THE UNIVERSITY OF LARKANO
BUSINESS ADMINISTRATION
DEPARTMENT
LECTURE NO: 2
CORPORATE FINANCE
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CORPORATE FINANCE (BBA 2K21) BY: SHAGUFTA SALEEM SHAIKH
How
Corporations
Raise Venture
Capital and
Issue Securities
Copyright © 2015 by The McGraw-Hill Companies, Inc. All rights reserved
Topics Covered
Venture Capital
Features of Venture Capital
Stages
The Initial Public Offering
General Cash Offers by Public Companies
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Meaning of Venture Capital
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Venture Capital
Venture capital means funds made available
for startup firms and small businesses with
high growth potential.
Venture capital is financial support to young,
rapidly growing companies/ individuals that have
the potential to develop into significant economic
contributors by the Business men / Group to
create a product or service which has a unique
idea.
Young firms often require venture capital to
finance growth
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Company Growth
Venture capital provides entrepreneurs
with financing to grow their firms
Firms issue securities to further finance
their growth
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Features of Venture Capital
Long time horizon: In general, venture capital
undertakings take a longer time say, 5 to 10 years at a minimum
to come out commercially successful; one should, thus, be able
to wait patiently for the outcome of the venture.
Lack of liquidity: Since the project is expected to run at
start-up stage for several years, liquidity may be greater
problem.
High Risk: The risk of the project is associated with the
management, product and operations.
High-tech: However, a venture capitalist looks not only for
high-technology but the innovativeness through which the
project can succeed.
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Features of Venture Capital
Equity participation and capital gains: A venture
capitalist invests his money in terms of equity. He dose not look
for any dividend or other benefits, but when the project
commercially succeeds, then he can enjoy the capital gain which
is his main benefit.
Participation in management: Unlike the traditional
financier or banker, the venture capitalist can provide
managerial expertise to entrepreneurs besides money.
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Stages of Venture Capital Financing
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A. Early Stage Finance
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B. Later Stages of Finance
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Types of Venture Investors
Angel investors
– Investors who finance companies in their earliest
stages of growth
Corporate ventures
– Corporations that offer venture assistance to
finance young, promising companies
Private equity investing
– Investors who offer funds to finance firms that do
not trade on public stock exchanges such as the
NYSE or NASDAQ
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Initial Public Offering
When a firm requires more capital than private
investors can provide, it can choose to go public
through an initial public offering, or IPO.
– Primary Offering
• When new shares are sold to raise additional cash for
the company
– Secondary Offering
• When the company’s founders and venture capitalists
cash in on some of their gains by selling shares
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Benefits of Going Public
Ability to raise new capital
Stock price provides performance measure
Information more widely available
Diversified sources of finance
Reduced borrowing costs
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Initial Public Offering
Initial Public Offering (IPO) – When a private company
sells shares of its stock for the first time to the public
and becomes a public company.
Underwriter – An underwriter is any party, usually a
member of a financial organization , that evaluates and
assumes another party’s risk in insurance, loans or
investments for a fee, usually in the form of a
commission, premium, spread or interest.
Prospectus - Formal summary that provides
information on an issue of securities
Underpricing - Issuing securities at an offering price set
below the true value of the security 15- 20
Arranging Public Issues
Steps to issue a new public security:
1. SEC Registration
• Prospectus—a formal summary that provides
information on an issue of securities
2. Select Underwriter / Undertake Roadshow
3. Set final issue price for public
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IPO Flowchart
2
Underwriter Firm Investors
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5
1. Underwriter provides advice to firm
2. Underwriter pays firm for a number of shares
3. Firm provides shares to underwriter to be resold
4. Underwriter offers shares to investors
5. Investors purchase shares from underwriter
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Underwriter Spread
Spread - the difference between the public offer price
and the price paid by underwriter
Example
Assume the issuing company incurs $1 million in expenses to
sell 3 million shares at $40 each to an underwriter; the
underwriter sells the shares at $43 each. What is the spread
for this deal?
Formula: Spread = Number of shares X (Selling price of
underwriter – purchase cost to underwriter)
3 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 × $43 − $40 = $9 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
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Underwriting Arrangements
Firm Commitment - Underwriters buy the
securities from the firm and then resell them to
the public
Best Efforts Commitment - Underwriters agree to
sell as much of the issue as possible but do not
guarantee the sale of the entire issue
Flotation Costs - The costs incurred when a firm
issues new securities to the public
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Underwriting Arrangements
Example
How much will a firm receive in net funding from a firm
commitment underwriting of 250,000 shares priced to the
public at $40 if a 10% underwriting spread has been added to
the price paid by the underwriter? Additionally, the firm pays
$600,000 in legal fees.
Cost to public = $40
Net to issuer = $40/1.10 = $36.36
Therefore, the spread was $3.64 per share
Net to issuer = 250,000 × $36.36 = $9,090,000
Less legal fees 600,000
$8,490,000
So, the firm will receive approximately $8,490,000 in net funding after accounting for
the underwriting spread and legal fees.
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Underpricing of an IPO
Underpricing: Issuing securities at an offering price set
below the true value of the security
Example – (continued)
Assume the issuer incurs $1 million in other expenses to sell 3
million shares at $40 each to an underwriter and the
underwriter sells the shares at $43 each. By the end of the first
day’s trading, the issuing company’s stock price had risen to
$70. What is the total cost of underpricing?
Formula: cost of underpricing = Number of shares X (Market
price per share – offering price per share)
Cost of underpricing:
3 million($70 - $43) = $81 million
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The Underwriters
Value of Issues Number of
($ billions) Issues
JP Morgan Chase $389 1,464
Deutsche Bank 375 1,499
Barclay’s Capital 369 1,171
Bank of America Merrill Lynch 327 1,304
Citi 309 1,138
Morgan Stanley 277 1,186
Goldman Sachs 270 815
Credit Suisse 235 980
UBS 225 1,008
BNP Paribas 214 803
Top Underwriters in 2011
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General Cash Offers
Seasoned Offering - Sale of securities by a firm
that is already publicly traded
General Cash Offer - Sale of securities open to all
investors by an already public company
Shelf Registration - A procedure that allows firms
to file one registration statement for several
issues of the same security
Private Placement - Sale of securities to a limited
number of investors without a public offering
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Rights Issue
Rights Issue - Issue of securities offered only to
current stockholders
Example
Barclays Bank currently has 12.68 billion shares
outstanding. The market price is Rs.2.85/share
Barclays decides to raise additional funds via a 1
for 4 rights offer at 1.85/share If we assume 100%
subscription, what is the value of each right?
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To calculate the value of each right in a 1-for-4 rights offer, you can
use the following formula:
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