TOPIC 1_CHAPTER 15 - INTRODUCTION TO CORPORATE FINANCE

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Copyright © 2018 by The McGraw-Hill Companies, Inc. All rights reserved
MFA 3043
TOPIC 1
INTRODUCTION TO
CORPORATE FINANCE

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LEARNING OUTCOME
 Explain major corporate financial management
decisions.
 Identify and discuss the range of corporate
Islamic financing including common stock,
corporate conventional and Islamic debt (sukuk).
 Discuss how business may increase capital
through venture capital, initial public offering and
private placement.
 Explain the Shariah Framework for Islamic
Finance and the reason behind.

Because learning changes everything.®
Fundamentals of
Corporate Finance,
11th Edition
CHAPTER 15: How
Corporations Raise Venture
Capital and Issue Securities
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R A I S I N G C A P I TA L
CHAPTER 15
Copyright © 2023 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

© McGraw Hill, LLC
Venture Capital 1
Young firms often require venture capital to finance growth.
• The issuance of securities is a complex process that the
successful financier must comprehend.
• Venture capital provides entrepreneurs with financing to grow
their firms.
• Firms issue securities to further finance their growth.
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Venture Capital 2
Steps to obtaining venture funding:
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Venture Capital 3
Venture Capital
Money invested to finance a new firm
• Success of a new firm is highly dependent on the effort of
the managers; restrictions are placed on management by
the venture capital company.
• Funds are usually dispersed in stages after levels of
success are achieved.
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Venture Capital
First Stage Market Value Balance Sheet ($ millions)
Assets Liabilities and Equity
Cash from new equity 0.5 New equity from venture capital 0.5
Other assets 0.5 Your original equity 0.5
Value 1.0 Value 1.0

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Venture Capital
 Sources of Venture Capital
– 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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Initial Public Offering
 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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 Initial Public Offering (IPO)
– First offering of stock to the general public
 Underwriter
– Firm that buys an issue of securities from a company and resells it
to the public
 Spread
– Difference between public offer price and price paid by
underwriter
 Prospectus
– Formal summary that provides information on an issue of
securities
 Underpricing
– Issuing securities at an offering price set below the true value of
the security

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 Benefits of Going Public
– Ability to raise new capital
– Stock price provides performance measure
– Information more widely available
– Diversified sources of finance
– Reduced borrowing costs

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Arranging Public Issues
 Steps to issue a new public security
– SEC (Securities and Exchange Commission)
Registration
• Prospectus — a formal summary that provides
information on an issue of securities
– Select Underwriter / Undertake Roadshow
– Set final issue price for public

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IPO Flowchart
Investors
Firm
Underwriter
1
2
4
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
Example
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?
Spread — the difference between the public
offer price and the price paid by underwriter
3 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 × $43 − $40 = $9 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

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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
 Flotation Costs
– The costs incurred when a firm issues new securities to the
public

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Underwriting Arrangements
Example
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.
Cost to public = $40
Net to issuer = $40/1.10 = $36.36
Therefore, the spread was $3.64 per share
Net to issuer = 250,000 × $36.36 = $9,090,000
Less legal fees 600,000
$8,490,000

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Underpricing of an IPO
Example (continued)
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?
Underpricing — Issuing securities at an offering price
set below the true value of the security
Cost of underpricing:
3 million($70 - $43) = $81 million

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General Cash Offers
 Seasoned Offering
– Sale of securities by a firm that is already publicly traded
 General Cash Offer
– Sale of securities open to all investors by an already public
company
 Shelf Registration
– A procedure that allows firms to file one registration
statement for several issues of the same security
 Private Placement
– Sale of securities to a limited number of investors without a
public offering

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Rights Issue
Rights Issue — Issue of securities offered only
to current stockholders
Example
Barclays Bank currently has 12.68 billion shares
outstanding. The market price is £2.85/sh.
Barclays decides to raise additional funds via a 1
for 4 rights offer at £1.85/sh. If we assume 100%
subscription, what is the value of each right?

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Rights Issue
Current market value = 12.68 bil × £2.85/sh = £36.14 bil
Total shares = 12.68 bil + 3.17 bil = 15.85 bil
Amount of new funds = 3.17 bil × £1.85/sh = £5.86 bil
New share price = (36.14 + 5.86)/15.85 = £2.65/sh
Example
outstanding. The market price is £2.85/sh. Barclays decides
to raise additional funds via a 1 for 4 rights offer at
£1.85/sh. If we assume 100% subscription, what is the value
of each right?

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Rights Issue
Example
outstanding. The market price is £2.85/sh. Barclays
decides to raise additional funds via a 1 for 4 rights offer
at £1.85/sh. If we assume 100% subscription, what is the
value of each right?
Value of a right =
preprice − issue price
held shares
new shares
+ 1
Value of a right =
2.85 − 1.85
4
1
+ 1
= 0.20

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Shariah Framework for Islamic Finance
and the reason behind
 Shariah governance is integral to the Islamic financial
system’s stability. The institutionalization of a sound
Shariah governance framework strengthens public
confidence in the integrity, management, and business
operations of the Islamic financial institutions.
 The main principles of Islamic finance are that: Wealth
must be generated from legitimate trade and asset-based
investment. (The use of money for the purposes of
making money is expressly forbidden.) Investment should
also have a social and an ethical benefit to wider society
beyond pure return.

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Why there is a need for Shariah
governance in Islamic finance?
 Because of the obligation of Shariah
principles, IFIs must ensure all activities are
based on Shariah guidelines. The lack of
such a governance framework may spark
conflicts that may lead to financial and
non-financial losses.

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TUTORIAL
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TOPIC 1_CHAPTER 15 - INTRODUCTION TO CORPORATE FINANCE

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