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IPOs
1
IPO
An IPO is the first time that the general public
is able to invest in the firm
An IPO generally happens when a firm needs
more money than it can raise from VC’s
VC’s
come in after credit cards, friends, and
family
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Venture Capital
These are typically limited partnerships, where
investment managers raise money from qualified
investors
Four main suppliers of venture capital:
1.
2.
3.
Old Money
Large firm with established venture-capital subsidiaries.
Qualified Individuals
Individuals worth over $1,000,000 and incomes above
$100,000
The Basic Process
Management gets Board approval to go public
The firm files a registration statement with the
SEC
The SEC studies the registration statement
This
is the waiting period
The firm prepares and files an amended
registration statement with the SEC
Once the firm gets SEC approval, starts selling and
sets a share price
An Example of a Tombstone
Types of IPO’s
Firm Commitment
Best Efforts
Dutch Auction
Firm Commitment
The firm sells the shares to the underwriting
syndicate (Primary Sale)
The Syndicate resells to the public (Secondary
Sale)
Spread:
difference between what the syndicate buys
the shares for and sells them for
In
the US the spread is typically about 7%
Syndicate bears the risk of not selling all the
shares
Most
common type of IPO in the US
Best Effort
Underwriter makes a “best effort” to sell the
securities at an agreed-upon price
The firm bears the risk of not selling all shares
If there is not enough demand the firm can pull
the offer
Firm still pays the underwriter, but keeps all the shares
Not very common
Dutch Auction
The underwriter simply records investors bids
Number
of shares and price per share
Greatly reduces the importance of the underwriter
The price is the highest bid that clears the market
Investors have an incentive to bid high
Higher bids are more likely to win, while you
are unlikely to pay the price you bid
Google was the first large Dutch Auction IPO
Dutch Auction Example
Firm TUM is offering 1,000 shares through a Dutch
Auction. What is the price of each share?
Investor
Price Bid
Shares
Bid
Abbie
Bill
$75
$70
500
250
Charlie
David
Edward
$65
$60
$55
150
100
75
Fancy
$50
200
Win
Shares
Received
Price Paid
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IPO Underpricing
IPOs are generally offered at a prices below
their true market value
This implies that the firm is “leaving money
on the table”
IPOs are potentially underpriced because:
Of
the difficulty in setting an accurate price
Private companies are very hard to value
Underwriter wants to ensure a large day one return
Managers want to ensure their ability to go back to
the market
SEOs
A Seasoned (Secondary) Equity Offering is
when a public company offers additional
equity to the public
This is generally the result of the firm needing
cash for investments
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SEO Announcement and Firm Value
The market value of existing equity drops on the
announcement of a SEO
The price may drop because:
Managers
are likely to issue stock when they think it
is overpriced
May be issuing equity to repurchase debt, because of
a fear of financial distress
A share now entitles you to less of the company than
it did before the SEO
The Costs of Equity Public Offerings
Proceeds
(in millions)
2 - 9.99
10 - 19.99
20 - 39.99
40 - 59.99
60 - 79.99
80 - 99.99
100 - 199.99
200 - 499.99
500 and up
Direct Costs
SEOs
IPOs
2.88%
15.36%
8.81%
11.63%
7.24%
9.81%
6.20%
9.21%
5.81%
8.65%
5.56%
8.34%
5.00%
7.67%
4.26%
6.72%
3.64%
5.15%
Underpricing
IPOs
18.18%
10.02%
17.91%
29.57%
39.20%
45.36%
37.10%
17.72%
12.19%