unit 11 | financing & listing securities

Question 1

Basic Forms of Business Organization

Answer 1

• Proprietorship
• Partnership
• Limited Partnerships
• General Partnerships
• Corporation

Question 2

Proprietorship

Answer 2

• Most basic form of business ownership
• Exists for very simple, one-person businesses
• Proprietor is owner & operator of business
• The business is not a separate legal entity → owner is personally liable from a legal perspective
• Difficult for owners to generate/obtain capital to grow business

Question 3

Partnership

Answer 3

Similar to proprietorship except that there are 2 or more owners
- Accounting & law firms stay because they don’t have a huge need for capital

Question 4

Limited Partnerships

Answer 4

• Must include one general partner who has to be involved in the business & has personal liability
• Limited partners cannot be involved in business operations & liability is limited to their investment
• Many hedge fund are structured as limited partnerships
  > Ex. KPMG LLP (Limited Liability Partnership)
  > You resign from the firm once you become a partner (no longer employee) → have to buy equity

Question 5

General Partnerships

Answer 5

• Partners have unlimited liability & partners are liable for the actions of all partners
• Most partnerships have moved away from this model in recent years given the liability issues

Question 6

Corporation

Answer 6

• The most dominant form of organization when measured by dollars of assets or sales
• Separation is the key word:
  > Ownership is separated from management
  > Ownership is transferred by the buying & selling of shares
  > Separate legal entity → owners do not have legal liability for corporation or employee actions
• Easy access to capital

Question 7

Regulation of corporations is governed by:

Answer 7

• Government act of incorporation
• The corporation’s charter (original act of incorporation setting out basic rules & regulations)
• By-laws (subsequent to charter, these are rules & regulations set by the corporation’s board of directors & approved by shareholders. Ex → compensation policies, payments of dividends, authority of senior management)

Question 8

Shareholder rights (set by by-laws)

Answer 8

• Most decisions within a corporation are decided by the BOD and/or management
• Significant events like electing directors, selling the corporation (or even a lot of shares) requires shareholder approval
• Most decisions are passed with a 50.1% approval from shareholders

Question 9

What is a proxy

Answer 9

A proxy allows someone else to vote on behalf of a shareholder (if given the right)

Question 10

Why does proxy fights happen

Answer 10

Increasingly activist investors have engaged in proxy fights (or proxy contests) to influence boards or management teams
- Ex. Carl Icahn’s attempt to get Apple to return more cash to its shareholders

Question 11

Incorporation process - shareholders

Answer 11

• Shareholders own the corporation & have the ultimate say in how the company runs
• BOD are elected by shareholders to ensure corporate decisions are made in the best interest of shareholders
• The Chief Executive Officer (CEO) of the corporation is typically on BOD
• The chairman of the BOD oversees & chairs board meetings & typically has greater influence on its actions
  
  • CEO is sometimes the chairman → not liked by shareholders
• Boards are required to have a minimum # of independent directors → directors who are not management or aligned with a very large shareholder

Question 12

Government & Corporate Financing

Answer 12

• Governments need capital
• Investors have capital
• Investment firms/investment dealers/brokerage firms act as the “go-between” to facilitate the raising of capital
  > The government’s cost of capital is the investor’s return
  > Therefore, the raising of capital is a negotiated process

Question 13

Private placements

Answer 13

• Sales of corporate debt or equity to private investors
  > Not done in public markets
• Not available to the general public (one on one negotiation)
• Managed by investment dealers
• Typically do not require a prospectus

Question 14

Why is there controversy around private placements?

Answer 14

Retail investors are not given access/fear that large institutions are given preferential access/valuation for securities

Question 15

Public offerings

Answer 15

• The sale of securities (debt or equity) to the public from corporations
• Investment dealers manage the process
• A prospectus sets out the terms of the offering (timing, price, what the proceeds will be used for); lengthy legal document
• A greensheet (or bluesheet for RBC) is a marketing document (6-8 paged) that summarizes the offering & is used by the investment dealer to sell the offering

Question 16

Initial public offering (IPO)

Answer 16

Sale of corporate equity for the first time
- When equity is first listed on a stock exchange or when they “go public”

Question 17

How is the share price for an IPO determined?

Answer 17

• Investment dealer/underwriter will do extensive investigating (“due diligence”) about the corporation’s operations & financial viability
  > From this, future financial projections are made
  > Other similar companies are reviewed to see how they are valued
  > Other similar IPOs are reviewed to see how they were valued
• From these investigations & valuation discussions, a total value of the company is estimated
• A discount to this total value may be applied given that equity in the corporation is being sold for the first time

Question 18

Why does company management go on “road shows”?

Answer 18

• To meet prospective investors gauge interest
• Investment dealer will gather feedback & “build a book”
  Investors will indicate interest at various prices

Question 19

How does value per share set to balance?

Answer 19

(i) high enough to maximize proceeds for corporation
(ii) low enough to ensure that all shares are sold & that there is positive buying in the market after the IPO

Question 20

Secondary Issues (Equity Issues)

Answer 20

Issuance of equity after the first sale

Question 21

Who gets the proceeds from the sale of stock?

Answer 21

• If the sale is newly issued shares, the corporation gets the proceeds and uses them to pay down debt, invest in new products/markets
• If the sale is from existing shares owned by current holders, those holders get the proceeds

Question 22

Why are secondary issues often done under the Short-Form Prospectus Distribution (SFPD) System?

Answer 22

• Allows companies to issue “short-form” prospectuses which are much shorter than prospectuses for IPOs
• Saves a great amount of time, hassle & money

Question 23

What are short-form prospectuses most often used for?

Answer 23

“Bought deals”
- Investment dealers/underwriters “buy the deal”
- Corporation is guaranteed proceeds

Question 24

What if overnight markets decline or investors are not interested in buying the issue?

For example, what if share price declines & stock sales at $45

Answer 24

• Investment dealers lose $1 per shares
• Worse → what if investment dealers cannot sell all of the offering & have to hold the shares; if their value continues to decline, tens of $$$ millions can be lost (+ a few jobs for those that made the decisions for that bought deal)

Question 25

To protect against declines in a share price after an IPO or equity issue, there are several after-market stabilization procedures:

Answer 25

• Underwriters sell more shares than was originally intended (usually ~ 5%)
  > If the share price declines after the equity issue, the underwriters exercise their “over-allotment” or “green shoe” option that allows them to buy shares in the market to cover this “short” position (they sell shares that they don’t own)
  > Very common
• Penalize other underwriter whose customers sell shares in aftermarket (not common)
• Establish a “stabilizing bid” to purchase shares less than the offering price (not common)
  > Investors wants to stabilize the shares to keep profits