Embed Size (px)
Transcript of Investment Banking
Chapter 23Investment Banks, Security Brokers and Dealers, and Venture Capital Firms
Chapter PreviewWe examine the role played by investment banks (primary market), securities dealers and brokers (secondary market), and venture capital firm (pre-market). Topics include:Investment BanksSecurity Brokers and DealersRegulation of Securities Firms
Chapter Preview (cont.)Relationship Between Securities Firms and Commercial BanksVenture Capital Firms
Investment BanksInvestment banks perform a variety of crucial functions in financial marketsUnderwrite the initial sale of stocks and bondsDeal maker in mergers, acquisitions, and spin-offsMiddleman in the purchase and sale of companiesPrivate broker to the very wealthy
Investment BanksInvestment banks were essentially created in the U.S. by the passage of the Glass-Steagall Act. Prior to this, investment banking activities were part of large, money-center commercial banks.The lines between investment banks and commercial banks again begins to blur as legal separation between investment banks and commercial banks is no longer required.
Investment BanksInvestment banks play many roles in both the primary and secondary markets. We will focus on their role in three areas:Underwriting Stocks and BondsEquity SalesMergers and Acquisitions
Underwriting Stocks and BondsThe process of underwriting a stock or a bond issue requires that the investment banker purchase the entire offering at a predetermined price and then resell the offering (securities) in the market. The services provided during this process include:Giving AdviceFiling DocumentsUnderwriting, Best Efforts, or Private Placement
Underwriting Stocks and BondsGiving adviceExplaining current market conditions in to help determine why type of security (equity, debt, etc.) to offerAssisting in determining when to issue, how many, at what price (more important with IPOs than SEOs)
Underwriting Stocks and BondsFiling DocumentsSEC registration (filing) is required for issues greater than $1.5 million and with a maturity greater than 270 days.A portion of the registration statement known as the prospectus is made available to the public.Debt issues require several additional steps, including acquiring a credit rating, hire a bond counsel, etc.For equity issues, the investment banker may also arrange for the securities to appear on one of the exchanges.
Underwriting Stocks and BondsUnderwriting (firm commitment)The investment banker purchases the entire offering at a fixed price and then resells the offering to the market.An underwriter may form an underwriting syndicate to diffuse part of the underwriting risk.Placement of a tombstone in, for instance, the Wall Street Journal (example on next slide).
Underwriting Stocks and Bonds
Underwriting Stocks and BondsThe goal of underwriting is for all of the shares in an offering to be spoken for. However, this may not occur.Fully subscribed: all shares are spoken forUndersubscribed: underwriting syndicate unable to generate interest in all of the available sharesOversubscribed: interest in more shares than are available (may lead to rationing).
Underwriting Stocks and BondsFigure 23.1 Using Investment Bankers to Distribute Securities to the Public
Underwriting Stocks and BondsBest Efforts: An alternative to a firm commitment, the underwriter does not buy the issue, but rather makes its best effort to sell the entire issue.Private Placements: The entire issue is sold to a small, select group of investors. This is rarely done with equity issues.
Underwriting Stocks and BondsEquity Sales: when a firm sells an entire division (or maybe the entire company), enlisting the aid of an investment banker.Assists in determining the value of the division or firm and find potential buyersDevelop confidential financial statements for the division for prospective buyer (confidential memorandum)Prepare a letter of intent to continue, assist with due diligence, and help reach a definitive agreement
Mergers and AcquisitionsInvestment bankers may assist both acquiring firms and potential targets (although not both in the same deal).Deal may be a hostile takeover, where the target does not wish to be acquired.Investment bankers will assist in all areas, including deal specifics, lining up financing, legal issues, etc.
Securities Brokers and DealersSecurities firms with brokerage services offer several types of services:Brokerage ServiceOther servicesFull-Service Brokers versus Discount Brokers
Securities Brokers and DealersSecurities Orders: when you call a brokerage house to buy or sell a security, you essentially have three options:Market Order: buy or sell security at current priceLimit Order: you specify the most you are willing to pay (buy) or the least you are willing to accept (sell) for a securityShort Sales: sell a security you dont own with the intent of buying it back at a later date (hopefully at a lower price)
Securities Brokers and DealersOther ServicesInsurance against loss of actual security documentsMargin credit for purchasing equity with borrowed fundsOther services driven by market demand (e.g., the Merrill Lynch cash management account)
Securities Brokers and DealersFull Service Brokers: offer clients research and investment advice, but usually charge a higher commission on trades.Discount Broker: provides facilities to buy/sell securities but offers no advice. Many on-line discount brokerage firms do have significant research available
Securities Brokers and DealersSecurities DealersHold inventories of securities on their own accountProvide liquidity to the market by standing by ready to buy or sell securities (market maker)Especially important for thinly traded securities
Regulation of Securities FirmsTwo acts passed in 1933 and 1934 provide the primary basis of todays markets. The major provisions include:Establishment of the SECRegistration requirement for new securitiesReporting requirements for companies and insidersProhibition of market manipulation
Relationship Between Securities Firms and Commercial BanksGlass-Steagall stipulated that investment banking and commercial banking would be separated.G-L-B Act removed some of these barriers.Commercial banks are slowly gaining regulatory permission to engage in the full range of services offered by investment banks.
Venture Capital FirmsThese firms provide funds for start-up companiesOften become very involved with firm management and provide expertise
Venture Capital FirmsDescription of IndustryTypically limited partnershipsExamples of venture-backed firms include Apple Computer, Cisco Systems, Starbucks, TCBY, etc.Table on next slide shows the level of venture involvement in companies over the last fourteen years.
Venture Capital Investments
Venture Capitalists Reduce Asymmetric InformationManagers of start-ups may have objectives that differ significantly from profit maximization.Venture capitalists can reduce this information problem in several waysLong-term motivationSit on the board of directorsDisburse funds in stages, based on required resultsInvest in several firms, diversifying some risk
Origins of Venture CapitalFirst U.S. venture capital firm was established in 1946.Most venture capital firms in the 1950s and 1960s funded development in oil and real estate.Funding has shifted from wealthy individuals to pension funds / corporations. This is one of the few risky investments pension funds are permitted.
Structure of Venture Capital FirmsMost are limited partnershipsSource of capital includes wealthy individuals, pension funds, and corporationsInvestors must be willing to wait years before withdrawing money
Life of Venture Capital DealFundraisingVenture firm solicits commitments, usually less than 100 per dealInvestment phaseSeed investingEarly stage investingLater stage investingExitUsually IPO as mergerNational Venture Capital Association (click on Industry Research)http://www.nvca.com
Venture ProfitabilityThe 20-year average return is over 20%, with seed investing providing the highest average (24.5%) and later stage funding providing the lowest (18%).Despite some phenomenal years (1999), venture capital has had negative returns in recent years.