16-*Venture CapitalPrivate financing for relatively new businesses in exchange for stockUsually entails some hands-on guidanceMany VC firms are formed from a group of investors that pool capital and then have partners in the firm decide which companies will receive financingSome large corporations have a VC division

16-*Choosing a Venture CapitalistLook for financial strengthChoose a VC that has a management style that is compatible with your ownObtain and check referencesWhat contacts does the VC have?What is the exit strategy?

16-*Selling Securities to the PublicManagement must obtain permission from the Board of DirectorsFirm must file a registration statement with the SECSEC examines the registration during a 20-day waiting periodA preliminary prospectus, called a red herring, is distributed during the waiting periodIf there are problems, the company is allowed to amend the registration and the waiting period starts overSecurities may not be sold during the waiting periodThe price is determined on the effective date of the registration

Registration StatementRegulation ASmall-issue ExemptionWaiting period (20days)Red HerringLetter of commentTombstoneProspectus

16-*

Alternative Issue MethodsGeneral cash offersRights offersIPOsSEOs16-*

16-*UnderwritersServices provided by underwritersFormulate method used to issue securitiesPrice the securitiesSell the securitiesPrice stabilization by lead underwriterSyndicate(Principal Underwriters and other members) group of investment bankers that market the securities and share the risk associated with selling the issueGross Spread(Underwriting Discount) difference between what the syndicate pays the company and what the security sells for initially in the market

Types of underwriting1. firm commitment underwriting(Purchase-Resale Agreement)2. Best efforts underwriting3. Dutch auction underwriting(Uniform Price auction)16-*

16-*Firm Commitment UnderwritingIssuer sells entire issue to underwriting syndicateThe syndicate then resells the issue to the publicThe underwriter makes money on the spread between the price paid to the issuer and the price received from investors when the stock is soldThe syndicate bears the risk of not being able to sell the entire issue for more than the cost

16-*Best Efforts UnderwritingUnderwriter must make their best effort to sell the securities at an agreed-upon offering priceThe company bears the risk of the issue not being soldThe offer may be pulled if there is not enough interest at the offer price and the company does not get the capital and they have still incurred substantial flotation costsNot as common as it used to be

16-*Dutch Auction UnderwritingUnderwriter accepts a series of bids that include number of shares and price per shareThe price that everyone pays is the highest price that will result in all shares being soldThere is an incentive to bid high to make sure you get in on the auction but knowing that you will probably pay a lower price than you bidGoogle was the first large Dutch auction IPO

The aftermarketThe period after a new issue is initially sold to the public is referred as Aftermarket.During this time, the members of underwriting syndicate generally do not sell securities for less than the offering pricePurpose is to stabilize the price16-*

16-*Green Shoes and LockupsGreen Shoe provision(over-allotment option for 30 days)Allows the syndicate to purchase an additional 15% of the issue from the issuerAllows the issue to be oversubscribedProvides some protection for the underwriters as they perform their price stabilization functionLockup agreementsRestriction on insiders that prevents them from selling their shares of an IPO for a specified time periodThe lockup period is commonly 180 daysThe stock price tends to drop when the lockup period expires due to market anticipation of additional shares hitting the street

Quiet PeriodAll communications with the public must be limited to ordinary announcements and other purely factual matters.Ends 40 calendar days after IPOPurpose is to record all the relevant information into prospectus 16-*

16-*New Equity Issues and PriceStock prices tend to decline when new equity is issuedPossible explanations for this phenomenonSignaling and managerial informationSignaling and debt usageIssue costsSince the drop in price can be significant and much of the drop may be attributable to negative signals, it is important for management to understand the signals that are being sent and try to reduce the effect when possible

16-*Issuance CostsSpreadOther direct expenses legal fees, filing fees, etc.Indirect expenses opportunity costs, i.e., management time spent working on issueAbnormal returns price drop on existing stockUnderpricing below market issue price on IPOsGreen Shoe option cost of additional shares that the syndicate can purchase after the issue has gone to market

16-*Rights Offerings): Basic ConceptsIssue of common stock offered to existing shareholdersRights offer is cheaper than the cash offerAllows current shareholders to avoid the dilution that can occur with a new stock issueRights are given to the shareholdersSpecify number of shares that can be purchasedSpecify purchase priceSpecify time frameRights may be traded OTC or on an exchange

16-*The Value of a RightThe price specified in a rights offering is generally less than the current market priceThe share price will adjust based on the number of new shares issuedThe value of the right is the difference between the old share price and the new share priceHolder-of-record-date(date of record): the date on which existing shareholders on company records are designated as the recipients of stock rights. Ex-right date: the beginning of the period when stock is sold without a recently declared right, normally 2-trading days before the holder-of-record date.

16-*DilutionDilution is a loss in value for existing shareholdersPercentage ownership shares sold to the general public without a rights offeringMarket value firm accepts negative NPV projectsBook value and EPS occurs when market-to-book value is less than one

16-*Types of Long-term DebtBonds public issue of long-term debtPrivate issuesTerm loansDirect business loans from commercial banks, insurance companies, etc.Maturities 1 5 yearsRepayable during life of the loanPrivate placementsSimilar to term loans with longer maturityEasier to renegotiate than public issuesLower costs than public issues

15.*15.*See the instructors manual for more information on some of the groups that provide capital for VC operations. One group that students may be particularly interested in is discussed in an article in the May 16, 2000 special issue of Inc. magazine. The article discusses a venture capital firm that received the majority of its financing from professional athletes (pp. 63 65).

www: Click on the web surfer icon to go to the PriceWaterhouseCoopers web site. The site provides information on venture capital deals each quarter.15.*Financial strength you want to have the option to obtain additional financingStyle do you want a hands-on or hands-off VC?Contacts will the VC provide you with additional business contacts that can help your business succeed?Exit strategy VCs are not long term investors what are the provisions for the VC getting out of the business?

www: Click on the web surfer icon to go to a web site that allows entrepreneurs to search for capital and VCs to search for prospective investments.

Video Note: Going Public shows what must be done to take a company public a common exit strategy for many VCs.

15.*Registration statements dont have to be filed if the loan will mature in less than nine months or the issue involves less than $5 million

The SEC makes no statement about the financial strength of the firm, it just indicates that the registration is in order15.*15.*15.*Price stabilization is an important component of the lead underwriters job for IPOs. For more information, see Stabilization Activities by Underwriters After Initial Public Offerings by Aggarwal in the June 2000 issue of The Journal of Finance.

Spread the typical spread for IPOs between $20 and $80 million is 7%. For more information, see The Seven Percent Solution by Chen and Ritter in the June 2000 issue of The Journal of Finance

15.*15.*This is a good place to review the difference between primary and secondary market transactions. Technically, the sale to the syndicate is the primary market transaction and the sale to the public is the secondary market transaction.

Note that the cost of the issue includes the price paid to the issuing company plus the expenses of selling the issue15.*15.*15.*15.*15.*15.*Signaling and managerial information managers may choose to sell new shares of stock when they believe the current stock price is high (they can issue fewer shares at a higher price)

Signaling and debt usage issuing equity may send a signal that management believes the company currently has too much debt

Issuing securities, especially stock, is very expensive and the decrease in price may be partial compensation for the cost of the issue15.*15.*15.*15.*15.*