1. 1 Chapter 18 Issuing Capital and the Investment Banking Process McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Introduction Firms finance assets with capital – Retained earnings – Debt – Equity 18-2

3. Sources of Capital for New and Small Firms Debt – Borrowing from friends and relatives – Bank loans – Venture capitalists Equity – Venture capitalists 18-3

4. Debt Financing Bank Loans – New and small firms rely on banks – Availability of small-business loans was heavily affected by the 2008 financial crisis 18-4

5. Bank Loans Small Business Loans – Risky for commercial banks – Banks use small-business scoring models 18-5

6. Bank Loans Mid-market firms – Sales between $5 million and $100 million per year – Rely on banks for funding 18-6

7. Credit Process Flow Chart 18-7

8. Loan Commitments Loan commitment agreements specify – maximum loan amount – interest rate terms – length of loan 18-8

9. Fixed versus Floating Rate Loans – Interest rates for variable-rate loans change over the life of the loan – Floating rate loans are set at a fixed spread over a prevailing benchmark rate 18-9

10. Small Business Administration Created to help small businesses Basic loan guarantee program – for qualified new firms that cannot get reasonable long-term financing from other financial institutions 18-10

11. Equity Financing and Expertise New and high-risk firms use venture capital (VC) for financing – Professionally managed – VC firm takes an equity stake in the firm financed – VC firms are actively involved in the business 18-11

12. Venture Capital Firms Institutional venture capital firm types: – Venture capital limited partnerships – Financial venture capital firms – Corporate venture capital firms – Small Business Investment Companies 18-12

13. Angel Venture Capitalists Majority of VC equity investments from wealthy individuals (angels), not institutions Angel VCs want – High return – Easy exit 18-13

14. The Choice to Go Public Choice made when firm’s capital needs exceed its ability to raise capital Initial public offering (IPO) of firm’s stock – Equity is publicly traded in stock markets for the first time 18-14

15. The Choice to Go Public Benefits of being a public firm – Access to a larger pool of equity capital – Stock market provides a market value for the firm’s stock 18-15

16. The Choice to Go Public Benefits of being a public firm – Firm’s managers can be rewarded with firm’s stock – Original owners can diversify their holdings 18-16

17. The Choice to Go Public Disadvantages of being a public firm – Costs of an IPO – Public disclosure of information required — may be valuable to competitors – Shareholders demand a great deal of information 18-17

18. Public Firms’ Capital Sources Debt Financing – Commercial Paper Unsecured, short-term promissory note Used to raise short-term cash, often working capital 18-18

19. Commercial Paper Trading process – Can be sold directly to investors or through broker dealer – Firm’s credit rating critical because commercial paper is unsecured debt 18-19

20. Long-Term Debt Corporate bonds Minimum denomination on publicly traded bonds is $1,000 Most coupon-paying bonds pay interest semiannually 18-20

21. Trading Process for Corporate Bonds Initial sale made by public offering or private placement to institutional investors – Large firms use large investment banks – Smaller firms use small regional investment banks 18-21

22. Trading Process for Corporate Bonds Investment banks – Firm commitment underwriting Entire issue bought by bank at fixed price (discount from par) and resold at higher price Issuing firm has price guarantee – investment bank has risk 18-22

23. Firm Commitment Underwriting Corporate Bond Issue 18-23

24. Trading Process for Corporate Bonds Competitive sale — highest bid from group of underwriters wins Negotiated sale — issuing firm negotiates with single investment bank 18-24

25. Trading Process for Corporate Bonds Best efforts underwriting – Underwriter does not buy issue but instead acts as a placing or distribution agent for a fee – Price risk remains with issuing firm 18-25

26. Equity Financing Majority of both the board of directors and the firm’s existing stockholders must approve any new stock issue 18-26

27. The Trading Process for Corporate Equity Primary market – IPO – Seasoned offering is when the firm already has publicly-traded shares 18-27

28. Primary Market Stock Transaction 18-28

29. The Securities and Exchange Commission (SEC) must approve any new issues to the public The Trading Process for Corporate Equity 18-29

30. The Trading Process for Corporate Equity Stock issues – Firm commitment underwriting – Best-efforts basis Registration statement – Full disclosure of firm information, risks, management background and securities to be issued 18-30

31. Prospectus – Red herring prospectus is preliminary version of the public offering prospectus – Official prospectus describes issue Shelf registration allows multiple stock issues for two years under one registration The Trading Process for Corporate Equity 18-31