- start up is bought by another company - through an initial public offering
- the firms equity is made available to the public for the first time
what are public equity markets
corporations ‘go public’ when they raise equity finance by selling shares to the public for the first time through initial public offering
what are the types of IPO
- primary offering
- new shares are issued to raise additional capital - secondary offering
- existing large shareholders (like venture capital firms) cash in by selling part of their stake in the company
in practice, IPOs are often a mix of primary and secondary offerings
what are IPO benefits
- better access to capital (aided by liquidity and transparency of public markets)
- diversify the initial investors
- current equity holders usually sell a fraction of their shares
- exit strategy for VCs and other investors
what are IPO disadvantages
- monetary costs
- administrative costs
- underwriting costs = fee that investment banks charge for their services
- underpricing: IPO issue price «_space;day one closing price - disclosure requirements
- loss of control and freedom
- dilution of ownership stake and greater regulatory oversight
what are underwriters
in a typical IPO, the firm hires an investment banks who acts as the underwriter
they perform a number of functions
- like offering advice on the pricing of the issue
- preparation of documents
- marketing and selling the shares to selected investors
- sometimes guaranteeing the proceeds of the issue
can cost as much as 11% of the offer value
what is IPO underpricing
underwriters may sell the new shares at a lower price than the valuation in order to attract investors
- but this represents a cost to the existing owners
- underpricing (measured by issue price - price at the end of day one) can be large
but
- can be difficult to get the issue price right
- too high an issue price = not enough shares sold
what are seasoned equity offerings and what are 3 ways of making a SEO
a company already listed can raise additional equity by a seasoned equity offerings
- general cash offer
- sale of securities open to all investors - private placement
- sale of securities to a limited number of investors without a public offering - rights issue
- issue of securities offered only to current stockholders
- an “X for Y” rights offer = for every Y shares u own, u have the option to buy X more shares from the company
what is debt
debt = a contract that sets out the features of a loan
what are bonds
long-term securitised loans - they can be re-sold
- typically viewed by investors as lower risk than equity because
1. legal obligation to pay interest and capital
2. debt securities rank higher than equity when it comes to bankruptcy of the firm
what are creditors/ debt holders
they typically receive legally obligated interest payments (fixed/ floating rates), and repayment of principal at maturity
what are interest payments
generally paid out of pre-tax profits
- there is a tax advantage to a company using debt finance
what are credit ratings
agencies provide ratings to indicate the likelihood of default
- top rating = AAA
- lowest rating = D
- generally there is a low probability of default for AAA rated bonds = earn investors a lower interest rate
- the risk of default increases as we go down the ratings and interest rate increases
- bonds rated BBB and above = investment grade bonds
what’s unsecured vs secured debt
unsecured : no collateral - backed by the company’s creditworthiness
secured lender can serve collateral upon default
- like mortgage bonds : long term debt secured by a firm’s property
- asset backed bonds: securities backed by a portfolio of assets
what is secured debt
backed by specific assets ( collateral) which lenders can claim in the event of default
- reduces the lender’s risk and often results in lower interest rates
