Chapter 14Fundamentals of

Corporate FinanceFourth Edition

How Corporations Issue Securities

PRESENTED BY

D-R EVGENI ZOGRAFSKI

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Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved

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Topics Covered

Venture CapitalThe Initial Public OfferingThe UnderwritersGeneral Cash OffersThe Private Placement

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Venture Capital

Infant companies raise venture capital to set up a new firm. Venture capital firms (VC) have the same interest as managers-to increase the value of firm. Success of a new firm is highly dependent on the effort of the managers, so restrictions are placed on management by the VC and funds are usually dispersed in stages, after a certain level of success is achieved. VC are usually represented in Board. They help company to bring their products to the market. Usually VC leaves the project in 3-5 years, with average rate of return of 33%.

Venture Capital

Money invested to finance a new firm

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Venture Capital

First – stage Market value Balance sheet $.M.

Assets Liabilities and Equity

Cash $0.5 New equity (VC) $0.5

Other assets $0.5 Original equity $0.5

Value $1.0 $1.0

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Venture Capital

Second Stage Market Value Balance Sheet ($mil)

Assets Liabilities and Equity

Cash from new equity 1.0 New equity from 2nd stage 1.0

Other assets 2.0 Equity from 1st stage 1.0

Your original equity 1.0

Value 3.0 Value 3.0

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Initial Offering

A Firm is said to go public when it sells its first issue in a general offering to investors or IPO or primary offering

Initial Public Offering (IPO) - First offering of stock to the general public.

Underwriter – Firm (investment bank) that buys an issue of securities from a company and resells it to the public. They play triple role: 1)procedural and financial advice;2) buying stocks; 3)reselling stocks to the publicFor big issues syndicate of underwriters needed (Microsoft IPO needs 114 underwriters)

Spread – Underwriter receive payments in the form of spread = Difference between public offer price and price paid by underwriter.

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Initial Offering

Prospectus - Formal summary (a document) that provides information on an issue of securities. It is approved by SEC and SE and distributed to the public

How to set the issuing price? Using Discounted Cash Flow (DCF) methods- the true value per share

Road-shows-marketing the new issue of shares to talk with potential investors

Under-pricing – Underwriters usually try to under-price the new issue, issuing securities at an offering price set below the true value of the security. It represents a cost to the existing shareholders since the new investors are allowed to buy shares in the firm at a favorable price

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Initial Public Offering

0

2

4

6

8

10

12

14

16

18

Tot

al D

irec

t C

osts

(%

of

issu

e)

Value of Issue ($mil)

2-9.99

10-19.99

20-39.99

40-59.99

60-79.99

80-99.99

100-199.99

200-499.9

500 and up

Expenses

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The Underwriters

062,3$ers UnderwritAll

163America ofBank

224Bank Deutsche

253WarburgUBS

261BrothersLehman

278StanleyMorgan

302SachsGoldman

315MorganJP

347BostonCS/First

433Lynch Merrill

$487BarneySmith Salomon Citigroup/

issues) total of ($bil

2001in rsUnderwrite U.S. Top

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General Cash Offers

Seasoned Offering - Sale of securities by a firm that is already publicly traded (new issue of securities).

General Cash Offer - Sale of securities open to all investors by an already public company (public offering).

Private Placement - Sale of securities to a limited number of investors without a public offering. Less costly compared to other forms of new issues of securities and well suited for small and risky firms

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Rights Issue

Current Market Value = 9 mil x $15 = $135 mil Total Shares = 9 mil + 3 mil = 12 mil Amount of new funds = 3 mil x $12 = $36 mil

New Share Price = (136 + 36) / 12 = $14.25/sh Value of a Right = 15 - 14.25 = $0.75

Rights Issue - Issue of securities offered only to current stockholders.

Example - YRU Corp currently has 9 million shares outstanding. The market price is $15/sh. YRU decides to raise additional funds via a 1 for 3 rights offer at $12 per share. If we assume 100% subscription, what is the value of each right?

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Market reaction

New issue of common stocks result in decline of stock price

Additional supply depressed the stock priceBut it depends on valuation

if the issue price is under valued, is not the case,

if the issue price is over valued stock price will decrease

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Web Resources

www.ventureeconomics.com

www.vnpartners.com

www.freeedgar.com

www.ipo.com

http://cbs.martketwatch.com

www.tfibcm.com

http://bear.cba.ufl.edu/ritter