Raising Capital: Financing a Business

1. Raising Capital: Financing a Business Financing a Business

2. Topics • Basic Concepts • Commercial Bank- Short Term • Commercial Bank- Long Term • Non Bank Financing • Early Stage Financing • Going Public • Other Financing a Business

3. Basic Concepts • Primary vs. Secondary Market • I. Bank vs. C. Bank • Efficient Markets Financing a Business

4. Stocks and Bonds Money Primary Market Secondary Market securities money Financial Markets Investors Firms Bob Sue Financing a Business

5. How to Create Value through Financing • Fool Investors • Empirical evidence suggests that it is hard to fool investors consistently. • Reduce Costs or Increase Subsidies • Certain forms of financing have tax advantages or carry other subsidies. Some ways of raising capital are cheaper than others. • Create a New Security • Sometimes a firm can find a previously-unsatisfied clientele and issue new securities at favorable prices. • In the long-run, this value creation is relatively small, however. Financing a Business

6. Commercial Bank – Short Term • Short term loans • Compensation • Collateral and protection • Letter of credit (LC) • Reverse repurchase agreement (REPO) Financing a Business

7. Commercial Bank –Short Term Loans • Single payment loans • Installment loans • Discount loans • Credit lines or bank facility • Repayment on demand Financing a Business

8. Commercial Bank –Compensation • Commitment fee (1/2 %) • Compensating balances (10% in checking) • Interest rate Financing a Business

9. Commercial Bank –Collateral and Protection • Unsecured • Collateralized (financial strength with escape) • Asset-based loans (value of the assets) • Key executive insurance (payable to bank) • Personal guarantees Financing a Business

10. Commercial Bank –Letter of Credit (LC) • Guarantee by bank • Importing and exporting Financing a Business

11. Commercial Bank –Reverse Repurchase Agreement (REPO) • Sell T-Bill for $998 • Agree to buy back the T-Bill for $1000 in 10 days Financing a Business

12. Commercial Bank – Longer Term Loans • Term loans • Periodic repayment or interest w/ balloon • Collateral (fixed assets) • Lease financing • Mortgage financing Financing a Business

13. 4. Non-Bank Short-Term Financing • Account payable (implicit cost) • Commercial finance companies (risky asset backed, factoring, leases) • Factoring (credit cards) • Commercial paper (rated, 3-months, unsecured IOU from prestigious firm, $25,000 minimum) • Direct or finance paper (GE Capital Corporation or GMAC) • Indirect or dealer paper (through I. bank) • Small business administration • Guarantees to repay up to 90% of loan • Paper work! But new micro loans • Grants (i.e. Small Business Innovation Development Act) • All federal agencies with R&D budgets must spend some on small tech business Financing a Business

14. Stages of Financing • Seed-Money Stage: • Small amount of money to prove a concept or develop a product. • Start-Up • Funds are likely to pay for marketing and product refinement. • First-Round Financing • Additional money to begin sales and manufacturing. • Second-Round Financing • Funds earmarked for working capital for a firm that is currently selling its product but still losing money. • Third-Round Financing • Financing for a firm that is at least breaking even and contemplating expansion; a.k.a. mezzanine financing. • Fourth-Round Financing • Financing for a firm that is likely to go public within 6 months; a.k.a. bridge financing. Financing a Business

15. 5. Early Stage Financing • Bootstrapping • Early equity Financing a Business

16. Bootstrapping (few resources) • Entrepreneur resources (Gates and Allen in a cheap apartment) • Few employees (subcontract, temps,…) • Lease, share, or barter • OPM (i.e. suppliers) Financing a Business

17. Early Equity • Personal resources(savings, cards, parents, friends and family) • Private investors • Angels • Private placement • Venture capital • Strategic alliances • Small Business Investment Company (SBIC) Financing a Business

18. Angels • $20 – 750K • Referral • Former entrepreneurs, wealthy individuals • Faster than VC’s • Demand less control than VC’s • Invest smaller amounts than VC’s Financing a Business

19. Private Placement • SEC Regulation A (under $1.5 mill. New, no audit, less reporting) • SEC Regulation D • Rule 504 ($1 mill./yr. To any number, sophisticated or not) • Rule 505 ($5 mill./yr. To 35 accredited investors) • Rule 506 (unlimited amount to accredited and relations, but no general solicitation) • Small Corporate Offering Registration, Form SCOR U-7 (question and answer) Financing a Business

20. Venture Capital • The limited partnership is the dominant form of intermediation in this market. • There are four types of suppliers of venture capital: • Old-line wealthy families. • Private partnerships and corporations. • Large industrial or financial corporations have established venture-capital subsidiaries. • 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. • Demand convertible preferred stock • Demand control Financing a Business

21. Strategic Alliances • Companies invest in other companies for strategic reasons (i.e., leverage technology). • Fast deals, good valuations • What if your product allows Adobe to increase the price of its products by $5? • What if your product allows Sprint’s fiber optic cables to carry 10% more volume? • Offer validation, introductions, promotions… Financing a Business

22. Small Business Investment Company (SBIC) • VC investment companies licensed by the SBA. Financing a Business

23. 6. Going Public (IPO vs. SEO) • Approval from board • Pick investment bank and pre-underwriting conference • Prepare and file registration statement with SEC • 20-day waiting period, letter of comment, 20 more days • Road show, built a book, preliminary prospectus or red herring, syndicate registrar and transfer agent (but no selling) • Pricing (file amendment), final prospectus, purchase, tombstone • Resale • After market, stabilization, and lockup • Green shoe provision or over allotment option Financing a Business

24. Pick Investment Bank and Pre-Underwriting Conference • Debt, equity, or hybrid • Competitive bid or negotiated offer • Public or private • Firm commitment or best efforts • Cash offer or rights offer • Shelf registration, SEC Rule 415 • Exchange (NYSE, AMSE, Nasdaq) Financing a Business

25. Issuing New Securities Financing a Business

26. Allocation of Underwriting Spread Financing a Business

27. Public vs Private Placement of Bonds Financing a Business

28. Costs • Spread (7%) • Other direct expenses (filing fees, legal fees, printing, mailing, registrar and transfer agent) • Indirect expenses (management time, accountants time) • Abnormal returns (seasoned issue price drop of around 3%) • Underpricing (why are so many content to sell assets for 85% of value?) • Green shoe option Financing a Business

29. The Costs of Public Offerings Proceeds Direct Costs Underpricing (in millions) SEOs IPOs IPOs 2 - 9.99 13.28% 16.96% 16.36% 10 - 19.99 8.72% 11.63% 9.65% 20 - 39.99 6.93% 9.70% 12.48% 40 - 59.99 5.87% 8.72% 13.65% 60 - 79.99 5.18% 8.20% 11.31% 80 - 99.99 4.73% 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% Financing a Business

30. An Example of a Tombstone Advertisement Financing a Business

31. Average First-Day Returns by Month for SEC-Registered IPOs: 1960-2005 Financing a Business

32. 7. Other • ADR and GDR • Euromarket • Swaps • Convertibles • Warrants • Junk Bond • Securitization Financing a Business