Deck 23: The Mechanics of Raising Equity Capital

Question 1

For many start-ups,the first round of outside private equity financing is often obtained from ________ which may also bring expertise to the firm that the entrepreneur lacks.

A) venture capital firms
B) angel investors
C) institutional investors
D) corporate investors

Answer 1

angel investors

Question 2

Which of the following statements is false?

A) A venture capital firm is a limited partnership that specializes in raising money to invest in the private equity of young firms.
B) Venture capitalists typically control about three-quarters of the seats on a start-up's board of directors, and often represent the single largest voting block on the board.
C) The initial capital that is required to start a business is usually provided by the entrepreneur herself and her immediate family.
D) Individual investors who buy equity in small private firms are called angel investors.

Answer 2

Venture capitalists typically control about three-quarters of the seats on a start-up's board of directors, and often represent the single largest voting block on the board.

Question 3

Use the information for the question(s) below.
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 2 million shares of stock. Since then, you have sold an additional 1 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $5 million and would receive 2 million newly issued shares in return.
Assuming that this is the venture capitalist's first investment in your firm,the post-money valuation of your shares are closest to:

A) $5.0 million
B) $12.5 million
C) $4.0 million
D) $2.5 million

Answer 3

$5.0 million

Question 4

Use the information for the question(s) below.
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 2 million shares of stock. Since then, you have sold an additional 1 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $5 million and would receive 2 million newly issued shares in return.
Assuming that this is the venture capitalist's first investment in your firm,what percentage of the firm will you own?

A) 50%
B) 40%
C) 33%
D) 25%

Question 5

________ can provide substantial capital for young companies.In return,________ often demand a great deal of control.

A) Institutional investors, institutional investors,
B) Corporate investors, corporate investors
C) Venture capital firms, venture capitalists
D) Sovereign wealth funds, sovereign wealth funds

Question 6

Once a company goes public,it must satisfy all of the requirements and new standards that focused on more thorough ________,________ and more stringent requirements for the board of directors.These standards,in general,were designed to provide better protection for ________.

A) financial disclosure; greater accountability; companies
B) financial disclosure; less accountability; investors
C) financial disclosure; greater accountability; investors
D) financial disclosure; less accountability; companies

Question 7

Sovereign wealth funds (SWFs)are pools of money controlled ________.

A) by publicly traded corporations
B) by private firms
C) by a government
D) by non-profit organizations

Question 8

Prior to an IPO,in Canada,the first step is the preparation of ________.

A) the audited financial statements and the registration statement
B) the registration statement only
C) the preliminary prospectus and the registration statement
D) the preliminary prospectus only

Question 9

Use the information for the question(s) below.
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 2 million shares of stock. Since then, you have sold an additional 1 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $5 million and would receive 2 million newly issued shares in return.
The post-money valuation of your firm is closest to:

A) $12.5 million
B) $5.2 million
C) $10.0 million
D) $5.0 million

Question 10

In the U.S.about 77% of businesses are ________,but 85% of sales are generated by ________ while in Canada,about 80% of businesses are ________,but more than 70% of incomes before tax are generated by ________.

A) organized as corporations; sole proprietorships or partnerships; either sole proprietorships or partnerships; businesses organized as corporations
B) either sole proprietorships or partnerships; businesses organized as corporations; businesses organized as corporations; sole proprietorships or partnerships
C) businesses organized as corporations; sole proprietorships or partnerships; businesses organized as corporations; sole proprietorships or partnerships
D) either sole proprietorships or partnerships; businesses organized as corporations; either sole proprietorships or partnerships; businesses organized as corporations

Question 11

Which of the following statements is false?

A) The general partners work for the venture capital firm and run the venture capital firm; they are called venture capitalists.
B) An important consideration for investors in private companies is their exit strategy - how they will eventually realize the return from their investment.
C) When a company founder decides to sell equity to outside investors for the first time, it is common practice for private companies to issue common stock rather than preferred stock to raise capital.
D) Institutional investors such as pension funds, insurance companies, endowments, and foundations manage large quantities of money.

Question 12

Which of the following statements is NOT true regarding angel investors?

A) They are typically arranged as limited partnerships.
B) For many start-ups, the first round of outside private equity financing is often obtained from them.
C) Because their capital investment is often large relative to the amount of capital already in place at the firm, they typically receive a sizeable equity share in the business in return for their funds.
D) These investors are frequently friends or acquaintances of the entrepreneur.

Question 13

Which of the following is NOT a common name for a corporation that invests in private companies?

A) Strategic investor
B) Corporate partner
C) Venture partner
D) Strategic partner

Question 14

In Canada,________ usually takes the lead in reviewing and approving the preliminary prospectus.The other provincial securities commissions usually follow ________.

A) the Ontario Securities Commission (OSC); Ontario's decision
B) the Toronto Stock Exchange (TSX); TSX's decision
C) the Canadian Securities Administrators (CSA); CSA's decision
D) the relevant provincial securities commission; the relevant provincial's decision

Question 15

Which of the following statements is NOT true regarding venture capitalists?

A) They can provide substantial capital for young companies.
B) The firms offer limited partners a number of advantages over investing directly in start-ups themselves as angel investors.
C) They use their control to protect their investments, so they may therefore perform a key nurturing and monitoring role for the firm.
D) They might invest for strategic objectives in addition to the desire for investment returns.

Question 16

Use the information for the question(s) below.
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 2 million shares of stock. Since then, you have sold an additional 1 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $5 million and would receive 2 million newly issued shares in return.
Assuming that this is the venture capitalist's first investment in your firm,the post-money valuation of the angel investor's shares are closest to:

A) $12.5 million
B) $4.0 million
C) $5.0 million
D) $2.5 million

Question 17

In Canada the average size of an IPO in 2007 was about ________,which is quite ________ compared to IPOs in other countries.

A) $35 billion; small
B) $35 million; small
C) $35 million; big
D) $35 billion; big

Question 18

In Canada,________ accounted for 32% of private equity funds under management in 2007,up from 28% in 2006.

A) venture capitalists
B) corporate investors
C) sovereign wealth funds
D) institutional investors

Question 19

Use the information for the question(s) below.
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 2 million shares of stock. Since then, you have sold an additional 1 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $5 million and would receive 2 million newly issued shares in return.
Assuming that this is the venture capitalist's first investment in your firm,what percentage of the firm will the venture capitalist own?

A) 50%
B) 40%
C) 25%
D) 33%

Question 20

Which of the following statements is false?

A) The preferred stock issued by young companies typically does not pay regular cash dividends.
B) The preferred stock issued by young companies usually gives the owner an option to convert it into common stock on some future date, so it is often called callable preferred stock.
C) If the company runs into financial difficulties, the preferred stockholders have a senior claim on the assets of the firm relative to any common stockholders.
D) Preferred stock issued by mature companies such as banks usually has a preferential dividend and seniority in any liquidation and sometimes special voting rights.

Question 21

Which of the following statements regarding firm commitment IPOs is false?

A) 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.
B) The underwriter purchases the entire issue (at the offer price) and then resells it at a slightly higher price to interested investors.
C) It is the most common underwriting arrangement.
D) The underwriter guarantees that it will sell all of the stock at the offer price.

Question 22

Use the information for the question(s) below.
Luther Industries is in the process of selling shares of stock in an auction IPO. At the end of the bidding period, Luther's investment bank has received the following bids:
What will the offer price of these shares be if Luther is selling 1 million shares?

A) $17.00
B) $17.50
C) $17.25
D) $16.75

Question 23

The two advantages of going public are ________ and ________.

A) greater liquidity; better access to capital
B) better cash flows; better access to capital
C) greater liquidity; better access to free cash
D) greater liquidity; better control

Question 24

Which of the following statements is false?

A) After deciding to go public, managers of the company work with an underwriter, an investment banking firm that manages the offering and designs its structure.
B) The shares that are sold in the IPO may either be new shares that raise new capital, known as a secondary offering, or existing shares that are sold by current shareholders (as part of their exit strategy), known as a primary offering.
C) Many IPOs, especially the larger offerings, are managed by a group of underwriters.
D) At an IPO, a firm offers a large block of shares for sale to the public for the first time.

Question 25

Use the information for the question(s) below.
Luther Industries is in the process of selling shares of stock in an auction IPO. At the end of the bidding period, Luther's investment bank has received the following bids:
The proceeds from the IPO if Luther is selling 1.25 million shares is closest to:

A) $20.6 million
B) $21.6 million
C) $21.1 million
D) $20.9 million

Question 26

Which of the following statements regarding exit strategies is false?

A) An alternative way to provide liquidity to its investors is for the company to become a publicly traded company.
B) An important consideration for investors in private companies is their exit strategy, or how they will eventually realize the return from their investment
C) Often large corporations purchase successful start-up companies. In such a case, the acquiring company purchases the outstanding stock of the private company, allowing all investors to cash out.
D) Roughly 25% of venture capital exits from 2001-2005 occurred through mergers or acquisitions.

Question 27

Use the information for the question(s) below.
Luther Industries is in the process of selling shares of stock in an auction IPO. At the end of the bidding period, Luther's investment bank has received the following bids:
What will the proceeds from the IPO be if Luther is selling 1.1 million shares ?

Question 28

Which of the following statements regarding best efforts IPOs is false?

A) For smaller IPOs, the underwriter commonly accepts the deal on this basis.
B) The underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price.
C) Often these arrangements have an all-or-none clause: either all of the shares are sold in the IPO, or the deal is called off.
D) If the entire issue does not sell out, the underwriter is on the hook.

Question 29

Use the information for the question(s) below.
During the most recent fiscal year, KD Industries had revenues of $400 million and earnings of $30 million. KD has filed a registration statement with the SEC for its IPO. Before it is offered, KD's investment bankers would like to estimate the value of the company using comparable companies. The investment bankers have assembled the following information based on data for other companies in the same industry that have recently gone public. In each case the ratios are based upon the IPO price.
Based upon the price/earnings ratio,what would be a reasonable value for KD?

Question 30

The fees for Canadian IPOs are ________ those for similar-sized IPOs in the U.S.but the total fee as a percent of the IPO size is calculated for every IPO,and the average percentage spread across all IPOs in Canada is ________ the average percentage spread across all IPOs in the U.S.

A) higher than; less than
B) higher than; also higher than
C) less than; higher than
D) less than; also less than

Question 31

Which of the following statements is false?

A) The process of selling stock to the public for the first time is called a seasoned equity offering (SEO).
B) Public companies typically have access to much larger amounts of capital through the public markets.
C) By going public, companies give their private equity investors the ability to diversify.
D) The two advantages of going public are greater liquidity and better access to capital.

Question 32

Which of the following statements is false?

A) Underwriters appear to use the information they acquire during the book-building stage to intentionally underprice the IPO, thereby reducing their exposure to losses.
B) The blue tooth option allows the underwriter to issue more stock, amounting to 15% of the original offer size, at the IPO offer price.
C) The lead underwriter usually makes a market in the stock and assigns an analyst to cover it.
D) In most cases, the preexisting shareholders are subject to a 180-day lockup; they cannot sell their shares for 180 days after the IPO. Once the lockup period expires, they are free to sell their shares.

Question 33

Part of the registration statement,called the preliminary prospectus,circulates to investors before the stock is offered.This preliminary prospectus is also called a(n)

A) IPO filing.
B) 10-K filing.
C) blue whale.
D) red herring.

Question 34

Use the information for the question(s) below.
Luther Industries is in the process of selling shares of stock in an auction IPO. At the end of the bidding period, Luther's investment bank has received the following bids:
What will the offer price of these shares be if Luther is selling 800,000 shares?

Question 35

Which of the following statements is false?

A) In recent years, the investment banking firm of W.R. Hambrecht and Company has attempted to change the IPO process by selling new issues directly to the public using an online auction IPO mechanism called Open IPO.
B) The lead underwriter is the primary banking firm responsible for managing the deal. The lead underwriter provides most of the advice and arranges for a group of other underwriters, called the syndicate, to help market and sell the issue.
C) Because of the potential conflict of interest, the underwriter will not make a market in the stock after the issue.
D) The SEC requires that companies prepare a registration statement, a legal document that provides financial and other information about the company to investors, prior to an IPO. Company managers work closely with the underwriters to prepare this registration statement and submit it to the SEC.

Question 36

Which of the following statements is false?

A) Once the issue price (or offer price) is set, underwriters may invoke another mechanism to protect themselves against a loss - the over-allotment allocation.
B) Before the offer price is set, the underwriters work closely with the company to come up with a price range that they believe provides a reasonable valuation for the firm.
C) Before an IPO, the company prepares the final registration statement and final prospectus containing all the details of the IPO, including the number of shares offered and the offer price.
D) A "road trip" is where senior management and the lead underwriters travel around the country (and sometimes around the world) promoting the company and explaining their rationale for the offer price to the underwriters' largest customers - mainly institutional investors such as mutual funds and pension funds.

Question 37

Which of the following is NOT one of the four characteristics of IPOs that puzzle financial economists?

A) On average, IPOs appear to be underpriced.
B) The long-run performance of a newly public company (three to five years from the date of issue) is superior to the overall market return.
C) The number of issues is highly cyclical.
D) The costs of the IPO are very high, and it is unclear why firms willingly incur such high costs.

Question 38

Use the information for the question(s) below.
During the most recent fiscal year, KD Industries had revenues of $400 million and earnings of $30 million. KD has filed a registration statement with the SEC for its IPO. Before it is offered, KD's investment bankers would like to estimate the value of the company using comparable companies. The investment bankers have assembled the following information based on data for other companies in the same industry that have recently gone public. In each case the ratios are based upon the IPO price.
Based upon the price/revenue ratio,what would be a reasonable value for KD?

Question 39

Which of the following statements is false?

A) Once a company goes public, it must satisfy all of the requirements of public companies.
B) Organizations such as the relevant provincial Securities and Exchange Commission (SEC), the securities exchanges (including the TSX), and the Parliament of Canada adopted new standards that focused on more thorough financial disclosure, greater accountability, and more stringent requirements for the board of directors.
C) The major advantage of undertaking an IPO is also one of the major disadvantages of an IPO: when investors diversify their holdings, the equity holders of the corporation become more concentrated.
D) Several high profile corporate scandals during the early part of the twenty-first century prompted tougher regulations designed to address corporate abuses.

Question 40

Underpricing in Canada is ________,but the magnitude is ________ in many other countries.

A) significant; not as large as
B) insignificant; not as large as
C) insignificant; as large as
D) significant; as large as

Question 41

Which of the following statements is false?

A) The one advantage of a cash offer is that the underwriter takes on a larger role and, therefore, can credibly certify the issue's quality.
B) SEO underwriting fees average about 5% of the proceeds of the issue and, as with IPOs, the variation across issues of different sizes is relatively small.
C) As with IPOs, evidence suggests that companies over-perform following a seasoned offering.
D) Often the value destroyed by the price decline can be a significant fraction of the new money raised with a SEO.

Question 42

Which of the following statements is false?

A) Primary shares are new shares issued by the company.
B) Today, investors become informed about the impending sale of stock by the news media, via a road show, or through the book-building process, so tombstones are purely ceremonial.
C) In a cash offer, the firm offers the new shares to existing shareholders.
D) Historically, intermediaries would advertise the sale of stock (both IPOs and SEOs) by taking out advertisements in newspapers called tombstones.

Question 43

Use the information for the question(s) below.
Luther Industries has sold 10 million shares of stock in an SEO. The market price of Luther at the time was $25 per share. Of the 10 million shares sold, 6 million shares were primary shares being sold by the company, and the remaining 4 million shares were being sold by venture capitalists. Luther's underwriter charges 5% of the gross proceeds as an underwriting fee.
How much money did the venture capitalists receive?

Question 44

Use the information for the question(s) below.
Luther Industries has sold 10 million shares of stock in an SEO. The market price of Luther at the time was $25 per share. Of the 10 million shares sold, 6 million shares were primary shares being sold by the company, and the remaining 4 million shares were being sold by venture capitalists. Luther's underwriter charges 5% of the gross proceeds as an underwriting fee.
How much money did Luther raise?

Question 45

Use the information for the question(s) below.
During the most recent fiscal year, KD Industries had revenues of $400 million and earnings of $30 million. KD has filed a registration statement with the SEC for its IPO. Before it is offered, KD's investment bankers would like to estimate the value of the company using comparable companies. The investment bankers have assembled the following information based on data for other companies in the same industry that have recently gone public. In each case the ratios are based upon the IPO price.
When referring to IPOs,what is book building?

Question 46

Luther Industries currently has 100 million shares of stock outstanding at a price of $25 per share.The company would like to raise money and has announced a rights issue.Every existing shareholder will be sent one right per share of stock that he or she owns.The company plans to require twenty rights to purchase one share at a price of $20 per share.The amount of money that Luther will raise through its rights offering is closest to:

A) $500 million
B) $125 million
C) $100 million
D) $400 million

Question 47

Use the information for the question(s) below.
During the most recent fiscal year, KD Industries had revenues of $400 million and earnings of $30 million. KD has filed a registration statement with the SEC for its IPO. Before it is offered, KD's investment bankers would like to estimate the value of the company using comparable companies. The investment bankers have assembled the following information based on data for other companies in the same industry that have recently gone public. In each case the ratios are based upon the IPO price.
Describe the four characteristics of IPOs that puzzle financial economists.

Question 48

Which of the following statements is false?

A) More often than not, firms return to the equity markets and offer new shares for sale, a type of offering called a seasoned equity offering (SEO).
B) Usually, profitable growth opportunities occur throughout the life of the firm, and in some cases it is not feasible to finance these opportunities out of retained earnings.
C) When a firm issues stock using an SEO, it follows many of the same steps as for an IPO. The main difference is that a market price for the stock already exists, so the price-setting process is not necessary.
D) A firm's need for outside capital usually ends at the IPO.

Question 49

Which of the following statements is false?

A) In a rights offer, the firm offers the new shares only to existing shareholders.
B) Secondary shares are shares sold by existing shareholders, including the company's founder.
C) If a firm's management is concerned that its equity may be underpriced in the market, by using a rights offering the firm can continue to issue equity without imposing a loss on its current shareholders.
D) In the United States most offers are rights offers.

Question 50

Which of the following statements is false?

A) SEO rights offers have lower costs than cash offers.
B) The decision to raise financing externally usually implies that a firm plans to pursue an investment opportunity.
C) Although not as costly as IPOs, seasoned offerings are still expensive.
D) Researchers have found that, on average, the market greets the news of an SEO with a price increase.