McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

How Corporations Raise Venture

Capital and Issue Securities

Young firms often require venture capital to

finance growth.

The issuance of securities is a complex process that

the successful financier must comprehend.

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 Company Growth

Venture Capital provides entrepreneurs with

financing to grow their firms.

Firms issue securities to further finance their

growth.

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 Obtaining Venture Capital
 Steps to obtaining venture funding:
1. Prepare a business plan.

2. Receive first-stage financing.

3. Receive subsequent staged financing.

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 Venture Capital Ownership:
Example
Suppose a Venture Capital firm offers to purchase 1
million of your firm’s shares for $1 each, which will give
them 50% ownership in the firm. What value are they
placing on your firm?

$1, 000, 000

Value of the Firm =  $2, 000, 000
.50

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 Types of Venture Investors

 Angel Investors
• Investors who finance companies in their earliest stages of growth

 Corporate Venturers
• Corporations that offer venture assistance to finance young,
promising companies.

 Private Equity Investing

• Investors who offer funds to finance firms that do not trade on
public stock exchanges such as the NYSE or NASDAQ.

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Venture Capital Management

Venture Capitalist are not passive investors.

What do they provide beyond financing?

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 The Initial Public Offering
When a firm requires more capital than private investors can
provide, it can choose to go public through an Initial Public
Offering, or IPO.

 Primary Offering
– when new shares are sold to raise additional cash
for the company
 Secondary Offering
– when the company’s founders and venture
capitalists cash in on some of their gains by selling
shares.
Does a secondary offering provide additional capital to the firm?
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 Benefits of Going Public
 Ability to raise new capital

 Stock price provides performance measure

 Information more widely available

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 Benefits of Going Public

 Diversified sources of finance

 Reduced borrowing costs

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 Arranging Public Issues
Steps to issue a new public security:

1. SEC Registration
• Prospectus—a formal summary that provides
information on an issue of securities

2. Select Underwriter / Undertake Roadshow

3. Set final issue price for public

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 IPO Flowchart
1

2
Underwriter Firm Investors
3

5
1. Underwriter provides advice to firm
2. Underwriter pays firm for a number of shares
3. Firm provides shares to underwriter to be resold
4. Underwriter offers shares to investors
5. Investors purchase shares from underwriter
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 Underwriter Spread

Spread - the difference between the public offer

price and the price paid by underwriter

Assume the issuing company incurs $1 million in expenses to sell 3

million shares at $40 each to an underwriter; the underwriter sells
the shares at $43 each. What is the spread for this deal?

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 Underwriting Arrangements

Firm Commitment:
Underwriters buy the securities from the firm and then
resell them to the public.

Best Efforts Commitment:

Underwriters agree to sell as much of the issue as possible
but do not guarantee the sale of the entire issue.

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 Underwriting Arrangements:
Capital To Firm
How much will a firm receive in net funding from a firm commitment
underwriting of 250,000 shares priced to the public at $40 if a 10%
underwriting spread has been added to the price paid by the underwriter?
Additionally, the firm pays $600,000 in legal fees.

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 Underpricing of an IPO
Underpricing: Issuing securities at an offering price set below
the true value of the security.

Example: Assume the issuer incurs $1 million in other expenses to sell 3

million shares at $40 each to an underwriter and the underwriter sells the shares
at $43 each. By the end of the first day’s trading, the issuing company’s stock
price had risen to $70. What is the total cost of underpricing?

Cost of Underpricing:

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 Flotation Costs

Flotation Costs: The costs incurred when a firm

issues new securities to the public.

What are some of the specific costs incurred when a firm

issues new securities?

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 Types of Offerings
After the IPO, successful firms may issue additional
equity or debt.

 Seasoned Offering
 Rights Issue
Issue of securities offered only to current stockholders.
 General Cash Offer
Sale of securities open to all investors by an already-public
company.

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 Rights Issue: Example
An investor exercises his right to buy one additional share at
$20 for every five shares held. How much should each share be
worth after the rights issue if they previously sold for $50 each?

Pre-Rights Issue:

Post-Rights Issue:
+

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 General Cash Offer and
Shelf Registration
Shelf Registration: A procedure that allows firms to file one
registration statement for several issues of the same security.

Benefits of Shelf Registration:

1. Security issuance without excessive costs
2. Security issuance on very short notice
3. Timed issuance to capitalize on favorable market
conditions
4. Additional underwriter competition

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 Private Placements
In order to avoid registering with the SEC, a
company can issue a security privately.

Private Placement: The sale of securities to a limited

number of investors without a public offering

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Private Placements-Advantages

 Do not have to register with SEC

 Private placements cost less than public issues

 Contracts can be customized for each investor

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 Private Placements-
Disadvantages
 Difficult for investors to resell security

 Lenders often require higher return to compensate

for higher risk.
• Private placements typically yield .5% higher than
public issues

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