Chapter 16
Equity and the Investment
Banking Process
Adapted from Emery and Finnerty: Corporate Financial
Management by Dr. Del Hawley
1
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.
2
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.
3
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
4
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.
5
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
6
Rights and Privileges of Common Stock
 Dividend rights
 Voting rights
 Liquidation rights
 Preemptive rights
7
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.
8
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.
9
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
10
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
11
SEC Filings for IPOs by Quarter
12
Quarter
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 B
Source: Hoover’s IPO Central