Week 5 Flashcards
A much smaller but still important market is the
private equity market, where finance is raised by issuing securities that are not publicly traded
private equity includes
venture capital, which refers to the financing of new ventures or ‘start-up’ companies.
what are ordinary shares?
companies issue ordinary shares to raise finance
If a company has 100 000 issued shares and an investor holds 1000 shares, the investor has how much ownership interest?
what does this mean?
the investor has an ownership interest in 1 per cent of the net assets of the company.
when dividends are paid, or if the company is taken over by another company, or is placed into liquidation, the investor has the right to receive 1 per cent of the payments made to ordinary shareholders.
when may a company’s directors pay dividends?
periodically
describe residual claim
The interest held by shareholders is a residual claim in the sense that shareholders will receive dividends only after a company has met its obligations to all other claimants such as suppliers, employees, lenders and governments
describe shareholder’s residual claim during liquidiation
ordinary shareholders have a residual claim on the proceeds from the sale of the company’s assets.
while shareholders face a greater risk than lenders, what do they enjoy?
they enjoy limited liability. This is a legal concept that protects shareholders whose liability to meet a company’s debts is limited to any amount unpaid on the shares they hold
a shareholder is not personally liable for the company’s debt; the liability of shareholders is limited to any amount unpaid on the shares held
give an example of limited liability
For example, if an investor purchases shares with an issue price of $2.50 per share, that are partly paid to $1.75, the investor’s liability for future payments is limited to 75 cents per share.
Consequently, if the company is placed into liquidation and has insufficient cash to pay its creditors, holders of its partly paid shares can be required to contribute up to 75 cents per share towards the payment of creditors
describe the 3 important rights shareholders have in a listed company
- entitled to receive a proportional share of any dividend that is declared by directors
- As part owners of the company, ordinary shareholders exert a degree of control over its management through the voting rights attached to their shares
3, Shareholders have the right to sell their shares
Equity raised by issuing ordinary shares has important advantages as a source of finance
Dividends
A company is not required to pay dividends to ordinary shareholders: payment of dividends is at the discretion of directors. e.g. not pay when there’s a cash shortage, unprofitable
why is equity finance preferred over debt financing in terms of dividends?
failure to pay interest on debt or delays in paying interest can lead to serious legal consequences and can ultimately lead to a company being placed into liquidation.
Pros of ordinary shares
maturity date
Ordinary shares do not have any maturity date (theoretically existing in perpetuity), which means that the issuing company has no obligation to redeem them. (company can buy back the shares)
debt must be repaid (or ‘redeemed’) when it matures.
Pros of ordinary shares
RIsk
The higher the proportion of equity in a company’s capital structure, the lower is the risk that lenders will suffer losses as a result of the borrower experiencing financial difficulty
. Therefore, raising equity by issuing ordinary shares lowers the interest rate that a company will have to pay on debt.
Cons of issuing ordinary shares as a source of equity finance
ownership and control
company issues more ordinary shares to raise new capital, existing shareholders will have to either outlay additional cash or suffer some dilution of their ownership and control of the company.
Small shareholders may not be concerned if their interest in a company is diluted, but investors who own a significant proportion of a company’s shares may be unwilling to have their interest diluted.
Cons of issuing ordinary shares as a source of equity finance
ownership and control
But when you borrow,
there will be no dilution in ownership and control
Cons of ordinary shares
Cost
transaction costs of raising funds by issuing shares are usually higher than the costs of borrowing a similar amount.
- A share issue by a public company often requires a prospectus, which are costly to prepare
- share issues are often underwritten
private equity is used to describe 2 distinct types of investment:
Venture capital what is it?
‘venture capital’ and refers to funding for smaller and riskier companies with potential for strong growth.
Why are venture capitals attractive?
- the amount of capital required may be too small to justify the cost of a share market float.
- future of the venture—which at the earliest stage may be no more than an idea—may be too uncertain to attract funds from a large number of investors
second type of private equity is
the acquisition of a listed public company by a group of investors who ‘privatise’ the company so that it is delisted from the stock exchange.
second type of private equity is
acquisition of a listed public company involves
a high proportion of debt finance and are commonly known as leveraged buyouts (LBOs)
what is private equity? how can it be raised?
Private equity refers to equity securities that are not publicly traded. Private equity can be raised from various sources including family members, friends and ‘business angels’, but the more formal private equity market involves funds being channelled to businesses by private equity fund managers.
what are 4 categories of private equity funding
1. start-up financing for a business less than 30 months old where funds are required to develop the company’s products
- expansion financing where additional funds are required to manufacture and sell products commercially
- turnaround financing for a company in financial difficulty
- management buyout (MBO) financing where a business is purchased by its management team with the assistance of a private equity fund.
The market for new venture finance has some unique features that have developed to minimise the effects of these information problems
The main feature is
The main such feature is that finance for new ventures is normally provided in stages rather than as a single lump sum
- provision of finance at each stage is generally linked to the achievement of milestones, such as completion of a prototype