MOS 1023- Lecture #7 Nov 13/13.docx

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Western University
Management and Organizational Studies
Management and Organizational Studies 1023A/B
Maria Ferraro

Financing and Distribution MOS 1023 Lecture 7 Demand deposit Bootstrapping (ie. puling them up by themselves) - Initial Funding of the Firm - The process by which many entrepreneurs raise “seed” money and obtain other resources necessary to start their businesses - The initial “seed” money usually comes from the entrepreneur or other founders. - Other cash may come from personal savings, the sale of personal assets, loans from family and friends, use of credit cards. - The seed money, in most cases, is spent on developing a prototype of the product or service and a business plan. - Usually lasts 1 to 2 years Venture Capital (move company from bootstrapping period – ex. Dragons)  Venture capitalists are individuals or firms that help new businesses get started and provide much of their early-stage financing.  Individual venture capitalists or angel investors, are typically wealthy individuals who invest their own money in emerging businesses at the very early stages in small deals.  Three reasons exist as to why traditional sources of funding do not work for new or emerging businesses: 1. The high degree of risk (most suppliers like banks are not interested- therefore need venture capitalists) 2. Types of productive assets. 3. Informational asymmetry problems  The venture capitalists’ investments give them an equity interest in the company.  Often in the form of preferred stock that is convertible into common stock at the discretion of the venture capitalist. – because CS will go up if company does well - preferred stock doesn’t move up like this  Venture Capitalists Provide More Than Financing - The extent of the venture capitalists’ involvement depends on the experience of the management team. Ex. Pharmaceutical industry - One of their most important roles is to provide advice. - Because of their industry and general knowledge about what it takes for a business to succeed, they provide counsel for entrepreneurs when a business is being started and during early stages of operation. How Venture Capitalists Reduce Their Risk  Venture capitalists know that only a handful of new companies will survive to become successful firms.  Tactics to reduce risk: 1. funding the ventures in stages (stage funding) 2. requiring entrepreneurs to make personal investments 3. syndicating investments 4. in-depth knowledge about the industry Venture Capital Syndication (selling your ownership to others)  It is a common practice to syndicate seed- and early-stage venture capital investments.  Syndication occurs when the originating venture capitalist sells a percentage of a deal to other venture capitalists.  Syndication reduces risk in two ways: 1. it increases the diversification of the originating venture capitalist’s investment portfolio. 2. the willingness of other venture capitalists to share in the investment provides independent corroboration that the investment is a reasonable decision. The Venture Capital Exit Strategy  Venture capitalists are not long-term investors in the companies, but usually exit over a period of three to seven years.  Every venture capital agreement includes provisions identifying who has the authority to make critical decisions concerning the exit process. 1. Timing (when to exit) 2. The method of exit 3. What price is acceptable  There are three principal ways in which venture capital firms exit venture- backed companies: 1. Sell to a strategic buyer in the private market. (ex. Coke & Smart Water- company will compliment business in future) 2. Sell to financial buyer in the private market (looking at it as an investment) 3. Initial Public Offering: selling common stock in an initial public offering (IPO). (taking company from private to public stocks) Initial Public Offering (IPO)  One way to raise larger sums of cash or to facilitate the exit of a venture capitalist is through an initial public offering, or IPO, of the company’s common stock.  First-time stock issues are given a special name because the marketing and pricing of these issues are distinctly different from those of seasoned offerings.  Advantages Going Public: o The amount of equity capital that can be raised in the public equity markets is typically larger than the amount that can be raised through private sources. o Once an IPO has been completed, additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost. o Going public can enable an entrepreneur to fund a growing business without giving up control. o After the IPO, there is an active secondary market in which stockholders can buy and sell its shares. o Publicly traded firms find it easier to attract top management talent and to better motivate current managers if a firm’s stock is publicly traded.  Disadvantages to Going Public. o High cost of the IPO itself. o The costs of complying with ongoing SEC disclosure requirements o The transparency that results from this compliance can be costly for some firms.  INVESTMENT-BANKING SERVICES o To complete an IPO, a firm will need the services of investment bankers, who are experts in bringing new securities to the market. o Investment bankers provide three basic services when bringing securities to market–  Origination:  Includes giving the firm financial advice and getting the issue ready to sell. – thorough due diligence  The investment banker helps the firm determine whether it is ready for an IPO.  Once the decision to sell stock is made, the firm’s management must obtain a number of approvals.  File a registration statement with the Securities Exchange Commission  Underwriting:  The risk-bearing part of investment banking- who owns the risk of not selling shares or getting the price  The securities can be underwritten in two ways: 1. Firm-Commitment Underwriting o the investment banker guarantees the issuer a fixed amount of money from the stock sale. o Investment banker’s compensation – underwriter’s spread (what’s left over) o The underwriter bears the risk -price risk. If sells high its good worse if it sells less 2. Best-Effort Underwriting o the investment banking firm makes no guarantee to sell the securities at a particular price. o does not bear the price risk o compensation is based on the number of shares sold.  Underwriting Syndicates (spread the risk through a group of people=syndicate) o To share the underwriting risk and to sell a new security issue more efficiently, underwriters may combine to form a group called an underwriting syndicate. o Participating in the syndicate entitles each underwriter to receive a portion of the underwriting fee as well as an allocation of the securities to sell to its own customers.  Determining the Offer Price o One of the investment banker’s most difficult tasks is to determine the highest price at which the bankers will be able to quickly sell all of the shares being offered and that will result in a stable secondary market for the shares.  Due Diligence Meeting (about protection) o Before the shares are sold, representatives from the underwriting syndicate hold a due-diligence meeting with representatives of the issuer. o Investment bankers hold due-diligence meetings to protect their reputations and to reduce the risk of investors’ lawsuits in the event the investment goes sour later on.  Distribution:
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