The Mechanics of Raising Equity Capital
Private companies can raise equity capital from angel investors, venture capitalists, institutional investors, or
Advantages of raising money from a corporate investor are that the large corporate partner may provide
benefits such as capital, expertise, or access to distribution channels. The corporate partner may become an
important customer or supplier for the startup firm, and the willingness of an established company to invest
may be an important endorsement of the new company.
The disadvantages are that not all corporate investments are successful. The corporate partner may gain
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00/share = $28,000,000.
You will own 5,000,000 / 7,000,000 = 71.4% of the firm after the last funding round.
The two main advantages of going public are liquidity and access to capital. One of the major disadvantages
of an IPO is that once a company becomes a public company, it must satisfy all of the requirements of being
a public company such as SEC filings, and listing requirements of the securities exchanges.
Berk/DeMarzo • Corporate Finance
Underwriters face the most risk from a firm commitment IPO. With this method, they guarantee that they
will sell all of the stock at the offer price. If the entire issue does not sell at the IPO price, the remaining
shares must be sold at a lower price and the underwriter must take the loss.
With a best-efforts IPO, the underwriter does not guarantee that the stock will be sold, but instead tries to sell
the stock for the best possible price. In an auction IPO, the underwriters let the market determine the price
by auctioning off the company.
First, compute the cumulative total number of shares demanded at or above any given price:
The winning price should be $13.40, because investors have placed orders for a total of 1.8 million shares at
a price of $13.40 or higher.
a. With a P/E ratio of 20.0x, and 2005 earnings of $7.5 million, the total value of the firm at the IPO
= 20.0x ⇒ P = $150 million
There are currently (500,000 + 1,000,000 + 2,000,000) = 3,500,000 shares outstanding (before the IPO).
At the IPO, the firm will issue an additional 6.5 million shares, so there will be 10 million shares
outstanding immediately after the IPO. With a total market value of $150 million, each share should be
worth $150 / 10 = $15 per share.
After the IPO, you will own 500,000 of the 10 million shares outstanding, or 5% of the firm.
Underpricing refers to the fact that, on average, underwriters pick the IPO issue price so that the average
first-day return is positive. If you followed a strategy of placing an order for a fixed number of shares on
every IPO, your order will be completely filled when the stock price goes down, but you will be rationed
when it goes up. In effect you only get substantial amounts of stock when you do not want it. The winners’
curse is substantial enough so that the strategy of investing in every IPO does not yield above market returns.
The initial return on Margoles Publishing stock is ($19.00 – $14.00) / ($14.00) = 35.7%.
Who gains from the price increase? Investors who were able to buy at the IPO price of...