Stock Offerings and Investor Monitoring

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STOCK OFFERINGS AND

INVESTOR MONITORING
Team 01
PRIVATE
EQUITY
Private Equity

When a firm starts, its owner invests money in this firm. the founders may
also invite their friends and family. These funds are Private equity because
it is privately held and can’t sell their share to the public.

Financing by VC Funds

The private firm needs a large number of investments for its business. So
they obtain their funds from Venture Capital(VC) funds. A VC fund receives
money from wealthy investors and a pension fund for a long period of time.
Usually 5 to 10 years.
Financing by VC Funds (Contd.)

Private companies need equity financing because they borrow the


maximum amount of money from banks or other financial institutions.
Some of these companies thinking about IPO in the future but at present,
they are not large enough. So, they rely on VC funds.

Exit strategy of VC funds

Generally, VC funds exit their original investment within 4 to 7 years. VC


funds may exit in some ways. Such as:
Exit strategy of VC funds (Cont’d)

Sell the equity stake to the public.


When the private business goes to public offerings VC funds sell their equity
stake to the public. Many VC funds sell their shares of the business they
invest in during the first 6 to 24 months after the business goes public.

Company Acquiring
Alternatively, VC funds may cash out if the company is acquired by another firm.
Sometimes, a business can’t run in the long run. So at that moment, another firm
acquires that firm. In the meantime, the VC fund cashed out its funds and exited.
Thus, a VC fund serves as a bridge for financing the business until it either goes
public or is acquired.
Financing by Private Equity Funds

Private companies can get funds from Private Equity Funds. These funds are
from Institutional investors such as Pension funds or insurance companies.
There are some restrictions applied for investing a minimum amount of
funds such as $1 million. And the investor can’t withdraw this amount before
a certain period such as 5 years.
The difference between VC funds and Private equity funds is
Private equity funds purchase a majority stake in the company or the
entire company, whereas VC funds only invest in the company and get a
percentage of the profit of that company.
Private equity funds invest a larger amount than typical VC funds.
Financing by Private Equity Funds(Contd.)

For this large number of stakes, private equity funds can take control of the
company. And its managers usually take a percentage of the profit in return
for managing funds. The private equity funds usually charge an annual fee
to the investors such as 2 percent.

Use of Financial Leverage by Private Equity Funds

Private equity funds usually borrow heavily to finance their investment. For
this reason, they can purchase larger companies or to buy more
businesses. They can earn from their investment and their financial
leverage magnifies this return.
Use of Financial Leverage by Private Equity Funds
(Contd.)
If they fail to generate profit, this loss also be enhanced because of their
high degrees of leverage. Private equity funds heavily rely on financial
leverage. So, they want to invest more in companies when they can easily
obtain debt in financial markets.

Strategy of Private Equity Funds

We can divide their strategy based on some criteria.


Private equity firms find such a company, which is undervalued or
mismanagement. They improve this firm’s condition and they can
achieve their higher return.
Strategy of Private Equity Funds(Contd.)

They usually purchase a majority stake or all of a business. So, they


have control over the company. Then they restructure their business to
improve that firm's conditions.
When this firm’s performance is improved, they usually sell the
business stake after several years.
Some negative comments also arose about their strategy. One of these is
the “Laying off employees”
However, Private equity funds rebutted this allegation that these firms are
overstaffed and inefficient. So, they need to restructure to survive.
Exit Strategy by Private Equity Funds

Usually, Private equity funds exit in three ways.


As VC funds do, They also sell their stake in private businesses.
If the business conducts IPO Private equity funds sell their ownership to
new investors share and cash out.
Lastly, private equity fund sell their business to another company.

Financing By Crowdfunding
Besides Public equity funds and VC funds, new firms usually raise
crowdfunding. Crowdfunding is basically, where individual investors invest
a large amount. Crowdfunding is very important for small businesses.
Financing By Crowdfunding (Contd.)

Because In starting, a small business can’t attract VC funds or public equity


funds. At that moment, small businesses can get funds from crowdfunding.
For conducting and making easier Crowdfunding, the Jumpstart Our Job
Act 2012 was passed. This act encourages investors to invest in small
business groups. For this act, the small investors also invest in the
company.
To engage in crowdfunding, the companies provide their information.
There are hundreds of websites for raising crowdfunding.
At present, many startup companies start with crowdfunding. After
success, the companies go to VC funds.
PUBLIC EQUITY
Public Equity
Public equity essentially refers to shares or ownership of a public company,
i.e., a company that is listed on a public stock exchange like the DSE or CSE.

Founders can obtain large equity financing to support the firm’s growth or pay
off some of their debt. They may also hope to “cash out” by selling their own
original equity investment to others.
1)Ownership and Voting Rights
When a firm engages in a public offering, it issues (sells) many shares of
stock in the primary market in exchange for cash. This endeavor changes
the firm’s ownership structure by increasing the number of owners.

A public stock offering can appeal to many individual investors who want to
become shareholders so that they can earn a good return on their
investment if the firm performs well. They may also receive dividends on a
quarterly basis from the firms in which they invest. However, investors who
purchase shares of stock are also susceptible to large losses, as the stock
values of even the most respected firms have declined substantially in
some periods.
Common Stock:
The ownership of common stock entitles shareholders to a number of
rights. Usually, only the owners of common stock are permitted to vote
on certain key matters concerning the firm, such as the election of the
board of directors, authorization to issue new shares of common stock,
approval of amendments to the corporate charter,and adoption of by
laws.

Many investors assign their vote to management through the use of a


proxy, and many other shareholders do not bother to vote. As a result,
management typically receives the majority of the votes and can elect its
own candidates as directors.
Preferred Stock:

Preferred stock represents ownership in a company without significant


voting rights. Unlike common shareholders, preferred shareholders are
compensated through fixed dividends, which must be paid before any
dividends can be distributed to common shareholders. If earnings are
inadequate, preferred dividends may be omitted without risking
bankruptcy, although they are typically cumulative, meaning they must be
paid eventually.

Beyond their fixed dividends, preferred shareholders usually do not


participate in the company's profits, which are instead retained for
common shareholders or reinvested for company growth.
Preferred Stock(Cont’d)

Preferred stock involves lower risk than corporate bonds as dividends can
be skipped without facing immediate default. However, omitting dividends
may hinder the firm's ability to attract new capital until prior dividends are
paid, as it signals financial instability to investors.

Unlike bonds, preferred stock dividends are not tax-deductible for the
issuing firm, and to attract investors, higher dividend rates may be
necessary. Despite these drawbacks, preferred stock represents a
permanent source of financing with no maturity date, offering stability in
the firm's capital structure.
2) Participation of Financial Institutions in Stock Markets

In addition to participating in
stock markets by investing
funds, financial institutions
sometimes issue their own
stock as a means of raising
funds. Many stock market
transactions involve two
financial institutions. For
example, an insurance
company may purchase the
newly issued stock of a
commercial bank.
2) Participation of Financial Institutions in Stock Markets

Exhibit 10.2 summarizes the


various types of financial
institutions that participate in
the stock markets. Because some
financial institutions hold large
amounts of stock, their collective
sales or purchases of stocks can
significantly affect stock market
prices.
Secondary Market for Stocks

In addition to the primary equity market, which facilitates new equity


financing for corporations, a secondary equity market allows investors to
sell stocks that they previously purchased to other investors. Thus, the
secondary market creates liquidity for investors who invest in stocks.
Many investors are willing to invest in stocks only because they can easily
sell them at any time.
Stock Price Dynamics in the Secondary Market
Investors may decide to buy a stock when its market price is below their
valuation of that stock, which means they believe the stock is undervalued.
They may sell their holdings of a stock when its market price is above their
valuation, which means they believe the stock is overvalued. Thus,stock
valuation drives their investment decisions.

Investors often disagree on how to value a stock, such that some investors
may believe a stock is undervalued whereas others believe it is overvalued.
This difference in opinions allows for market trading, because it means
that at any given time some investors will want to buy a stock, while other
investors who previously purchased the stock will want to sell it in the
secondary market.
Stock Price Dynamics in the Secondary Market(Cont’d)

Stock prices change when the demand for shares either exceeds or falls
short of the available supply. Positive news regarding a company's
anticipated performance typically leads investors to believe that the stock
is undervalued at its current price. Consequently, demand for the stock
increases, causing its price to rise in the secondary market.

Conversely, negative news about a company's expected performance often


suggests that the stock is overvalued. This belief reduces demand for the
stock relative to its supply, resulting in downward pressure on its price in
the secondary market.
Stock Offerings
&
Repurchases
EVEN AFTER A FIRM HAS GONE
PUBLIC, IT MAY :

Issue more stocks

Repurchase previously
issued stocks
Secondary Stock Offerings is a new stock offering by a specific firm
whose stock is already publicly traded.
Purpose: Typically done to support growth, expansion, or other corporate initiatives.
Regulatory Process: Requires filing with the Securities and Exchange Commission (SEC)
and often involves hiring a securities firm for guidance.

Involves hiring a securities firm for guidance - why?


When a company wants to raise more money by selling more shares of its stock,
it aims to do so at the current market price. However, if there's not enough
demand for all the new shares, the price may need to be lowered to sell them all.
This can cause the stock price to drop temporarily. Many secondary offerings
lead to a 1 to 4 percent decline in the firm's stock price on the offering day,
reflecting the balance between increased supply and demand.
So, companies keep an eye on the stock market and prefer to issue new
shares when their stock price is high and the outlook for the company is
positive. This way, they can raise more money with fewer shares.

Preemptive Rights in Secondary Offerings:


Corporations may offer preemptive rights to certain groups, like existing
shareholders, granting them priority to purchase new stock. By offering
stock to existing shareholders first, the firm aims to maintain ownership
control and avoid dilution. Shareholders can exercise their preemptive
rights during a subscription period, typically lasting a month or less, at the
specified price and also have the option to purchase the new shares or sell
their preemptive rights to others.
Shelf Registration
What is Shelf Registration?
It is a way for companies to register securities with the SEC for up to two
years before actually issuing them.
How does it work?
It helps companies access funds quickly without delays caused by
registration processes. The registration statement outlines the company's
financing plans for the next two years, but the securities stay "on the shelf"
until needed. It unlocks quick access to funds and the ability to lock in
financing costs, especially useful when anticipating unfavorable conditions.
*Potential buyers should note that the information in the registration may
not always be up-to-date.
Stock Repurchases
Stock repurchases refer to corporate managers using excess cash to buy back
a portion of the firm's shares from the market.
Managers have insider knowledge about the firm's future prospects, leading to the
undervaluation of stock. Repurchases occur when managers believe the stock is
undervalued, allowing them to buy shares at a lower price than their perceived
worth. Repurchases often happen when share prices are low, indicating an
opportunity to buy back shares at a favorable price.

What happens when Stock Repurchase Announcements are made?


Stock prices tend to rise when repurchase announcements are made.
Investors perceive this as management signaling that shares are undervalued.
Investors typically respond favorably to this signal, viewing it as positive
Monitoring Publicly
Traded Companies
Reasons behind Monitoring
The main goal of any firm is to maximize shareholders' wealth. In most of
the cases, due to conlicts in decisions Agency Problem takes place. It
highlights the state when managers are more involved in personal interests
rather than the interests of the shareholders. If the managers serve their
own interest (such as paying themselves higher salaries), they will not
maximize the stock's price.
Ways to Monitor
If the price of the share is lower than expected, the shareholder can take
action to improve the management of the firm. In a general sense, a
shareholder can monitor the changes in the values (share price) of the
firm.
Ways to Monitor (Contd.)
The board of directors needs to ensure that the decisions taken by the
managers can increase the firm's performance as well as maximize
shareholders' wealth. Moreover, publicly traded companies should disclose
their financial statements so that investors can have enough knowledge about
the performance of the firms.
Role of Analysts
The analysts mainly communicate with the high-level managers and
publish their opinions in the form of ratings (or recommendations) for the
investors. They publicize the stock of the firm as Strong Buy, Buy, Hold, or
Sell. But when a firm advisory provides the same services as analysts, the
analysts get pressured to give
Role of Analysts (Contd.)
A higher rating so that they are employed for advisory services. Thus,
the analysts use a liberal rating system while rating the stocks.

Stock Engage Rules:


The US stock exchanges imposed new rules in the period from 2002-2004.
As per the rules:
Analysts should be operated independently and their compensation
should not be linked to the volume of advisory business generated.
Securities firms are mandated to disclose summaries of analysts'
ratings across all firms to enhance the transparency of the ratings.
The Sarbanes-Oxley Act

The Sarbanes-Oxley Act was enacted in 2002 for the proper disclosure of
financial statements so that investors can monitor the financial condition
of the firm effectively. This method helps to improve the reporting time as
well as prevents potential conflicts of interest.

It prevents internal controls, restricts certain relationships between


auditing firms and client companies, limits compensation to audit
committee members and requires CEOs and CFOs to certify financial
accuracy. Even it has improved transparency, investors still face
challenges in obtaining comprehensive financial data which can lead to
valuation errors.
The Sarbanes-Oxley Act(Contd.)
Cost of Being Public: Though the Sarbanes-Oxley Act is an effective one,
implementing such a process is very costly. The cost may exit 1 million USD
per year which encourages the small public firms to revert to private
ownership. They can eliminate the substantial reporting costs then.

Shareholder Activisim
The shareholder have three options when they are displeased by the
managers. Such as: to do nothing or to sell the stocks or engage in
shareholder activism. The way by which shareholders can influence
corporations’ behavior by exercising rights is shareholder activism.
Shareholder Activisim(Contd.)
Communication with the firm: When shareholders convey their concerns
to other investors, this places more pressure on the managers or the board.
Since institutional investors directly communicate with high-level
managers, they can easily share their ideas. When institutional investors
communicate as a team, the firms become more responsive. Then
Institutional Shareholder Service(ISS) organizes conference calls with the
higher executives to talk about the overall management of the firm.

Proxy Contest: This is a more formal approach than direct communication.


That means the shareholders can take an attempt to change the
composition of the board. But this process is applicable only when the firm
ignores an informal request to change.
Shareholder Activisim(Cont’d)

The shareholders can elect one or more directors (who share their views) if
they gain enough votes. That means the shareholders will have some
control in decision-making.
For executing this method effectively, the Institutional Shareholder
Services recommend voting a certain way so that the shareholders can
exercise power over the management decisions.
MARKET FOR
CORPORATE
CONTROL
Market for Corporate Control
When control and ownership of a company change hands through various market
transactions its called a market for Corporate control

Few different ways it could occur -

1)Mergers and Acquisitions (M&A): Companies may engage in voluntary mergers or


acquisitions, where one company combines with another to form a new entity or one
company acquires the other.

2)Hostile Takeovers: In a hostile takeover, an acquiring company bypasses the target


company's management and board by directly approaching shareholders to purchase
a significant number of shares. This is typically done when the target company's
leadership opposes the acquisition.
3)Tender Offers: An acquiring company may make a public offer to purchase a specified
number of shares directly from the shareholders at a premium to the current market
price. Shareholders can choose to sell or retain their shares.

4)Proxy Contests: Activist investors or other companies may try to gain control by
influencing the shareholders' voting process during annual meetings. They may seek to
replace current board members with individuals who support the acquisition.

5)Stock Accumulation: An acquiring entity may gradually accumulate a significant


number of shares in the open market, becoming a major shareholder. Once a certain
ownership threshold is reached, they may have increased influence and control over the
target company.

6)Management Buyouts (MBOs): In a management buyout, the existing management


team of a company, possibly with the help of external investors, purchases a controlling
stake from the current shareholders, taking the company private.
Use of LBOs to Achieve Corporate Control

What is a Leveraged Buyout (LBO)?


A leveraged buyout occurs when an entity (usually a private equity firm) acquires a
controlling stake in a company using significant debt financing. The target company's
assets often serve as collateral for the loans.

How LBOs Achieve Corporate Control


1)Target Identification: Private equity firms identify companies they believe are
undervalued or could generate high returns if restructured. These may be public
companies or divisions of larger corporations.

2)Heavy Borrowing: The acquirer borrows a large portion of the purchase price, often
from banks or by issuing high-yield bonds (sometimes known as "junk bonds").
Use of LBOs to Achieve Corporate Control (Cont’d)

3)Leveraging the Target's Assets: The target company's own assets and cash flows are
used as collateral for the loans, minimizing the acquirer's direct financial investment.

4)Gaining Control: The acquirer purchases enough shares to gain control of the
company, often targeting a majority stake. This may involve taking the company
private if it was originally public.

5)Restructuring for Efficiency: Post-acquisition, the new owners restructure the


company to improve efficiency and pay down debt. This can include cost-cutting, asset
sales, or changes in management.
Barriers to the Market for Corporate Control

The power of corporate control to eliminate agency problems is limited by barriers that
can make it more costly for a potential acquiring firm to acquire another firm whose
managers are not serving the firm’s shareholders. Some of the more common barriers
to corporate control are identified next.

1)Antitakeover Amendments: Antitakeover amendments, such as those demanding a


two-thirds shareholder vote for a takeover, are intended to safeguard shareholders
from acquisitions that may diminish their investment value. However, they can also
serve as barriers, constraining acquisition prospects and possibly disadvantaging
shareholders by limiting potential value-enhancing opportunities.
Barriers to the Market for Corporate Control(Cont’d)

2)Poison Pills: Poison pills are defensive measures enacted by a firm's board of
directors, granting shareholders or managers special rights in specific circumstances,
without shareholder approval. For instance, a poison pill might offer existing
shareholders the option to purchase additional shares at a discount in response to a
takeover attempt, making it costlier and more challenging for potential acquirers to
succeed.

3)Golden Parachutes A golden parachute offers compensation to managers if they lose


their jobs or control of the firm, typically granting them shares or other benefits upon
acquisition. While it may incentivize managers to prioritize long-term shareholder
wealth, it can also protect them at the expense of shareholder interests and deter
takeovers by raising acquisition costs.
THANK YOU
ANY
QUESTIONS?

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