Week 5 Flashcards
Exit
the event or process by which investors or founders sell their stake in a company to realize returns on their investment
Types of exit
- IPO (initial public offering): shares are sold to the public
- Acquisition: a corporate buyer (e.g., Google) purchases all the shares in the company.
- Buyout: the entrepreneur repurchases the company using debt financing.
- Liquidation: occurs when the company fails or cannot sustain operations.
Exit route and timing （By VC and angel investors)
Exit route: Venture capitalists prefer the IPO as the exit route because it tends to be the most profitable
VC uses trade exchanges/acquisition to exit both successful and unsuccessful investments
Timing: 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
Why do firms go public
- 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
Costs of going public
- Loss of proprietary information to competitors
- Meeting disclosure rules
- Loss of decision-making control
Direct costs: hiring an underwriter
Indirect costs: The first day market price exceeds the offer price by an average of 10-12%
Process of going public
First step is preliminary estimate of value, which involves assessing the company’s value using methods on the left.
Second step is filing range reported in preliminary prospectus, new information from market (market conditions influencing the valuation) and due diligence (detailed view of the company)
Third step is issue price reported in final prospectus, this incorporates updated market information, final interest levels from potential investors and completion of the “take-down”
Types of IPO offering
- Fixed Price Offering:
A single, agreed-upon price is set for all investors interested in purchasing shares in the IPO.
- Auction:
Shares are auctioned to interested buyers. The price is determined based on demand through the auction process. For example, Google used an auction mechanism for its IPO.
- Book Building:
This is a more flexible method where the price is determined based on investor demand. It involves several steps: - Prepare Prospectus
- Establish Pricing Range
- Roadshow
- Underwriter Collects Demand Information
- Set Final Offer Price
- Share Allocation
Under pricing
Closing price - issue price / issue price
what explains under pricing
- 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
- Asymmetric information between issuers and investors
- Asymmetric information between informed and uninformed investors
- Therefore, underpricing can be both a friction as well as a rational phenomenon, where the entrepreneur is paying (e.g. for a broaden ownership base) rather than just leaving money on the table
After IPO - Quiet Period
During the first 25 days after the IPO the firm and its underwriters have to remain silent about the firm’s financial prospects
After IPO: Lock-up Period
Underwriters require that initial pre-IPO shareholders do not sell their stock for a pre-determined period (usually 180 days)
Long-run Underperformance
o 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
o 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)
Underperformance - Heterogeneity
First-day return is inversely related to three-year stock price performance
