University of Colorado-BoulderLeeds School of Business

ESBM 4570Entrepreneurial Finance Office: KOBL S431Spring 2017 Office Hours: Th (1 pm – 3 pm)T 3:30 pm – 6:15 pm, KOBL S125 sanjai.bhagat@colorado.edu

I. Course Objective

The objective of the course is to provide the student with a state-of-the-art understanding of

valuation of small and mid-cap public and private firms, and the economics of contracts as it applies to entrepreneurship and new venture

finance. The course will cover the following topics: finance and the entrepreneur; project and

business valuation; creating value through financial contracting (staging of financing); financing sources (venture capital, other); and exit strategies (initial public offering, other).

II. Course Materials

Course materials consist of Entrepreneurial Finance (Stanford University Press, by J.K. Smith and R.L. Smith and R.T. Bliss, 2011) and Damodaran On Valuation (Second Edition, Wiley Online, by A. Damodaran, 2015), (http://onlinelibrary.wiley.com/book/10.1002/9781119201786)

and scholarly journal articles and working papers.

Lecture notes/overheads can be accessed from my home-page:http://leeds-faculty.colorado.edu/bhagat/

Please check your ---@colorado.edu email frequently for emails from me regarding updates to class lectures, recent relevant articles in the financial media, and class announcements.

Articles from the Wall Street Journal will be used to motivate some of the class discussion. www.wsj.com/studentoffer

III. Course Outline and Readings

A. Valuation

1. A. Damodaran, “Valuation Approaches and Metrics,” 2005, Foundations and Trends in Finance.

2. Valuation Chapter 1, Introduction to Valuation.

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[http://pages.stern.nyu.edu/~adamodar/ “Books & Support” “Damodaran On Valuation (Second Edition)” “Website for book”]

3. Valuation Chapter 2, Estimating Discount Rates. http://people.stern.nyu.edu/adamodar/

4. Valuation Chapter 3, Estimating Cash Flows.5. Valuation Chapter 4, Estimating Growth and Terminal Value.6. Valuation Chapter 6, Firm Value DCF Models.7. Valuation Chapter 9, Firm and Enterprise Value Multiples.8. Valuation Chapter 12, The Value of Intangibles.9. Valuation Chapter 14, The Value of Liquidity.10. Entrepreneurial Finance Chapters 8, 9, 10, New Venture Valuation.

11. S. Bhagat, "Real Options in the Telecommunications Industry," in Real Options: The NewInvestment Theory and its Implications for Telecommunications Economics (1999), Kluwer Academic Publishers, Boston, MA. Options Real Options

12. L. Courteau, J.L. Kao and T. O’Keefe, “Gains to Valuation Accuracy of Direct Valuation Over Industry Multiplier Approaches,” 2003, University of Alberta working paper. [ValuationAccuracy.pdf]

13. A. Schreiner and K. Spremann, “Multiples and their Valuation Accuracy,” Yale University working paper, 2007.

14. J. Liu, D. Nissim, and J. Thomas, “Is Cash Flow King in Valuations?” Financial Analysts Journal 63, Number 2, 2007.

15. H.J.Seppanen, “Financial Statement Information and Evaluation of Newly Listed High-Technology “Nano Caps”” Aalto University (Finland) working paper, 2010.

16. S. Sievers and J. Klobucnik, “Valuing High Technology Growth Firms,” Journal of Business Economics, December 2013, Volume 83, Issue 9, pp 947–984. http://link.springer.com/article/10.1007/s11573-013-0684-2

17. http://www.mckinsey.com/Business-Functions/Strategy-and-Corporate-Finance/Our-Insights/Valuing-high-tech-companies?cid=other-eml-alt-mip-mck-oth-1602Marc Goedhart, Tim Koller, and David Wessels. February 2016.

B. Private Equity

1. S. N. Kaplan and P. Stromberg, “Leveraged Buyouts and Private Equity, NBER paper, 2008. http://www.privateequityatwork.com/

2. Steven J. Davis , John Haltiwanger , Ron S. Jarmin , Josh Lerner and Javier Miranda, “Private Equity and Employment,” US Census Bureau Center for Economic Studies Paper No. CES-WP-08-07R, 2014. Private Equity

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3. Paul Gompers, Steven N. Kaplan and Vladimir Mukharlyamov, “What Do Private Equity Firms Do?” 2014, Harvard University working paper.

4. Paglia, John and Harjoto, Maretno Agus, The Effects of Private Equity and Venture Capital on Sales and Employment Growth in Small and Medium Sized Businesses (June 5, 2014). Journal of Banking and Finance, Vol. 47, pp. 177-197, 2014.

5. J. Haltiwanger, R. Jarmin, J. Miranda, “Who Creates Jobs?” Review of Economics and Statistics 95, May 2013, 347-361.

C. Financial Contracting

1. Entrepreneurial Finance Chapters 11, 12, 13. VentureCapital-Yearbook2. http://leeds-faculty.colorado.edu/bhagat/VentureCapital.ppt VC-update

siliconvalley

3. S. N. Kaplan and P. Stromberg, "Venture Capitalists as Principals: Contracting, Screening, and Monitoring," 2001, American Economic Review 91(2 May), 426-430. http://leeds-faculty.colorado.edu/bhagat/VC-Contracting.ppt ImpliedReturn SampleCapitalizationTable

4. S.N. Kaplan and Per Stromberg. "Financial Contracting Theory Meets The Real World: An Empirical Analysis Of Venture Capital Contracts," Review of Economic Studies, 2003, v70(2,Apr), 281-315.

5. S. N. Kaplan, B. A. Sensoy, and P. Stromberg, “Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies,” Journal of Finance 64, 2009, 75-115.

6. O. Bengtsson and B. A. Sensoy, “Changing the Nexus: The Evolution and Renegotiation of Venture Capital Contracts,” Journal of Financial and Quantitative Analysis / Volume 50 / Issue 03 / June 2015, pp 349-375.DOI:  http://dx.doi.org/10.1017/S0022109015000137

7. O. Bengtsson and B. A. Sensoy, “Investor Abilities and Financial Contracting: Evidence from Venture Capital,” Journal of Financial Intermediation 20, 477-502, 2011.

8. Brian Broughmana and Jesse Fried, “Renegotiation of cash flow rights in the sale of VC-backed firms,” Journal of Financial Economics 95, Issue 3, March 2010, Pages 384-399.

9. Bernstein, Shai and Giroud, Xavier and Townsend, Richard R., The Impact of Venture Capital Monitoring (April 16, 2014). Journal of Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2341329 or http://dx.doi.org/10.2139/ssrn.2341329

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10. Gornall, Will and Strebulaev, Ilya A., The Economic Impact of Venture Capital: Evidence from Public Companies, (November 1, 2015). Stanford University Graduate School of Business Research Paper No. 15-55. Available at SSRN: http://ssrn.com/abstract=2681841 or http://dx.doi.org/10.2139/ssrn.2681841

11. Gompers, Paul A. and Gornall, Will and Kaplan, Steven N. and Strebulaev, Ilya A., How Do Venture Capitalists Make Decisions? (June 27, 2016). Harvard Business School. Available at SSRN: http://ssrn.com/abstract=2801385

12. Scott, Erin L. and Shu, Pian and Lubynsky, Roman, Are 'Better' Ideas More Likely to Succeed? An Empirical Analysis of Startup Evaluation (July 2015). Harvard Business School Technology & Operations Mgt. Unit Working Paper No. 16-013. Available at SSRN: http://ssrn.com/abstract=2638367 or http://dx.doi.org/10.2139/ssrn.2638367

13. Hochberg, Yael V. and Serrano, Carlos J. and Ziedonis, Rosemarie Ham, Patent Collateral, Investor Commitment, and the Market for Venture Lending (October 7, 2014), Rice University. Available at SSRN: http://ssrn.com/abstract=2506911 or http://dx.doi.org/10.2139/ssrn.2506911

D. Financing Sources

1. Entrepreneurial Finance Chapter 14.

2. S. Bhagat, “Why Do Venture Capitalists Charge Such High Discount rates?”Journal of Risk Finance, 2014. venture-discount-rates.doc VentureCapital.ppt

3. R. Nanda and M. Rhodes-Kropf, “Investment Cycles and Startup Innovation,” Harvard University working paper, 2011.

4. Kerr, William R. and Nanda, Ramana, Financing Innovation (November 5, 2014). Harvard Business School Entrepreneurial Management Working Paper No. 15-034. Available at SSRN: http://ssrn.com/abstract=2519572 or http://dx.doi.org/10.2139/ssrn.2519572

5. S. Cohen and Y. Hochberg, “Accelerating Startups: The Seed Accelerator Phenomenon,” MIT working paper, 2014.

6. Fehder, Daniel C. and Hochberg, Yael V., Accelerators and the Regional Supply of Venture Capital Investment MIT working paper, (September 19, 2014).

7. Hallen, Benjamin L. and Bingham, Christopher and Cohen, Susan, Do Accelerators Accelerate? The Role of Indirect Learning in New Venture Development (January 19, 2016). University of Washington. Available at SSRN: http://ssrn.com/abstract=2719810

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8. Bernthal, Brad, Investment Accelerators (August 11, 2015). University of Colorado Boulder, 2015. Available at SSRN: http://ssrn.com/abstract=2642436 or http://dx.doi.org/10.2139/ssrn.2642436

9. Bliemel, Martin J. and Flores, Ricardo G., Defining and Differentiating Accelerators: Insights from the Australian Context (August 7, 2015). UNSW Business School Research Paper No. 2016MGMT01. Available at SSRN: http://ssrn.com/abstract=2757536 or http://dx.doi.org/10.2139/ssrn.2757536

10. Yu, Sandy, The Impact of Accelerators on High-Technology Ventures (December 1, 2014). University of California Berkeley. Available at SSRN: http://ssrn.com/abstract=2503510

11. Hochberg, Yael V., Alexander Ljungqvist and Yang Lu, “Networking as a Barrier to Entry and the Competitive Supply of Venture Capital,” Journal of Finance, 2010, v 65 (June), 829-859.

12. Hildebrand, Thomas and Puri, Manju and Rocholl, Jörg, Adverse Incentives in Crowdfunding (October 06, 2014). Duke University working paper.

13. Ahlers, Gerrit K.C. and Cumming, Douglas J. and Guenther, Christina and Schweizer, Denis, Signaling in Equity Crowdfunding (October 14, 2012). York University.

14. Mollick, Ethan R., The Dynamics of Crowdfunding: An Exploratory Study (June 26, 2013). Journal of Business Venturing, Volume 29, Issue 1, January 2014, Pages 1–16.

15. Mollick, Ethan R., Delivery Rates on Kickstarter (December 4, 2015). University of Pennsylvania - Wharton School. Available at SSRN: http://ssrn.com/abstract=2699251

16. Mollick, Ethan R. and Kuppuswamy, Venkat, After the Campaign: Outcomes of Crowdfunding (January 9, 2014). UNC Kenan-Flagler Research Paper No. 2376997. Available at SSRN: http://ssrn.com/abstract=2376997 or http://dx.doi.org/10.2139/ssrn.2376997

17. Mollick, Ethan R. and Nanda, Ramana, Wisdom or Madness? Comparing Crowds with Expert Evaluation in Funding the Arts (August 26, 2015). Management Science, Forthcoming; Harvard Business School Working Paper No. 14-116. Available at SSRN: http://ssrn.com/abstract=2443114 or http://dx.doi.org/10.2139/ssrn.2443114

18. Hornuf, Lars and Schwienbacher, Armin, Crowdinvesting – Angel Investing for the Masses? (October 8, 2014). Handbook of Research on Venture Capital: Volume 3. Business Angels, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2401515

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19. Ahlers, Gerrit K.C. and Cumming, Douglas J. and Guenther, Christina and Schweizer, Denis, Signaling in Equity Crowdfunding (December 2, 2013). York University. Available at SSRN: http://ssrn.com/abstract=2362340 or http://dx.doi.org/10.2139/ssrn.2362340

20. Belleflamme, Paul and Lambert, Thomas, Crowdfunding: Some Empirical Findings and Microeconomic Underpinnings (August 30, 2014). Université Catholique de Louvain. Available at SSRN: http://ssrn.com/abstract=2437786 or http://dx.doi.org/10.2139/ssrn.2437786

21. Agrawal, Ajay and Catalini, Christian and Goldfarb, Avi, Are Syndicates the Killer App of Equity Crowdfunding? (February 25, 2015). MIT Sloan Research Paper No. 5126-15; Rotman School of Management Working Paper No. 2569988. Available at SSRN: http://ssrn.com/abstract=2569988 or http://dx.doi.org/10.2139/ssrn.2569988

22. Belleflamme, Paul and Omrani, Nessrine and Peitz, Martin, The Economics of Crowdfunding Platforms (March 20, 2015). Université Catholique de Louvain. Available at SSRN: http://ssrn.com/abstract=2585611 or http://dx.doi.org/10.2139/ssrn.2585611

23. Lambrecht, Anja and Goldfarb, Avi and Bonatti, Alessandro and Ghose, Anindya and Goldstein, Daniel G. and Lewis, Randall A. and Rao, Anita and Sahni, Navdeep S. and Yao, Song, How Do Firms Make Money Selling Digital Goods Online? (March 6, 2014). London Business School. Available at SSRN: http://ssrn.com/abstract=2363658 or http://dx.doi.org/10.2139/ssrn.2363658

24. Bernstein, Shai and Korteweg, Arthur G. and Laws, Kevin, Attracting Early Stage Investors: Evidence from a Randomized Field Experiment (August 27, 2015). Journal of Finance, Forthcoming; Rock Center for Corporate Governance at Stanford University Working Paper No. 185; Stanford University Graduate School of Business Research Paper No. 14-17. Available at SSRN: http://ssrn.com/abstract=2432044 or http://dx.doi.org/10.2139/ssrn.2432044

25. Caytas, Joanna Diane, Crowdfunding Venture Capital in Europe (October 1, 2015). Columbia Journal of European Law: Preliminary Reference, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2685502

26. O'Connor, Sean M., Crowdfunding's Impact on Start-Up IP Strategy (December 12, 2013). George Mason Law Review, Forthcoming; University of Washington School of Law Research Paper No. 2013-34. Available at SSRN: http://ssrn.com/abstract=2366937

E. Exit Strategies

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1. Entrepreneurial Finance Chapter 16.

2. J.R. Ritter, “Equilibrium in the IPO Market,” Annual Review of Financial Economics 3, 2011. IPO.ppt

IPO-US-World March2012-SenateHearings-1 March2012-SenateHearings-2

3. R. Aggarwal, S. Bhagat and S. Rangan, “Impact of Fundamentals on IPO Valuation,” Financial Management, 2009, 253-284. IPO Valuation.ppt

IPO Valuation International

4. C. S. Armstrong, A. Davila, G. Foster, and J.R.M. Hand, “Market-to-revenue multiples in public and private markets,” Australian Journal of Management 36, 15-57, 2011.

5. Michelle Lowry, Roni Michaely and Ekaterina Volkova, “Initial Public Offerings: A synthesis of the literature and directions for future research,” March 2017.

6. Ugur Celikyurta, , Merih Sevilirb, 1, and Anil Shivdasani , “Going public to acquire? The acquisition motive in IPOs ,” Journal of Financial Economics 96, Issue 3, June 2010, Pages 345-363.

7. C.W. Smith, Jr., "Investment Banking and the Capital Acquisition Process," Journal of Financial Economics 15, 1986, 3-30. RaisingCapital.ppt

F. Current Topics

1. R. Ball, “The Global Financial Crisis and the Efficient Market Hypothesis: What Have We Learned?” Journal of Applied Corporate Finance, Volume 21, Issue 4, pages 8–16, Fall 2009.

2. A. Brooks, “Five Myths About Free Enterprise,” Washington Post, July 13, 2012.

3. K. Hassett and A. Mathur, “The Cure for Wage Stagnation” Wall Street Journal, August 14, 2016http://www.wsj.com/articles/the-cure-for-wage-stagnation-1471210831“Taxes and Wages” American Enterprise Institute, June 2006.

4. S. Bhagat, http://www.realclearmarkets.com/articles/2015/07/23/as_greece_proves_austerity_is_government_spending_101757.htmlEuropeanCrisis

5. S. Bhagat and I. Obreja, “Corporate Employment and Cash Flow Uncertainty,”

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University of Colorado paper, 2015.

6. S. Bhagat and B. Bolton, “Bank Executive Compensation And Capital Requirements Reform” Journal of Corporate Finance, 2014. IBCompensation

7. Audretsch, David and Taylor Aldridge, “University Entrepreneurship and Economic Growth,” Indiana University, 2010.

8. Kerr, William, Josh Lerner and Antoinette Schoar, “The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis,” Harvard University, 2010.

9. Paige Ouimet and Rebecca Zarutskie, “Who Works for Startups? The Relation between Firm Age, Employee Age, and Growth,” Duke University working paper, October 1, 2011.

10. Kauffman Foundation, “Anatomy of an Entrepreneur,” 2009.

Tech-Governance

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IV. Course Schedule

January 17 Introduction

January 24 Valuation

January 31 Valuation Proposal due

February 7 Valuation

February 14 Valuation

February 21 Financial Contracting

February 28 Financial Contracting

March 7 Financial Contracting Paper first-half due

March 14 Venture Financing Midterm Exam

March 21 Venture Financing

March 28 Spring Break

April 4 Crowdfunding

April 11 Exit Strategies

April 18 Exit Strategies Paper due

April 25 Student Pitches

May 2 Student Pitches

May 11 Final Exam (1:30 pm – 2:30 pm)

V. Course PoliciesGrading

The grade breakdown is as follows:Item Weight

A. Class participation and attendance 10%B. Term Paper (proposal, due: January 31) 5%C. Term Paper (first half, due: March 7) 15%D. Midterm Exam (March 14) 20%E. Term Paper (full, due: April 18) 20%F. Term Paper (pitch) 10% G. Final Exam 20%

A. Class participation is critical to the success of this course. Student questions and

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comments are expected and welcome. Attendance will be taken at random (unannounced). Students are requested to place their name-cards in front of their desk at all times during class.

The class will be conducted in a professional manner: Students and the instructor are expected to be prepared for each class, and behave professionally in the class.

B. Proposals for the term paper are due on January 31, 2017, before the start of class. The proposal should answer the following two questions:

What will the paper be about? Why is this topic interesting and important?

You should also include a list of at least four academic papers or book chapters that you intend to read as background for your paper. References should be cited properly: author(s) name(s), title of paper, journal name and volume, journal page numbers, year of publication; for unpublished papers: the web-link, author(s) name(s), title of paper, and university affiliation of the authors should be noted. The proposal should be no more than a page.

C, E. The first half of the term paper is due on March 7, 2017, before the start of class. The term paper draft should be at least ten pages long, and include the following:

What is the paper about? Why is this interesting and important to study/read? A critical survey of the literature. Outline of the original analysis that would be of interest to somebody in the real world:

an investment banker, venture capitalist, or entrepreneur. References that includes at least four academic papers or book chapters.

The full term paper is due on April 18, 2017.

Student (elevator) pitches are scheduled for April 25 and May 2, 2017. The paper can be on any topic that will be covered in the course. The paper should include a critical survey of the literature and some original analysis that would be of interest to somebody in the real world: an investment banker, venture capitalist, or entrepreneur. The paper (including exhibits) should be between 20 and 25, double-spaced pages (twelve-point font, one-inch margin all-around).

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On your paper please note the following:On my honor, as a University of Colorado at Boulder student, I have neither given nor received unauthorized assistance on this paper.A Note on Academic Honesty & Plagiarism: The development of the Internet has provided students with historically unparalleled opportunities for conducting research swiftly and comprehensively. The availability of these materials does not, however, release the student from appropriately citing sources where appropriate; or applying standard rules associated with avoiding plagiarism. Please see http://www.colorado.edu/academics/honorcode

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F. 4 minutes to 5 minutes elevator pitch should cover the following: Topic Why is this topic of interest to somebody in the real world: an investment banker, venture

capitalist, or entrepreneur. Your analysis (briefly). Your conclusions.

Please observe the following during your elevator pitch No overheads (you will not have access to an overhead in an elevator or a lunch meeting). Please place your name card on the podium when you are presenting.

Guidelines for the Term Paper

Suggested order for the sections:

Cover Page

Paper Title, Student Names, Course, Date

Executive SummaryNo more than one page. The most important part of your paper! Briefly explain what the paper is about,

why this is an interesting and important topic, and your main findings/conclusions. Consider an entrepreneur, investment banker, investor, or venture capitalist as your primary reader of this page.

Introduction

What is the paper about?

Motivation: Why is this interesting and important to study/read?

Overview of the paper.

(Main Body)

Please consider using sub-sections to better organize your paper, and improve its readability.

Please check the transition between paragraphs.

(Footnotes on same page.)

Summary and Conclusions

Exhibits (Tables, Graphs, etc.)

Captions and legends in the exhibits should make them self-explanatory. Cite data sources.

References____________________________________________________________________

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Check for grammar and spelling.

All arguments/assertions should be supported using:logical constructs, and/ortheoretical considerations (cite references), and/orprevious empirical evidence (cite references).

Paper should be revised by you at least four times over a period no less than a week.

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D and G. The exams will consist of essay-type questions, and will be closed-book, closed-notes, and in-class. The exams will be based on study questions that will be handed out at least a week before the exam.

Readings

o We will not be covering all the readings in class. I will indicate in class the readings I will be covering in detail. The readings above would be relevant if you decide to write your term paper on the particular topic.

o You are advised to read the “critical portions” of the assigned readings for a particular class before that class.

o The critical portions of a reading include the abstract, introduction, summary/conclusions of the paper.

o You might wish to read the main body of the paper after we have discussed it in class.

Bloomberg data

The Bloomberg terminals in Room E-370 have a wealth of financial data. Some of this can be used for the valuation part of your term paper. Having a competency with the Bloomberg terminal and related data makes you very

attractive to future employers. Please go to http://burridgecenter.colorado.edu/html/indexlab.html

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Grade distribution:http://leeds.colorado.edu/asset/undergraduate/gradingpolicy.pdf

Guidance to Faculty Regarding Grade Distributions

In May 2011, the faculty of the Leeds School voted to establish the “grading guidelines” shared below. With this vote, the faculty returns to its preͲ2009 approach of grading guidelines.

These guidelines embody the faculty’s consensus about competition and fairness within, and across, classroom experiences at Leeds. In its discussions and preparations, the faculty relied heavily on norms and customs at topͲtier business schools throughout the U.S.

The following matrix provides guidance on grade distributions either at the course level or aggregated across multiple, simultaneous sections.

Course Level Maximum Average Course Grade Recommended Distribution 1000 and 2000 2.8 Not more than 15% AͲ or above

Not more than 65% B Ͳ or above At least 35% C+ or below

3000 3.0 Not more than 25% AͲ or above Not more than 75% B Ͳ or above At least 25% C+ or below

4000 3.2 Not more than 35% AͲ or above Not more than 85% B Ͳ or above At least 15% C+ or below

Also, please review http://www.colorado.edu/policies/fac_relig.html,http://www.colorado.edu/policies/classbehavior.html,http://www.Colorado.EDU/disabilityservices,and http://www.colorado.edu/policies/discrimination.html.

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Study Questions for ESBM 4570 (May 1, 2017)Please note: The Final Exam (May 11, 2017, 1:30 pm – 2:30 pm) will consist of two questions

drawn from these. It is expected that the answer to each question would take about 30 minutes.

1. Describe the various methods of estimating the cost of equity. Discuss the advantages and disadvantages of the various methods of estimating the cost of equity. [value-1.ppt; slides 45-48, slides 6-7]

2. Describe the stable growth, 2-stage growth, and 3-stage growth models. Discuss when each model is appropriate to use. [value-1.ppt; slides 77-80]

3. Describe and discuss how you would value a company that currently has negative earnings. [value-2.ppt; slides 185-186; example in slides 187-199]

4. Kaplan and Stromberg (2001, 2003) and note that VC contracts have the following features: antidilution rights, automatic conversion, and vesting and non-compete clauses. Describe these contractual features. What is the economic justification for including it in a VC contract? [VC-Contracting.ppt]

5. (a) Bengtsson and Sensoy (2009) note that more experienced VCs are less likely to seek downside protection. What is meant by downside protection in a VC contract? Why do more experienced VCs seek less downside protection?(b) Why do VCs usually take convertible preferred stock rather than common stock in the companies they invest in?(c) As a founder in a company you might get angel investment. It is wise to treat angel (and other) investors fairly. How would you ensure the securities the angel investor receives in your company are fairly priced? [VC-Contracting.ppt]

6. (a) Why do venture-capitalists use such high discount rates? [venture-discount-class.doc] [“Why Do Venture Capitalists Charge Such High Discount rates”](b) What is the relation between insider ownership and an IPO’s value as discussed by Aggarwal, Bhagat and Rangan (2009). [IPO Valuation.ppt]

7. Why are initial public offerings underpriced? Please be sure to discuss the theories based on a. asymmetric information (both when the issuer is more informed than the investor, and the investors are more informed than issuer), b. theories based on symmetric information, and c. theories focusing on the allocation of IPO shares.[IPO.ppt]

8. (a)Why do we have less IPOs today than, say, in the 1990s? [Lowry-Michaely 2017](b)Why would a privately-held successful tech startup with, say, $2 million in revenue, care about its corporate governance? [Tech-Governance.ppt, slides 2,4,5]

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MARKETS   HEARD ON THE STREET

Unicorns Looking Less Magical Through IPO Lens

Cloudera is cutting its last private valuation to sell its IPO, which bodes ill for other tech unicorns

https://www.wsj.com/articles/unicorns-looking-less-magical-through-ipo-lens-1492532308Tom Reilly’s Cloudera plans to go public this year. PHOTO: MATTHEW BUSCH/BLOOMBERG NEWSBy Dan Gallagher

Wall Street Journal, April 18, 2017 12:18 p.m. ET0  COMMENTS

Cloudera let some air out of its own planned IPO. That could be a poor omen for the large roster

of other richly valued tech companies now considering an exit strategy.

It is a big group: According to The Wall Street Journal’s tracking, 152 privately held

companies are sitting on valuations at or above $1 billion in the nonpublic market, granting them

so-called “unicorn” status. Their ranks have swelled by about 60% from this point two years ago.

Cloudera, which provides “big data” analytics software services to businesses, will be the fourth

such company to go public this year, following Okta ,MuleSoft and Snapchat parent Snap Inc.

None of those four companies are generating earnings or, for that matter, positive operating cash

flow. Yet the market has been more receptive to riskier plays this year than last, when investors

sought safer ground. Since the end of 2016 the Nasdaq Internet Index has jumped 14% while the

BVP Cloud Index has added more than 10%. Meanwhile, the biggest gainer among large-cap

technology-related companies so far has been Tesla—hardly a risk-free name.PoppedShare price performance of recent tech IPOs.THE WALL STREET JOURNALSource: FactSet%Change from IPO priceChange from first dayopening priceSnapMuleSoftAlteryxOktaYext-20-1001020304050

But Cloudera’s reduced valuation is another sign that public investors are rightly wary of cashing

out private companies whose valuations have soared through the abundance of private capital.

Cloudera was last valued at $4.1 billion three years ago, putting it in the top quartile of the so-

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called unicorn field. The company’s updated IPO terms from Monday imply a valuation closer to

$2 billion now.

A lower valuation will likely ensure a better debut, at least as far as optics go. All of the tech

IPOs so far this year have generated a satisfying pop on their first day above their offering price.

But for the bulk of investors who don’t have access to those early allotments, these stocks have

been disappointments. Snap and MuleSoft shares now are trading below their first-day opening

prices while Okta is up just 2% from that starting point since its April 7 debut. Yext, a smaller

tech company that listed last week, is down 4% from its first-day open.

A seemingly endless supply of private capital has allowed many tech startups to stay out of the

public limelight for a longer period while pursuing a growth-at-all-cost strategy. Now that public

investors are getting a look at those continuing costs, though, many are understandably hesitant

to pick up the tab.

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https://www.wsj.com/articles/spotify-finally-readies-an-ipo-thats-not-an-ipo-1491476403

Spotify Finally Readies an IPO...That’s Not an IPO

Music-streaming service considers a direct listing, bypassing the typical public-offering script

Spotify was last valued privately at $8.5 billion in June 2015. Above, the company’s Berlin offices last year. PHOTO: KRISZTIAN BOCSI/BLOOMBERG NEWSBy Maureen Farrell and 

Telis DemosApril 9, 2017Spotify AB, the music-streaming service, is preparing to go public this year. But it may not

create the payday Wall Street is used to.

The Swedish company, last valued at $8.5 billion, is seriously considering not holding a public

sale of shares. Instead it is exploring simply listing its shares on an exchange in what is known as

a direct listing, according to people familiar with the matter. It wouldn’t raise money—the

hallmark of an IPO—or use underwriters to sell the stock.

The approach has advantages for Spotify and its existing investors. It could enable the firm to

save tens of millions of dollars in underwriting fees, prevent its existing holders from having

their stakes diluted, and enable executives to publicly tout the company ahead of its listing,

unlike a strictly regulated IPO, the people said.

But it spells bad news for Wall Street, where underwriting is big business. Tech titans such as

Uber Technologies Inc. are already shirking the constraints of public markets, choosing instead

to raise money in the flush private arena. And when they have held IPOs, some have chosen

unconventional paths. Snap Inc., for example, negotiated a big cut in the fees it paid and also

withheld the right to vote from new investors.

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Spotify, which has raised more than $1 billion in equity, was last valued privately at $8.5

billion in June 2015. The company is targeting a public valuation of more than $10 billion, the

people said. The 10-year-old company may list its shares on a U.S. exchange as early as

September.

While Spotify executives have yet to decide on a path, their decision will be watched closely. If

the company does list this way successfully, it could create a path for other highly valued

technology companies with ready access to cash to quickly move into the public domain without

using the typical IPO script.

In a typical IPO, new investors buy shares from the company or its early investors, or both, the

night before they start trading. The initial price is set by underwriters following extensive private

meetings with potential new investors. In a direct listing, investors purchase shares in the open

market after they are listed. The price is set organically based on supply and demand. Currently,

Spotify’s shares are in the hands of the company’s founders, employees and investors.

In direct listings, early investors would be subject to less stringent lockups governing the sale of

insiders’ shares and the company could avoid the first-day trading pop that characterizes many

IPOs shepherded by underwriters. They are good for some investors but also indicate a company

potentially left money on the table. Having a public stock would also give Spotify’s investors

and employees the opportunity to cash in their shares.

There are risks to this approach, whose consideration by Spotify was earlier reported by

Mergermarket. With market forces determining the share price from the outset, the company’s

public debut could be more volatile and unpredictable. Also missing would be the large blocks of

stock underwriters typically allocate to investors they believe will hold the shares for the long

term and promote trading stability.

Spotify, which recently hired banks to advise on the process, could still choose to move forward

with a more-traditional IPO, one person said.

Several IPO watchers said they could think of few examples of major companies going public in

the U.S. in this way. Direct listings have mostly been used by small companies that don’t

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anticipate much trading in their stock, including those that have just emerged from bankruptcy.

But some sizable companies have used them over the years. Freddie Mac, for example, in 1989

became a public company by listing its existing stock in a similar fashion.

But Spotify’s consideration of a direct listing has a broader context. The number of public

companies in the U.S. has declined dramatically as private funding sources multiply and officials

weigh the cost of increased scrutiny from investors and regulators. When companies go public,

they are increasingly doing so in ways that insulate them from such forces, like handing founders

outsize voting control, as in Snap’s IPO.

All that is bad news for Wall Street.

Last year, investment banks generated the smallest amount of revenue from share sales in more

than 20 years, according to Dealogic. IPO activity and traditional stock sales by companies that

are already public have been anemic. Spotify’s advisers would get much smaller fees than IPO

underwriters typically receive, the people familiar with the matter said. In the case of the $4

billion Snap debut, underwriters shared about $100 million—one of the smallest fees on record

on a percentage basis.

Spotify wouldn’t be the first company to try to diminish the role of Wall Street. Google, now

part of Alphabet Inc., employed a so-called Dutch auction in its 2004 IPO in an effort to put

more shares in the hands of small investors and avoid a first-day pop. In a Dutch auction, the

highest bidders are sold the most shares at the IPO price.

But in a sign of the difficulty of bucking the traditional approach, Google’s IPO was priced at

$85 a share, below the $108 to $135 the company targeted, as investors struggled to pinpoint its

value. The shares soon started climbing and now change hands for about $850 apiece, after a

roughly 2-for-1 split in 2014.

Spotify last year issued a $1 billion convertible bond to parties including TPG and Dragoneer

Investment Group. The interest rate of 5% increases 1 percentage point every six months until

the company goes public, giving it a potential incentive to pursue a listing sooner rather than

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later. If it lists directly, Spotify would likely need to renegotiate terms of the facility, one of the

people said.

Spotify had agreed that the investors could convert the debt into equity at a 20% discount to the

share price if an IPO takes place one year hence. If it takes place later, the discount increases.

Since this wouldn’t be a typical public offering, it may not trigger a conversion. So Spotify may

need to negotiate with the investors a price at which they would receive equity.

—Matt Jarzemsky 

contributed to this article.

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