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Chapter 15

Chapter 15 ECON 2560

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Department
Economics
Course
ECON 2560
Professor
Tahsin Mehdi
Semester
Summer

Description
Chapter 15 ECON 2560 Venture Capital, IPOs & Seasoned Offerings VENTURE CAPITAL Venture Capital: Money invested to finance a new firm  Is provided by specialized venture capital firms, financial & investment institution s(such as banks & pension funds) & government agencies Angel: A wealthy individual investor in early-stage ventures  Seek this out if you need really early stage financing for a new enterprise  Angels also bring hands-on contribution to small-scale investments and early-stage ventures  It’s hard to convince a venture capitalist to invest in your business  Must 1 prepare a business plan that describes your product, the potential market, production method, and the resources (time, money, employees, facilities & equipment) needed for success nd  Once business has grown to point where it needs further equity, the 2 stage of financing involves issue of more shares from original investors to by other venture capital firms Venture Capital Companies  While some young companies g row with the help of angels, many others will raise capital from specialist venture capital firms which pool funds from a variety of investors, seek out fledgling companies to invest in, and then work w/ these companies as they try to grow  Most venture capital funds are organized as limited private partnerships w/a fixed life of about 10 years  Pension funds & other investors are the limited partners  The management company, which is the general partner, is responsible for making and overseeing the investments & in return gets a fixed fee as well as a share of the profits  Venture capitalists are not passive investors… they are usually represented on each company’s board of directors, help recruit senior management and they provide ongoing advice to business st  For every 10 1 stage venture capital investments, only 2 or 3 may survive as successful, self-sufficient business, and only 1 may pay off big THE INITIAL PUBLIC OFFERING  For many successful start-ups there comes a time when they need more capital than can comfortably by provided by a small # of individuals or venture capitalists  In this case company may choose to raise money by selling shares to the public st Initial Public Offering (IPO): 1 offering of stock to the general public  IPO is a primary offering when new shares are sold to raise additional cash for the company  Secondary offering when the company’s founders & the venture capitalist cash in on some of their gains by selling shares  IPOS can be (and commonly are) both primary & secondary Arranging a Public Issue  Once a firm decides to go public, the 1 task is to select the underwriters who usually play a triple role of providing company with procedural & financial advice, then buying the stock, and finally reselling it to the public Underwriter: Investment dealer that buys an issue of securities from a company & resells it to the public  A small IPO may only have 1 underwriter but larger issues usually requires a syndicate of underwriters who buy the issue and resell it  In the typical underwriting arrangement, (firm commitment), the underwriters buy the securities from the firm and then resell them to the public  Underwriters allowed to sell the shares at a slightly higher price than they paid for them Spread: Difference between the public offer price & price paid by underwriter  Before any stock can be sold to the public, the company must satisfy the requirements of provincial securities laws & regulations  Each province & territory in Canada has a securities commission or related authority and its own piece of legislation  The stock may have to be registered w/ and appropriate securities commission Prospectus: Formal summary that provides info on an issue of securities  This is the 1 part of the registration statement, the prospectus is distributed to the public  Contains some financial info, company’s history & plans for the future  It serves to warn investors about the risks involved in any investment in the firm  The securities commission while reviewing he preliminary prospectus may require it to be revised before approving  The company & its underwriters also need to set the issue price  To gauge how much the stock is worth they may undertake discounted cash flow calculations and/or look at the price-earnings ratios of the shares of the firm’s principal competitors  Before settling on the issue price the underwriters may arrange a “roadshow” which gives the underwriters an the company’s management an opportunity to talk to potential investors who can say if price is fair  The managers of the firm are eager to secure the highest possible price for their stock but underwriters are likely to be cautious b/c they will be left w/ any unsold stock if they overestimate investor demand Underpricing: Issuing securities at an offering price set below the true value of the security Floatation Costs: The costs incurred when a firm issues new securities to the public  Underpricing  Direct costs: prep of the registration statement & prospectus involves management, legal counsel & accountants as well as underwriters and their advisors  Direct costs: Underwriting commissions, legal, accounting & other admin costs THE UNDERWRITERS  Underwriters don’t just help the company make its IPOs, they are called in whenever a company wants to raise cash by selling securities to the public  Most companies raise capital just occasionally, but underwriters are in the business all the time  Underwriters are careful of their reps and wont handle a new issue unless they think the facts have been presented fairly to investors  For big issues, a group of underwriters (syndicate or banking group) will usually be formed to handle the sale  Companies get to make only 1 IPO but underwriters are in the business all the time  Wise underwriters realize that their rep is on the line & wont handle an issue unless they believe the facts have been presented fairly to investors  If a new issue goes wrong & the stock price crashes, the underwriters can find themselves very unpopular w/ their clients Who are the Underwriters?  Several hundred investment banks, security deals & brokers are at least sometimes involved in underwriting  The market for larger issues is dominated by the major investment dealers which specialize in underwriting new issues, dealing w/ securities & arranging mergers  These firms have great prestige, experience & financial sense LISTING ON THE STOCK MARKET  When a firm decides on an IPO of its stocks, it has to decide where its newly issued shares should be traded
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