Professional Documents
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Chapter Nineteen
Sixth Edition
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Prepared by Gady Jacoby University of Manitoba and Sebouh Aintablian American University of Beirut
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Executive Summary
Issuing securities involves the corporation in a number of decisions. This chapter looks at how corporations issue securities to the investing public. The basic procedure for selling debt and equity securities are essentially the same. This chapter focuses on equity.
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Chapter Outline
19.1 The Public Issue 19.2 The Basic Procedure for a New Issue 19.3 The Cash Offer 19.4 The Announcement of New Equity and the Value of the Firm 19.5 The Cost of Issuing Securities 19.6 Rights
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The difference between underwriters buying price and the offering price is called the spread. Because underwriting involves risk, underwriters combine to form an underwriting group called a syndicate
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19.4 The Announcement of New Equity and the Value of the Firm
The market value of existing equity drops on the announcement of a new issue of common stock. Reasons include
Managerial Information Since the managers are the insiders, perhaps they are selling new stock because they think it is overpriced. Debt Capacity If the market infers that the managers are issuing new equity to reduce their debt-to-equity ratio due to the specter of financial distress the stock price will fall. Falling Earnings
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19.6 Rights
An issue of common stock offered to existing shareholders is called a rights offering. Prior to the 1980 Bank Act, chartered banks were required to raise equity exclusively through rights offerings. If a preemptive right is contained in the firms 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.
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Private Placements
Avoid the costly procedures associated with the registration requirements that are a part of public issues. The OSC and SEC restrict private placement issues of no more than a couple of dozen knowledgeable investors including institutions such as insurance companies and pension funds. The biggest drawback is that the securities cannot be easily resold.
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Venture Capital
The limited partnership is the dominant form of intermediation in this market. There are five types of suppliers of venture capital: 1. Old-line wealthy families. 2. Private partnerships and corporations. 3. Large industrial or financial corporations with established venture-capital subsidiaries. 4. The federal government (through crown-related firms). 5. Individuals, typically with incomes in excess of $100,000 and net worth over $1,000,000. Often these angels have substantial business experience and are able to tolerate high risks.
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Stages of Financing
1. Seed-Money Stage:
Small amount of money to prove a concept or develop a product.
2. Start-Up
Funds are likely to pay for marketing and product refinement.
3. First-Round Financing
Additional money to begin sales and manufacturing.
4. Second-Round Financing
Funds earmarked for working capital for a firm that is currently selling its product but still losing money.
5. Third-Round Financing
Financing for a firm that is at least breaking even and contemplating expansion; a.k.a. mezzanine financing.
6. Fourth-Round Financing
Financing for a firm that is likely to go public within six months; a.k.a. bridge financing.
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