Final Exam

• Sources of funding


  • Internal funding: Retained earnings
  • External funding: Equity, Debt, Leasing, Others
• Who firms issue securities to

  • Market or public issue
  • Private placements/financial intermediaries
  • Existing security holders – Rights issues
• Equity financing


  One of the main capital sources – it has limited liability, ownership, residual claim (ranked last in distributions of dividends and funds from liquidation), non-redeemable (firm can't force shareholders to sell back their shares)
• Types of equity


  • Ordinary Shares
  • Preference Shares
• Angel Investors


  • Individual Investors who buy equity in small private firms – often the first significant source of outside funding
  • Common background: Entrepreneurs, Billionaires, Executives of multinational corporations
• Angel investors


  • Jeff Bezos
• Venture Capital Firm


  • A limited partnership that specializes in raising money (not providing personal funds like angel investors) to invest in the private equity of early-stage, high-risk, high-potential firms who lack funding for growth
• Limited partnership


  Structure of venture capital firms

  
• Compensation structure


  • Management fee: about 2% p.a. of the fund's committed capital
  • Carried interest: Most firms charge 20% of any positive return they make (↑risk = ↑return)
• Financing stages


  • Seed funding
  • Start-up
  • Growth (Series A round)
  • Second-Round
  • Expansion
  • Exit of venture capitalist
• Private Equity Firms


  • Organized very much like a venture capital firm (similar fees and investors are limited partners), but it invests in the equity of existing late-stage private and public firms rather than start-up companies
  • The main difference to venture capital firms is that private equity firms have a much larger pool of funds to invest
  • Often, private equity firms initiate their investment by finding a publicly traded firm and purchasing the outstanding equity, thereby taking the company private in a transaction called a leveraged buyout (LBO)
• Famous PE firms


  • The Blackstone Group
  • Neuberger Berman Group
  • Apollo Global Management
  • The Carlyle Group
  • KKR
  • Bain Capital
  • CVC Capital Partners
  • Warburg Pincus
  • Vista Equity Partners
  • EQT AB
• Leveraged buyout (LBO)


  A leveraged buyout occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage (borrowing)
• Institutional Investor


  • Institutional investors such as pension funds, hedge funds, mutual funds, insurance companies, endowments, and foundations are active investors in private companies
• Australian examples


  • Innovation Investment Fund (government fund)
  • UniSuper (pension fund)
• Strategic Investor


  • A corporation that invests in private companies. Also known as a Corporate Partner, Strategic Partner, or Strategic Investor
• Strategic Partner Example


  • Nike and Apple
• Financing Public Firms


  • Primary Offering: Initial Public Offering (IPO)
  • Secondary Offering: Shares sold by existing shareholders (non-dilutive), Seasoned Equity Offering (SEO):new shares (dilutive)
• Underwriter


  An investment banking firm that manages a security issuance and designs its structure
• Underwriting Spread


  The difference between the issue price and the price paid by the underwriter to the firm. This is the profit margin of the underwriter, a percentage of the issue price of a share of stock (~7% on average in the US)
• Underwriter Fees Example


  • Alibaba's underwriters earned $300 million in fees, taking home 1.2 percent of the proceeds
• Types of underwriting


  • Best-Efforts Basis
  • Firm Commitment (most common)
  • Auction IPO
• Best-Efforts Basis


  For smaller IPOs, a situation in which the underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price. Little risk for the underwriter, performing largely a marketing role for the firm's shares.
• Firm Commitment


  The most common type of underwriting, where the underwriter guarantees that it will sell all of the stock at the offer price by purchasing all the shares from the company at a price slightly below the offer and then selling the shares to the public at the offer, gaining the spread.
• Auction IPO


  Rather than setting a price itself and then allocating shares to buyers, the underwriter takes bids from investors and then sets the price that clears the market. The offer price will be the highest possible price where the number of bids at or above the price equals the number of shares offered. Not a very common IPO method.
• Auction IPO example


  • Company A is going public using an auction IPO and has received the following bids: [list of bids]
• Roadshow


  A presentation by an issuer of securities to potential buyers, intended to generate excitement and interest in the issue or IPO, and is often critical to the success of the offering.
• Book building


  The process by which an underwriter attempts to determine at what price to offer an IPO based on demand from institutional investors.
• IPO valuation


  The goal is to price the security issue at the exact price at which the demand for the shares equals the supply. An oversubscribed IPO like Alibaba, and an undersubscribed IPO like Facebook.
• Underpricing


  Underwriters generally set the issue price so that the average first-day return is positive, which allows them to manage their risk but results in the pre-IPO shareholders selling stock for less than they could get in the aftermarket.
• Winner's Curse


  Refers to a situation in competitive bidding when the high bidder, by virtue of being the high bidder, has very likely overestimated the value of the item being bid on.
• The number of IPO issues is highly cyclical, with more issues when times are good and fewer when times are bad.
• The costs of an IPO are very high, with a typical spread of 7% of the issue price, and there seems to be a lack of sensitivity of fees to issue size.
• Although shares of IPOs generally perform very well immediately following the public offering, it has been shown that newly-listed firms subsequently appear to perform relatively poorly over the following three to five years after their IPOs, which also applies to SEOs.
• Seasoned Equity Offering (SEO)

  A cash offer where a firm offers new shares to investors at large, or a rights offer where a firm offers new shares only to existing shareholders.
• Types of debt financing

  • Public Debt
  • Private Debt
• Public Debt


  A public bond issue is similar to a stock issue, with a prospectus including an indenture which is a formal contract between the bond issuer and a trust company representing the bondholders.
• Types of international bonds

  • Foreign bonds
  • Eurobonds
  • Global bonds
• Private Debt


  Debt that is not publicly traded, has the advantage of avoiding the cost of registration but the disadvantage of being illiquid, and is a bigger market than public debt.
• Types of private debt

  • Term Loan
  • Revolving Line of Credit
  • Syndicated Bank Loan