How Corporations Issue Securities

1
How Corporations Issue Securities

• Financial Institutions
• Student Presentations
• Venture Capital
• Initial Public Offering
• Other New Issue Procedures
• Subsequent Security Sales
• Private Placements

2
Financial Institutions

• Types of institutions
• Banks
• Insurance companies
• Pension funds
• Mutual funds
• Hedge funds
• Payment mechanism
• Borrowing and lending
• Pooling risk

3
Venture Capital

• First stage financing
• Advantages
• Deep pockets
• Contacts
• Experience with start-up companies
• Partnership in operations and financial success
• Incentives
• For managers
• Fully committed financially
• Will reap payoff only if successful
• For venture capitalist
• Downside protection
• Upside potential

4
Venture Capital - 2

• Second (and third or more) stage financing
• May include additional venture capitalists
• Ties funding to meeting objectives
• Most companies funded by venture capital do not
  succeed
• Open Prairie Ventures
• 2 of 15 start-ups actually considered successes
• Payoffs on successes provide enough to offset the
  losses on the rest of the investments

5
Venture Capital Market

• Venture capital investment trends
• 1995 8 billion
• 2000 105 billion
• 2006 26 billion
• Generally organized a limited private
  partnerships
• Management company
• Fixed fee and share of profits (2 plus 20)
• Limited partners
• Insurance companies or pension plans
• Wealthy investors
• Share in gains/losses
• Exit strategy for venture capitalist
• Selling firm
• Going public

6
Initial Public Offering

• Select managing underwriter and form underwriting
  syndicate
• Arrange spread and greenshoe option
• Register with SEC and issue prospectus
• Roadshow to interest potential investors and
  build book of demand
• SEC approval and issue price set
• Underwriters allocate stock
• Trading starts
• Managing underwriter makes liquid market

7
Underwriting a New Issue

• Role of underwriter and underwriting syndicate
• Financial advisors
• Buy the issue
• Resell it to the public
• Alternatives for underwriting syndicate
• Buy entire issue and resell it
• Best-efforts basis
• All-or-none arrangement
• Primary offering
• New shares
• Secondary offering
• Shares held by management, venture capitalist or
  other investors

8
Financial Terms for IPO

• Spread
• Difference between what underwriter pays and the
  offering price
• Typically 7 for 20 80 million IPOs
• Split among managing underwriter, syndicate and
  sales force
• Registration costs
• Greenshoe option
• Allows underwriter to buy and sell additional
  shares

9
Prospectus

• Number of shares
• Primary offering
• Secondary offering
• Price
• To public
• To underwriter
• Proceeds to company and other sellers
• Registration expenses
• Use of proceeds
• Company information
• Considerations Warnings
• Management and compensation
• Prior transactions
• Selling stockholders
• Underwriting agreement
• Legal matters

10
Underpricing of IPOs

• IPOs often end the first day of trading above the
  offering price
• Average first day returns approximately 19 over
  1963-2003
• Long term, IPOs underperform the market
• Why are IPOs underpriced?
• To assure selling entire issue
• To entice investors to IPOs of underwriter
• To reward favored clients
• Individual investors do not get favorable returns
  by bidding for each IPO

11
New Issue Procedures

• Bookbuilding
• Typical in US
• Fixed price offer
• Auction
• Google
• Discriminatory auction
• Uniform price auction
• Impact of winners curse

12
Subsequent Security Sales

• General cash offers
• Shelf registration
• More common for debt than equity
• Allows company to time market
• Spreads
• IPOs - around 7
• Seasoned equity - around 5
• Debt around 1
• Market reaction to stock issues
• US stocks approximately a 3 decline when stock
  issue is announced
• Signaling issue
• Rights issues

13
Private Placements

• Limits on number and type of investors
• Advantages
• Lower cost
• May deal directly with buyer
• Disadvantages
• No active market to determine price
• Hard to resell
• Example
• State Farm and debt issues

14
Summary

• Companies can raise capital in a variety of ways
• Venture capital is a stepping stone to more long
  term financing
• Initial public offerings are a complex process
• Issuing equity is more costly than issuing debt
• Underwriters play an important role in raising
  capital
• Underpricing of IPOs is typical
• Signaling inside information impacts stock price
• Beware of the winners curse in investing

15
Next Class

• Payout Policy
• Read Chapter 16