term 2 lecture 10 equity financing Flashcards
what are the 5 main sources of financing?
angel investors, venture capital firms, private equity firms, institutional investors and corporate investors
what are angel investors?
individual investors who provide the intial capital to enable private businesses to start. often rich and successful entrepreneurs who are willing to help new companies in exchange for a stake in equity. in recent times, reliance on angel financing extends much longer into the life cycle of start ups. investment size can reach a few million dollars although firms may have to tpa into larger funding sources as financing needs to grow
what is venture capital?
a limited partership that specialises in raising money to invest in the private equity of young firms. institutions investors such as pension funds are typically the limited partners. the general parterners who run the venture capital are called venture capitalists
what is the advantage of venture capital firms for limited partners over investing directly In start ups as angel investors?
limited partners are more diverisfied.
they can benefit from the expertise of the general partners
what are the disadvantages of the venture capital firms for limited partners over investing directly in start ups as angel investors?
general partners usually charge substantial fees. most firms charge 20% of any positive return they make, also charging an annual management fee of about 2% of the funds committed capital
what are private equity firms?
organiseed very much like venture capital limited partnership but invest in the equity of established privately held firms than start up companies. often initiate investment by finding publically traded firm and purchasing the outstanding equity, thereby taking the company private in a transaction called a leveraged buyout
private equity firms typically use a combination of debt and equity to finance the purchase
what is the key difference between private equity and venture capital?
the magnitude of the capital invested
what are institutional investors?
institutional investors such as pension funds, insurance companies, endowments and foundations are active investors in private companies. they may invest directly in private firms or indirectly by becoming limited partners in venture capital or private equity firms
what are corporate investors?
a corporation that invests in private corporations. while most other types of investors in private firms are primarily interested in the financial returns of their investments, corporate investors might invest for corporate strategic objectives in addition to financial returns for example daimler investing in tesla.
what is an IPO?
the initial public offering, the process of selling stock to the public for the first time
what is the advantage of the IPO?
greater liquidity for investors - private equity investors get the ability to diversify
better access to capital - public companies typically have access to much larger amounts of capital through the public markets
what are the disadvantages of an IPO?
the equity holders become more widely dispersed - this makes it difficult to monitor management
the firm must satisfy all of the requirements of public companies which are costly and time consuming ie SEC filings, Sarabanes Oxley etc
what are primary offerigns??
new shares availiable in a public offering that raise new capital
what is a secondary offering?
shares sold by existing shareholders in an equity offering
what are best efforts basis?
for smaller IPOs, a situation in which the underwriter does not guarantee that the stock will be sold but instead tries to sell the stock for the best possible price. often such deals have an all or non clause, either all the shares are sold on the IPO or the deal is called off
what is firm commitment?
an agreement between an underwriter and an issuing firm in which the underwriter guarantees that it will sell all of the stock at the offer price
what is an auction IPO?
a method of selling new issues directly to the public
what is an underwriter?
an investment banking firm that manages a security issuance and designs its structure. many IPOs especially larger offerings are managed by a group of underwriters
what is the lead underwriter?
the primary investment banking firm responsible for managing a security issuance
what is a syndicate
a group of underwriters who jointly underwrite and distribute a security issuance
what is a registration statement for a SEC filing?
a legal document that provides finanical and other information about a company to investors prior to a security issuance
what is the preliminary prospectus for a SEC filing?
part of the registration statmenet prepared by a company prior to an IPO that is circulated to investors before the stock is offered
what is the final prospectus for a SEC filing?
part of the final regristration statement prepared by a company prior to an IPO that contains details of the offering, including the number of shares offered and the offer price
what is the road show of an valuation?
During an IPO, when a company’s senior management and its underwriters travel around promoting the company and explaining their rationale for an offer price to the underwriters’ largest customers, mainly
institutional investors such as mutual funds and pension
funds
what is the book building of an valuation?
A process used by underwriters for coming up with an offer price, based on customers’ expressions of interest.
what is the spread in the pricing the deal and managing risk?
The fee a company pays to its underwriters that is a percentage of the issue price of a share of stock (typically 6-8%)
what is the risk that arises to the underwriter when providing a firm commitment?
When an underwriter provides a firm commitment, it is potentially exposing itself to the risk that the
banking firm might have to sell the shares at less than the offer price and take a loss.
* However, research shows that 75% of IPOs experience an increase in share price on the first day (only 9% experience a decrease)
what is the over allotment allocation (greenshoe provision)
?
in an IPO, an option that alllows the underwriter to issue more stock, usually amounting to 15% of the original offer size, at the IPO offer price. underwriters initially market both the initial allotment and the allotment in the greenshow provision by short selling the greenshoe allotment
if the issue is a success, the underwriter exercises the greenshoe option, thereby covering its short position. if the issue is not a success, the underwriter covers the short position by repurchasing the greenshoe allotment in the aftermarket, thereby supporting the price
what is the Lockup in the pricing of the deal and managing risk?
a restriction that prevents preexisting shareholders from selling their shares for some period, usually 180 days after an IPO
what are the 4 IPO puzzles??
is the issue price of IPOs below or above market price and what is the consequence?
what is the benefit to the underwriters of underpricing?
the underwriters benefit from underpricing as it allows them to manage their risk
who bears the cost of the underpricing?
the pre IPO shareholders bear the cost of underpricing, in effect, these owners are selling stock in their firm for less than they could get in the aftermarket
why can not all investors earn the attractive returns on IPO’s?
what is the long run performance of IPOs?
Although shares of IPOs generally perform very well immediately following the public offering, it has been shown that newly listed firms
subsequently appear to perform relatively poorly over the following three to five years after their IPOs.
what is a special purchase acquistion company SPAC?
A SPAC is a shell company that will typically find a target private firm and take it public by merging with the SPAC, with the SPAC being renamed to match the target after the merger (deSPAC).
how does a SPAC compare to an IPO?
a special purpose acquistion company can be argued to be cheaper and quicker way to go public although others argue it is no cheaper or efficient than a regular IPO (Gahng, Ritter and Zhang, 2023)
what is a seasoned equity offering?
SEO - when a public company offers new shares for sale.
why might public firms use a SEO?
they might use an SEO to raise additional equity.
what is the main difference between the SEO and an IPO?
the main difference is that a market price for the stock already exists, so the price setting process is not necessary
what are the two types of seasoned equity offerings?
cash offer - a type of SEO in which a firm offers the new shares to investors at large
rights offer - a type of SEO in which a firm offers the new shares only to existing shareholders. rights offer protect existing shareholders from ownership dilution and mitigate the drop in share price
what is the SEO price reaction?
researchers have found that on average, the market greets the news of an SEO with a price decline. signalling hypothesis is one potential explaination
