Equity Financing

1. Long-Term
Financing
Equity

2. Financial Decisions
Revisited
2

3. Section 1
An Introduction to Equity
Financing
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4. What is Equity?
 Several definitions are available
depending on the form of equity;
a. in accounting equation it’s the
difference between assets and
liabilities;
b. on the company statements the
amount injected by shareholders
to the business plus any retained
earnings;
c. a security which entitles it’s
holder the right of ownership;
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5. Superiors of Equity
Financing
 Equity financing is not required to be repaid;
 Unlike debt financing no installments are intended which
otherwise can be used in future growth;
 Lower debt leverages improves company’s future
borrowing options;
 There is no restrictions on company’s activities which
may possibly prevent it from taking advantage of new
opportunities;
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6. Drawbacks of Equity
Financing
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 Taking on equity investment ends up in
transferring some part of ownership rights
to investors;
 If there is a surge in earnings, you have to share a
portion of your earnings with the equity investor.
Over time, distribution of profits to other owners may
outgrow what you would have repaid on a loan;
 Your business may be subject to potential conflicts
deriving from different business visions or perspectives

7. Decisive Factors
 If company is experiencing creditworthiness
problem or currently overleveraged ✔
 If sharing decision-making is not convenient ✖
 If you rather share ownership/equity than
have to repay a bank loan ✔
 If business’s profitability forecasts are
hope rising ✖
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8. 8
SECTION 2
Raising Equity Capital

9. Stages of Attracting
Equity Capital
 Private companies may submit stocks and have shareholders.
However their shares are not traded in market or exposed to SEC
regulations. The ways of attracting equity capital are;
a. angel investors-for many start-ups, the first round of outside
private equity financing is often obtained from angels. Frequently,
these investors are friends or acquaintances of the entrepreneur.
These investors may have substantial influence in the business
decisions of the firm. Angels may also bring expertise to the firm that
the entrepreneur lacks;
• venture capitalists-a venture capital firm is a limited partnership
that specializes in raising money to invest in the private equity of
young firms.Typically they invest companies which are in growth
stage; 9

10. How to Raise Equity
Capital
institutional investors-pension funds,
insurance companies,endowments, and
foundations manage large quantities of
money. They may invest directly in private
firms, or they may invest indirectly by
becoming limited partners in venture capital or
private equity firms;
corporate investors-are established
corporations which purchase equity in younger,
private companies;
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11. How to Raise Equity Capital
IPO
 The process of selling stock to the public for the first time;
 The two advantages that going public offers are greater liquidity and
better access to capital;
 However there are disadvantages of offering shares to public such as;
a. there will be significantly greater public regulation, accountability and
scrutiny. The legal requirements the company faces will be greater,
and the company will also be subject to the rules of the stock
exchange on which its shares are listed;
b. a wider circle of investors with more exacting requirements will hold
shares;
c. there will be additional costs involved in making share issues, including
brokerage commissions and underwriting fees;
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12. The Mechanism of IPO
 A company about to issue new securities in order
to raise finance might decide to have the issue
underwritten;
 Underwriters are financial institutions
which agree to
buy at the issue price any securities which are not
subscribed for by the investing public;
 The shares that are sold in the IPO may
either be new shares that raise new capital,
known as a primary offering, or existing shares that are sold by current
shareholders, known as a secondary offering;
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13. The Mechanism of IPO
 Underwriters typically act in two ways;
a. best effort basis-the underwriter does not guarantee
that the stock will be sold, but instead tries to sell the
stock for the best possible price;
b. firm commitment IPO-more commonly underwriter
guarantees that it will sell all of the stock at the offer
price. The underwriter purchases the entire issue and
then resells it at the offer price. If the entire issue does
not sell out, the remaining shares must be sold at a
lower price and the underwriter must take the loss;
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14. Seasonal Offering
Right Issue
 The offer of new shares to existing
shareholders in the proportion of shares
currently held by these shareholders;
 Price of share is lower than normal
market price;
 It follows many of the same steps as
for IPO but the main difference is a
market price for the stock already exists, so the price-
setting process is not necessary;
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15. Seasonal Offerings
Right Issue
The main features of right issue are;
a.cheaper than IPO;
b. may offset the future negative effect of stock dilution***;
c. typically has negative effect on stock prices because it’s perceived
as a signal of financial distress by investors;
d.companies with good financial health also may apply right issue for
financing different projects;
e. enable current shareholders to maintain their proportionate stake in
the company;
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Dilution Illustration
Currently company has 10 shareholders and each one holds 1
shares(10%)of company. Company issues additional 20 shares which
are bought by one person. Now new shareholder owns 66% of
company while the old shareholders only possess 3% of company.

16. 16
SECTION 3
Types of Shares

17. General Framework of
Common Stocks
 Carries voting right;
 Higher yield is almost guaranteed over
the time as a result of company’s growth;
 Even if dividend is not paid
holders may earn through capital
appreciation;
 Common stocks are liquid so these can
be sold and purchase at fair price easily
and quickly;
 Common stock holders get the payment
last;
 There is a difficulty to control because
you’re also dependent of decisions of others; 17

18. Dual-Class Common Stock
 Two share classes may be issued depending on the
voting rights and dividend payments;
 Each type of share targets different investor segments;
a. Class A-inferior voting privilages but stronger claim to
dividends. This type of shares are typically offered to
general public;
b. Class B- may have superior voting rights but instead
weak claim to dividends. Generally offered to family
members, founders or executives;
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19. Preferred Stocks
 Represent some degree of ownership
but voting right is not inherent to them;
 Receives fixed dividend;
 Participating Preferred StockParticipating Preferred Stock where the
holder is allowed to participate in increasing
dividends if the common stockholders
receive increasing dividends;
 Paid before than common stock holders
in case of bankruptcy;
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20. Types of Preferred Stock
 Cumulative Preferred Stock-if company can’t afford to dividend
payment then the appropriate amount is accumulated in arrears and
represents the amount that is owed by company to investor.
Common stock holders can not be paid until the position of
cumulative preferred stock holders is closed;
 Non-cumulative Preferred Stock-sometimes referred as straight
shares. If company opts out dividend distribution then it is not owed
to the investor;
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21. Types of Preferred Stock
 Convertible Preferred Stock-
includes the provision to convert or
exchange preferred stocks to common
stocks at a fixed price;
 Redeemable Preferred Stock-a type
of preferred stock that enables the
issuer to buy back the stock at a
certain price and retire it, thereby
converting the stock to treasury stock;
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22. 22
SECTION 4
Price of Equity and
Dividend Policy

23. Price Terminology
 Par Value or Face Value-which appears on the face of
share. It’s typically $1 or less which ensures that shares
will not be sold below that price;
 Issue Price-the price which is quoted by company when
the shares are introduced to markets. Businesses apply
for the assistance of professional organizations for
determining the issue price;
 Market Price-the price which is shares are commonly
traded in Stock Exchanges;
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24. Factors Influencing Stock
Prices
 Company specific news-announcement of dividends,
introduction of a new product or a product recall,
securing a new large contract, anticipated takeover
or merger a change of management accounting
errors or scandals;
 Industry performance-for example competitor’s
performance;
 Economic factors-interest rates,inflation,economic
shocks,political uncertainties;
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25. Dividends as a
Passive Residual
 The firm uses earnings plus the additional financing
that the increased equity can support to finance any
expected positive-NPV projects;
 Any unused earnings are paid out in the form of
dividends. This describes a passive dividend policy;
Can the payment of cash dividends affectCan the payment of cash dividends affect
shareholder wealth?shareholder wealth?
If so, what dividend-payout ratio will maximizeIf so, what dividend-payout ratio will maximize
shareholder wealth?shareholder wealth?
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26. Factors Influencing
Dividend Policy
• Funding Needs of the Firm
• Liquidity
• Ability to Borrow
• Restrictions in Debt Contracts
(protective covenants)
• Control
Issues to ConsiderIssues to Consider
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27. Stock Dividends
 Stock DividendStock Dividend -A payment
of additional shares of stock to
shareholders. Often used in
place of or in addition to a
cash dividend;
 Companies may decide to
distribute stock to shareholders of
record if the company's availability
of liquid cash is in short supply;
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28. B/S Changes for the Stock
Dividend
 $800,000 ($5 x 20,000 new shares) transferred
(on paper) “out of” retained earnings;
 $100,000 transferred “into” common stock
account;
 $700,000 ($800,000 - $100,000) transferred
“into” additional paid-in-capital;
 “Total shareholders’ equity” remains unchanged
at $10 million; $40 sales price
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29. Stock Dividends
Before 5% Stock DividendBefore 5% Stock Dividend
Common stock
($5 par; 400,000 shares400,000 shares) $ 2,000,000$ 2,000,000
Additional paid-in capitalAdditional paid-in capital 1,000,0001,000,000
Retained earningsRetained earnings 7,000,0007,000,000
Total shareholders’ equity $10,000,000
After 5% Stock DividendAfter 5% Stock Dividend
Common stock
($5 par; 420,000 shares420,000 shares) $ 2,100,000$ 2,100,000
Additional paid-in capitalAdditional paid-in capital 1,700,0001,700,000
Retained earningsRetained earnings 6,200,0006,200,000
Total shareholders’ equity $10,000,000
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30. Stock Dividends,
EPS, and Total Earnings
 Assume that investor SP owns 10,000 shares and the firmAssume that investor SP owns 10,000 shares and the firm
earned $2.50 per share;earned $2.50 per share;
 Total earnings = $2.50 x 10,000 = $25,000;
 After the 5% dividend, investor SP owns 10,500 shares10,500 shares
and the same proportionate earnings of $25,000;
 EPS is then reduced to $2.38 per share because of the
stock dividend ($25,000 / 10,500 shares = $2.38 EPS$2.38 EPS);
After a stock dividend, what happens to EPS andAfter a stock dividend, what happens to EPS and
total earnings of individual investors?total earnings of individual investors?
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31. Stock Dividends and
Stock Splits
 Similar economic consequences as a 100% stock
dividend;
 Primarily used to move the stock into a more popularPrimarily used to move the stock into a more popular
trading range and increase share demand;trading range and increase share demand;
 Assume a company with 400,000 shares of $5 par
common stock splits 2-for-1. How does this impact theHow does this impact the
shareholdersshareholders’ equity accounts?;’ equity accounts?;
Stock SplitStock Split -- An increase in the number of
shares outstanding by reducing the par value of
the stock.
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32. Stock Splits
Before 2-for-1 Stock SplitBefore 2-for-1 Stock Split
Common stock
($5 par; 400,000 shares400,000 shares) $ 2,000,000$ 2,000,000
Additional paid-in capitalAdditional paid-in capital 1,000,0001,000,000
Retained earningsRetained earnings 7,000,0007,000,000
Total shareholders’ equity $10,000,000
After 2-for-1 Stock SplitAfter 2-for-1 Stock Split
Common stock
($2.50 par; 800,000 shares800,000 shares) $ 2,000,000$ 2,000,000
Additional paid-in capitalAdditional paid-in capital 1,000,0001,000,000
Retained earningsRetained earnings 7,000,0007,000,000
Total shareholders’ equity $10,000,000
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33. Stock Repurchase
Reasons for stock repurchase:
 Available for management stock-option plans;
 Available for the acquisition of other companies;
 “Go private” by repurchasing all shares from outside
stockholders;
 To permanently retire the shares;
Stock RepurchaseStock Repurchase -- The repurchase (buyback) of
stock by the issuing firm, either in the open
(secondary) market or by self-tender offer.
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34. Repurchasing as
Part of Dividend Policy
AssumeAssume::
– Earnings after taxes $ 800,000
– Number of commonNumber of common
shares outstandingshares outstanding ÷÷ 400,000400,000
– Earnings per shareEarnings per share $ 2$ 2
– Current market price
per share $ 31
– Expected dividend per share $ 1
– Expected total dividendsExpected total dividends to beto be
paid outpaid out $ 400,000$ 400,000
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35. Repurchasing as
Part of Dividend
Policy
If dividend is paid, shareholders receiveIf dividend is paid, shareholders receive::
– Expected dividend per share $ 1
– Market price per shareMarket price per share $ 30$ 30
– Total valueTotal value $ 31$ 31
If shares repurchased, shareholders receiveIf shares repurchased, shareholders receive::
– Dividend per share $ 0
– Market price per share* $ 31
– Total valueTotal value $ 31$ 31
* Shares repurchased = $400,000 / $31 = 12,903
Original P/E ratio = $30$30/$2 = 15
“New” EPS = $800,000 / 387,097 = $2.07
“New” market price = $2.07 x 15 = $31 35

36. 36
SECTION 5
Role of Shares in
Company Management

37. Two methods of voting: (1) in person or (2) by proxy
ProxyProxy -- A legal document giving one person authority to act for another.
Voting Rights
 SEC regulates the solicitation of proxies and requires
companies to disseminate information to their shareholders
through proxy mailings;
 Most shareholders, if satisfied with company performance,
sign proxies in behalf of management;
 Shareholders are generally geographically widely dispersed;
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38. Voting Procedures
 Majority-rule votingMajority-rule voting - a method of electing corporate
directors, where each common share held carries one vote
for each director position that is open; also called statutorystatutory
votingvoting;
 Cumulative votingCumulative voting - a method of electing corporate
directors, where each common share held carries as many
votes as there are directors to be elected and each
shareholder may accumulate these votes and cast them in
any fashion for one or more particular directors;
The board of directors are elected under either:
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39. Voting
Procedures Example
 Under majority-rule votingUnder majority-rule voting: You may cast 100 votes (1
per share) for each of the 9 director positions open for a
maximum of 100 votes per position;
 Under cumulative votingUnder cumulative voting: You may cast 900 votes (100
votes x 9 positions) for a single position or divide the
votes amongst the 9 open positions in any manner you
desire;
You are a shareholder ofYou are a shareholder of FunFinMan, Inc.FunFinMan, Inc. YouYou
own 100 shares and there are 9 directorown 100 shares and there are 9 director
positions to be filled.positions to be filled.
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40. Minimum Votes to
Elect a Director --
Cumulative
 For example, to elect 3 directors out of 9 director
positions at FunFinMan, Inc., (100,000 voting shares
outstanding) would require 30,001 voting shares30,001 voting shares.
(100,000 shares) x (3 directors)
10
Total number of
voting shares
Specific number of
directors sought
Total number of directors to be elected + 1
X
+ 1
+ 1 = 30,001 shares30,001 shares
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41. Thank You
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