FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab

CHAPTER FOURTEEN CHAPTER FOURTEEN Common Equity

Learning Objectives 1. Discuss the rights of shareholders. 2. Explain the difference between par value, book value, and market value. 3. Recognize two restrictions on the purchase or resale of securities. 4. Understand and explain the differences between the terms public offering, private placement, and rights offering. 5. Identify some of the challenges with initial public offerings (IPOs).

Introduction Common shares are certificates of corporate ownership that have no maturity date. Common shares are certificates of corporate ownership that have no maturity date. Financial liability to shareholders is limited to the amount of their investment. Financial liability to shareholders is limited to the amount of their investment.

Rights of Shareholders Shareholders have the following rights: Shareholders have the following rights: 1. to do as they want with their shareholdings 2. to share in the earnings of the company when dividends are declared 3. to benefit from retained earnings once all claims are satisfied 4. to elect directors 5. to vote on general questions brought up at shareholder meetings 6. to examine the company’s books and records

Features of Common Shares Authorized and outstanding shares Authorized and outstanding shares Firms charter authorizes the maximum number of shares that can be issued Firms charter authorizes the maximum number of shares that can be issued Outstanding shares represent the number portion of authorized shares that have been sold and are held outside the company Outstanding shares represent the number portion of authorized shares that have been sold and are held outside the company Canada Business Corporations Act allows companies to repurchase their own outstanding common shares Canada Business Corporations Act allows companies to repurchase their own outstanding common shares

Features of Common Shares Par value – the stated monetary face value that is specified at the time of original issue. It may be set at any amount. Par value – the stated monetary face value that is specified at the time of original issue. It may be set at any amount. Today, shares are predominantly without par value Today, shares are predominantly without par value Advantage of no par value is the shares are always fully paid and non-assessable, regardless of the price at which they are sold to the public Advantage of no par value is the shares are always fully paid and non-assessable, regardless of the price at which they are sold to the public

Features of Common Shares Book value – the shareholders’ equity of a firm as shown on the balance sheet less the book value of preferred stock divided by the number of outstanding common shares Book value – the shareholders’ equity of a firm as shown on the balance sheet less the book value of preferred stock divided by the number of outstanding common shares Going concern value – the value reflected in the price of shares trading in the market, representing the proportionate interest in the firm as an operating entity Going concern value – the value reflected in the price of shares trading in the market, representing the proportionate interest in the firm as an operating entity

Features of Common Shares Resale of shares Resale of shares trading of shares can take place on organized exchanges or in the OTC markets trading of shares can take place on organized exchanges or in the OTC markets Letter stock Letter stock shares that are issued by a firm and sold to an individual, corporation or institution without normal disclosures shares that are issued by a firm and sold to an individual, corporation or institution without normal disclosures Escrow shares Escrow shares when shares are tuned over to a trustee usually at the request of the security commission or stock exchange when shares are tuned over to a trustee usually at the request of the security commission or stock exchange

Common Share Financing Advantages to raising funds through common shares: Advantages to raising funds through common shares: no critical maturity date no critical maturity date no fixed charges have to met (i.e. dividends) no fixed charges have to met (i.e. dividends) the credit standing of the business is enhanced by any increase in shareholders’ equity the credit standing of the business is enhanced by any increase in shareholders’ equity Disadvantages to raising funds through common shares: Disadvantages to raising funds through common shares: controlling group of shareholder may suffer dilution of voting control controlling group of shareholder may suffer dilution of voting control cost associated with the sale of common shares cost associated with the sale of common shares

Issuing Stock Prospectus - a document containing information about the securities being offered and about the corporation issuing the securities Prospectus - a document containing information about the securities being offered and about the corporation issuing the securities Items contained in the prospectus include: Items contained in the prospectus include: financial statements financial statements information on securities to be issued information on securities to be issued amount to be raised and how proceeds will be used amount to be raised and how proceeds will be used letter signed by the CEO giving facts about the company letter signed by the CEO giving facts about the company approval of the contents by the company’s board of directors approval of the contents by the company’s board of directors

Selling of New Financial Assets Public offering – new securities are made available for sale to the general public Public offering – new securities are made available for sale to the general public Initial public offering (IPO) – An issuer selling securities for the first time Initial public offering (IPO) – An issuer selling securities for the first time Firms use the expertise of an investment dealer to underwrite the issue Firms use the expertise of an investment dealer to underwrite the issue Two types of underwriting practices: Two types of underwriting practices: firm commitment firm commitment best effort best effort

Selling of New Financial Assets Letter of intent – an informal agreement between the underwriter and the issuer outlining the securities involved, the size of the offering, and an offer by the dealer to purchase the issue under certain conditions Letter of intent – an informal agreement between the underwriter and the issuer outlining the securities involved, the size of the offering, and an offer by the dealer to purchase the issue under certain conditions Marketing of the new issue involves: Marketing of the new issue involves: the prospectus the prospectus the underwriter and underwriting syndicate which allows for wider distribution of the issue and reduces risk the underwriter and underwriting syndicate which allows for wider distribution of the issue and reduces risk

Private Placements Private placement – where a financial institution purchases the entire issue of securities with the terms and price determined through private negotiations Private placement – where a financial institution purchases the entire issue of securities with the terms and price determined through private negotiations Advantages of private placements: Advantages of private placements: exemption from registration and disclosure requirements of the province’s securities statutes exemption from registration and disclosure requirements of the province’s securities statutes lower dealer fees lower dealer fees

Rights Offering Rights offering – the firm’s current shareholders are given the right to subscribe to a new issue of securities at a specified subscription price Rights offering – the firm’s current shareholders are given the right to subscribe to a new issue of securities at a specified subscription price Most common with issues of new common shares or securities convertible into common shares since they recognize the shareholders’ right to maintain proportional ownership Most common with issues of new common shares or securities convertible into common shares since they recognize the shareholders’ right to maintain proportional ownership

Rights Offering Advantages of a rights offering: Advantages of a rights offering: high probability of a successful sale high probability of a successful sale issuing and underwriting expenses are reduced issuing and underwriting expenses are reduced Disadvantages of a rights offering: Disadvantages of a rights offering: time required to complete the sale time required to complete the sale dependent on the relationship between the subscription price for new shares and their prevailing market price dependent on the relationship between the subscription price for new shares and their prevailing market price

Summary 1. Common shares are certificates of ownership in a company that bear substantial risks. They are the lowest obligation for a firm. 2. As owners of the company, shareholders have many rights commiserate with their holdings. Minority positions can be strengthened by combined voting efforts. 3. We can distinguish among authorized, issued, and outstanding shares. Shareholders have approved authorized shares for issue. Issued shares have been actually sold.

Summary 4. Shares may have par value or be without par value. 5. The book value of common shares is given as the net worth of a firm less the par value of preferred shares divided by the number of outstanding common shares. It may bear little relation to market value, which is based on the firm’s current operations and future prospects.

Summary 6. Generally, there are no restrictions on the purchase or resale of common shares. Exceptions are letter stock and escrow shares. 7. Issuing common shares is the least risky way of raising funds. But it can be the most expensive when the firm has to not only satisfy shareholder expectations by maintaining high returns, but dividends, which are paid out of after-tax earnings.

Summary 8. New securities can be sold through public offerings, private placements, or rights offerings. 9. Initial public offerings (IPOs) are securities issued for the first time.