Issuing Securities to the PublicThe Public IssueThe Process of A Public OfferingAlternative Issue MethodsThe Cash OfferFirm CommitmentBest EffortsGreen Shoes and LockupsThe Announcement of New Equity and the Value of the FirmWork the Web ExampleThe Cost of New IssuesThe Costs of Public OfferingsRightsMechanics of Rights OfferingsMore on Rights OfferingsRights Offering ExampleSlide 17Slide 18The Rights PuzzleShelf RegistrationThe Private Equity MarketPrivate PlacementsVenture CapitalSlide 24Choosing a Venture CapitalistStages of FinancingSummary and ConclusionsIssuing Securities to the Public19.1 The Public Issue19.2 Alternative Issue Methods19.3 The Cash Offer19.4 The Announcement of New Equity and the Value of the Firm19.5 The Cost of New Issues19.6 Rights19.7 The Rights Puzzle19.8 Shelf Registration19.9 The Private Equity Market19.10 Summary and ConclusionsThe Public IssueThe Basic ProcedureManagement gets the approval of the Board of Directors.The firm prepares and files a registration statement with the SEC.The SEC studies the registration statement during the waiting period.The firm prepares and files an amended registration statement with the SEC.If everything is copasetic with the SEC, a price is set and a full-fledged selling effort gets underway.The Process of A Public OfferingSteps in Public Offering Time1. Pre-underwriting conferences2. Registration statements 3. Pricing the issue4. Public offering and sale 5. Market stabilization Several months 20-day waiting period Usually on the 20th day After the 20th day 30 days after offeringAlternative Issue MethodsThere are two kinds of public issues:The general cash offerThe rights offerAlmost all debt is sold in general cash offerings.The Cash OfferThere are two methods for issuing securities for cash:Firm CommitmentBest EffortsThere are two methods for selecting an underwriterCompetitiveNegotiatedFirm CommitmentUnder a firm commitment underwriting, the investment bank buys the securities outright from the issuing firm.Obviously, they need to make a profit, so they buy at “wholesale” and try to resell at “retail”.To minimize their risk, the investment bankers combine to form an underwriting syndicate to share the risk and help sell the issue to the public.Best EffortsUnder a best efforts underwriting, the underwriter does not buy the issue from the issuing firm. Instead, the underwriter acts as an agent, receiving a commission for each share sold, and using its “best efforts” to sell the entire issue.This is more common for initial public offerings than for seasoned new issues.Green Shoes and LockupsGreen Shoe provisionAllows syndicate to purchase an additional 15% of the issue from the issuerAllows the issue to be oversubscribedProvides some protection for the lead underwriter as they perform their price stabilization functionLockup agreementsRestriction on insiders that prevents them from selling their shares of an IPO for a specified time periodThe lockup period is commonly 180 daysThe stock price tends to drop when the lockup period expires due to market anticipation of additional shares hitting the streetThe Announcement of New Equity and the Value of the FirmThe market value of existing equity drops on the announcement of a new issue of common stock.Reasons includeManagerial InformationSince the managers are the insiders, perhaps they are selling new stock because they think it is overpriced.Debt CapacityIf the market infers that the managers are issuing new equity to reduce their debt-equity ratio due to the specter of financial distress the stock price will fall.Falling EarningsWork the Web ExampleHow have recent IPOs done?Click on the web surfer to go to the Bloomberg site and follow the “IPO Center” linkHow many companies have gone public in the last week?How have companies that went public three months ago done? What about six months ago?The Cost of New Issues1. Spread or underwriting discount2. Other direct expenses3. Indirect expenses4. Abnormal returns5. Underpricing6. Green Shoe OptionThe Costs of Public OfferingsEquityProceeds Direct Costs Underpricing(in millions) SEOsIPOsIPOs 2 - 9.9913.28%16.96%16.36%10 - 19.998.72%11.63% 9.65%20 - 39.996.93%9.70% 12.48%40 - 59.995.87%8.72% 13.65%60 - 79.995.18%8.20% 11.31%80 - 99.994.73%7.91% 8.91%100 - 199.99 4.22%7.06%7.16%200 - 499.99 3.47%6.53%5.70%500 and up 3.15%5.72%7.53%RightsIf a preemptive right is contained in the firm’s articles of incorporation, the firm must offer any new issue of common stock first to existing shareholders.This allows shareholders to maintain their percentage ownership if they so desire.Mechanics of Rights OfferingsThe management of the firm must decide:The exercise price (the price existing shareholders must pay for new shares).How many rights will be required to purchase one new share of stock.These rights have value:Shareholders can either exercise their rights or sell their rights.More on Rights OfferingsEx-rights – the price of the stock will drop by the value of the right on the day that the stock no longer carries the “right”Standby underwriting – underwriter agrees to buy any shares that are not purchased through the rights offeringStockholders can either exercise their rights or sell them – they are not hurt by the rights offering either wayRights offerings are generally cheaper, yet they are much less common than general cash offers in the U.S.Rights Offering ExamplePopular Delusions, Inc. is proposing a rights offering. There are 200,000 shares outstanding trading at $25 each. There will be 10,000 new shares issued at a $20 subscription price.What is the new market value of the firm?What is the ex-rights price?What is the value of a right?Rights Offering ExampleWhat is the new market value of the firm?There are 200,000 outstanding shares at $25 each.There will be 10,000 new shares issued at a $20 subscription price.shares 20$shares 000,10share 25$shares 000,200000,200,5$ Rights Offering ExampleWhat is the ex-rights price?There are 110,000 outstanding shares of a firm with a market value of $5,200,000.Thus the value of an ex-rights share is:7619.24$shares 000,210000,200,5$•Thus the value of a right is $0.2381 = $25 – $24.7619The Rights PuzzleOver 90% of new issues are
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