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Chapter 16

Equity and the Investment Banking Process

Adapted from Emery and Finnerty: Corporate Financial Management by Dr. Del Hawley

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Public Offerings

General cash offers Securities are offered to investors at large. Underwriters are often used.

Rights offering New common stock is sold to existing

stockholders.

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Primary and Secondary Offerings

In a primary offering, the firm sells newly issued shares to investors.

In a secondary offering, insiders and large institutional shareholders sell shares they hold in a registered public offering.

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Role of the Underwriters

Investment bankers An intermediary between the issuer and the

purchaser. Provides advice regarding type of security, terms,

and price. Helps prepare documentation.

Underwriting A form of insurance. Risk bearing

Syndicated offering process

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Flotation Costs

Include both the gross underwriting spread and the out-of-pocket expenses.

Economies of scale

Vary by security type: Holding issue size constant, Common stock has highest flotation cost Bonds have the lowest flotation costs Flotation costs of preferred stock are in between.

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Main Features of Common Stock

Perpetual security

Not redeemable

May or may not have a par value

Charter specifies the number of authorized shares: Outstanding shares Treasury shares Multiple classes of common stock Other

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Rights and Privileges of Common Stock

Dividend rights

Voting rights

Liquidation rights

Preemptive rights

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Going Public

A firm “goes public” when it offers common stock to the public for the first time in its life. Initial Public Offering (IPO)

Subsequent issues of common stock are called “seasoned” issues.

Underwriters try to price the IPO issue at 10% to 15% below the expected trading price.

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Going Private

A small group of investors purchase the entire common equity of a publicly traded firm.

Firm is no longer subject to reporting requirements.

Substantial transaction cost involved in going public and private.

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Advantages of Going Public

Raise new capital

Achieve liquidity and diversification for current shareholders

Establish a clear value for holdings

Create a negotiable instrument

Increase the firm’s equity financing flexibility

Enhance the firm’s image

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Disadvantages of Going Public

Disclosure requirements SEC regulations Sarbanes-Oxley requirements

Accountability to public shareholders Market pressure to perform short-term Pressure to pay dividends

Dilution of ownership interest

Expense of going public

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SEC Filings for IPOs by QuarterQuarter Number of Filings Total Capital to be Raised

2003 17 $3.6B

Q1 2004 72 $10 B

Q2 2004 24 $4.8 B

Q3 2004 12 $1.8 B

Q4 2004 22 $3.7 B

Q1 2005 48 $8.9 B

Q2 2005 21 $7.5 B

Q3 2005 48 $9.8 B

Q4 2005 63 $9.8 B

Q1 2006 94 $15.5B

Q2 2006 14 $4.6B

Q3 2006 12 $2.0B

Q4 2006 25 $5.3B

Q1 2007 54 $12.7 BSource: Hoover’s IPO Central