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Securities Markets, Start-Up Financing and More

Randy's, a family-owned restaurant chain operating in Alabama, has grown to the point where expansion throughout the entire southeast is feasible. The proposed expansion would require the firm to raise about $15 million in new capital. Because Randy's currently has a debt ratio of 50 percent, and also because the family members already have all their personal wealth invested in the company, the family would like to sell common stock to the public to raise the $15 million. However, the family does want to retain voting control. You have been asked to brief the family members on the issues involved by answering the following questions:

a. What agencies regulate securities markets?

b. How are start-up firms usually financed?

c. Differentiate between a private placement and a public offering.

d. Why would a company consider going public? What are some advantages and disadvantages?

e. What are the steps of an initial public offering?

f. What criteria are important in choosing an investment banker?

g. Would companies going public use a negotiated deal or a competitive bid?

h. Would the sale be on an underwritten or best efforts basis?

i. Without actually doing any calculations, describe how the preliminary offering range for the price of an IPO would be determined?

j. What is a roadshow? What is bookbuilding?

k. Describe the typical first-day returns of an IPO and the long-term returns to IPO investors.

l. What are the direct and indirect costs of an IPO?

m. What are equity carve-outs?

n. In what other ways are investment banks involved in issuing securities?

o. What is meant by going private? What are some advantages and disadvantages?

p. How do companies manage the maturity structure of their debt?

q. Under what conditions would a firm exercise a bond's call provision?

r. Explain how firms manage the risk structure of their debt with: (1) project financing, and (2) securitization.

Solution Preview

a. What agencies regulate securities markets?

Answer: The main agency that regulates the securities market is the Securities And Exchange Commission. Some of the responsibilities of the SEC include: regulation of all national stock exchanges--companies whose securities are listed on an exchange must file annual reports with the SEC; prohibiting manipulation by pools or wash sales; controls over trading by corporate insiders; and control over the proxy statement and how it is used to solicit votes.
The Federal Reserve Board controls flow of credit into security transactions through margin requirements. States also have some control over the issuance of new securities within their boundaries. The securities industry itself realizes the importance of stable markets, therefore, the various exchanges work closely with the sec to police transactions and to maintain the integrity and credibility of the system.

b. How are start-up firms usually financed?

Answer: The first financing comes from the founders. The first external financing comes from angels, who are wealthy individuals. The next external financing comes from a venture capital fund. The fund raises capital from institutional investors, usually around $70 to $80 million. The managers of the fund are called venture capitalists. The fund invests in ten to twelve companies, and the venture capitalist sits on their boards.

c. Differentiate between a private placement and a public offering.

Answer: In a private placement stock is sold directly to one or a small group of investors rather than being distributed to the public at large. A private placement has the advantage of lower flotation costs; however, since the stock would be bought by a small number of outsiders, it would not be actively traded, and a liquid market would not exist. Further, since it would not have gone through the SEC registration process, the holders would be unable to sell it except to a restricted set of "sophisticated" investors. Further, it might be difficult to find investors willing to invest large sums in the company and yet be minority stockholders. Thus, many of the advantages listed above would not be obtained. For these reasons, a public placement makes more sense in Randy's situation.

d. Why would a company consider going public? What are some advantages and disadvantages?

Answer: A firm is said to be "going public" when it sells stock to the public for the first time. A company's first stock offering to the public is called an "initial public offering (IPO)." Thus, Randy's will go public if it goes through with its planned IPO. There are several advantages and disadvantages to going public:

Advantages to going public:

· Going public will allow the family members to diversify their assets and reduce the riskiness of their personal portfolios.

· It will increase the liquidity of the firm's stock, allowing the family stockholders to sell some stock if they need to raise cash.

· It will make it easier for the firm to raise funds. The firm would have a difficult time trying to sell stock privately to an investor who was not a family member. Outside investors would be more willing to purchase the stock of a publicly held corporation which must file financial reports with the sec.

· Going public will establish a value for the firm.

Disadvantages to going public:

· The firm will have to file financial reports with the SEC and perhaps with state officials. There is a cost involved in preparing these reports.

· The firm will have to disclose operating data to the ...

Solution Summary

The solution provides answers on various subjects from choosing an investment banker to bookbuilding to equity carve-outs for this mini case question. 2287 words.