PART 2

THE IB BUSINESS OF
EQUITIES
CONTENT

1 Private equity

2 Venture capital

3 Buyout funds

4 Equity underwriting & IPOs

Chapter 6 and chapter 8

After finishing this part, you should be
able to
• Understand the role of venture capital and private
equity firms – their evolution, structure, participants
and investment objectives. Understand private
equity exist strategies. Similar issues relating to
buyout operations are addressed as well
• Have the perspective of the equity business, equity
underwriting – key players and their roles
• Have fundamental knowledge on IPO’s and follow-
on issues
1. Private equity
▫ IBs are involved with private equity investments,
from raising capital for the fund to taking the
portfolio company public or selling out to other
businesses.
▫ Venture capital investing, buyouts are an integral
part of the IB business. IBs‘ private equity
investing will benefit other operations as well,
such as underwriting and financial advisory

▫ So, what is private equity?

1. Private equity
▫ The simplest definition of Private Equity (PE) is
that it is equity – that is, shares representing
ownership of or an interest in an entity – not
publicly listed or traded. A source of investment
capital, private equity actually derives from
accredited individuals and institutons that
purchase shares of private companies or acquire
control of public companies with plans to take
them private, eventually become delisting them
from public stock exchanges
▫ The company in which the PE fund has made an
investment is called the portfolio company
1. Private equity
▫ PE has come to be used to describe the business
of taking a company into private ownership in
order to restructure it before selling it again at a
hoped-for profit
▫ Most of the private equity industry is made up of
large institutional investors and large private
equity firms funded by a group of investors
▫ In most cases, considerably long holding period
are often required (illiquidity) for PE investments.
PE funds typically impose limitations on investors’
ability to withdraw their investment
1. Private equity
▫ A private equity firm is an investment
management company that provides financial
backing and makes investments in the private
equity of startup or operating companies through
a variety of loosely affiliated investment
strategies including leveraged buyouts, venture
capital
▫ PE is of interest to banks because it has several
benefits, including management fees,
performance fees, and contributing to underwriting
and M&A business
1. Private equity
▫ Organizational Structure
1. Private equity
▫ PE firms generally operate as partnerships
▫ The general partner (GP) is frequently the PE firm
itself and has the responsibility of managing
operational activities
▫ The limited partners (LP) are passive investors
that finance the PE firm’s operations. LPs may
include pension funds, insurance companies, fund
of funds, high net-worth individuals, family offices,
endowments, foundations. To invest in a specific
PE fund as a LP, an individual or organization
must meet certain qualifications
1. Private equity
▫ The fee structure for PE firms varies, but it
typically consists of a management fee and a
performance fee (in some cases, a
yearly management fee of 2% of assets managed
and 20% of profits upon sale of the company).
How firms are incentivized can vary considerably
▫ Given that a PE firm with $1 billion of assets
under management might have no more than two
dozen investment professionals, and that 20% of
gross profits can generate tens of millions of
dollars in fees for the firm, it is easy to see why
the PE industry has attracted top talent
1. Private equity
▫ Management fees are annual fees that a PE firm
(i.e., the GP) charges its LPs. Management fees
are approximately 1.5% to 2% of either committed
or invested capital. Committed capital is capital
that an LP commits to a fund regardless of
whether the funds are used whereas invested
capital refers only to funds that are actually
invested in a fund
▫ Management fees help cover the operating
expenses of a PE firm (e.g., legal and accounting
compliance, transaction or deal fees, salaries,
rent, travel, etc)
 1. Private equity
▫ A PE firm make most of its profit from an
performance fee or incentive fee. After fully paying
off the invested capital of its LPs, the PE firm
retains about 15-20% of the profits and remits the
remaining 80-85% to its LPs
▫ A PE firm can take its portion of the profits only
after it reaches a hurdle rate, which is often 7-10%
For example, if the hurdle rate is 8%
with a profit split of 80:20 between the
LPs and the PE firm, the LPs get all
the returns until the returns exceed
8%. The next 2% is allocated to the
PE firm to restore the 80:20 profit
split. Any returns above 10% are then
allocated according to the 80:20 split.
1. Private equity

PE Life cycle

Each fund follows a timeline similar to this

1. Private equity

PE Life Cycle
1. Private equity

PE International’s list of the world’s biggest PE firms, based

on how much capital they raised over the last 5 years
1. Private equity
1. Private equity
▫ Because PE firms are continuously in the process
of raising, investing and distributing their private
equity firms, capital raised can often be the
easiest to measure
▫ Other metrics can include the total value of
companies purchased by a firm or an estimate of
the size of a firm's active portfolio plus capital
available for new investments
1. Private equity

PE strategies
▫ When it comes to doing the deal, PE investment
strategies are numerous; two of the most common
are venture capital and leveraged buyouts
1. Private equity

Exit Considerations
▫ There are multiple factors in play that affect the
exit strategy of a PE fund. Here are some
necessary questions to ask:
 When does the exit need to take place? What is the
investment horizon? (typically from 4 to 7 years)
 Is the management team amenable, ready for an exit?
 What exit routes are available?
 Is the existing capital structure of the business
appropriate?
 Is the business strategy appropriate?
 Who are the potential acquirers and buyers? Is it another
private equity firm or a strategic buyer?
 What IRR will be achieved?
1. Private equity

Exit Considerations
▫ Typical Exist Routes
for PE funds - PE
firms take either one
of two paths: total
exit or partial exit
1. Private equity

Exit Considerations
▫ Total exit - can be a trade sale to another buyer,
LBO by another PE firm, or a share repurchase
▫ Partial exit
 Private placement, where another investor
purchases a piece of the business
 Ccorporate venturing, in which the management
increases its ownership in the business
 Corporate restructuring, where external investors get
involved and increase their position in the business
by partially acquiring the private equity firm’s stake
▫ A flotation or an IPO is a hybrid strategy of both
total and partial exit
1. Private equity

Example deals
▫ Grab: Uber’s rival located in Southeast Asia, Grab, raised $750
million in 2016. This funding was a growth equity investment led
by Softbank as part of Grab’s Series F round of funding. Softbank
is a Japanese-based, multinational company that has a variety of
minority, late-stage investments in the transportation,
telecommunication, and technology industries
▫ Buffalo Wild Wings: In November 2017, Roark Capital Group
committed to purchasing Buffalo Wild Wings for $2.4 billion,
which was roughly a 34 percent premium to Buffalo Wild Wing’s
stock value at the time of the initial bid. Roark Capital Group is a
private equity group based in Atlanta, Georgia, that focuses on
consumer and business service companies. Besides its new
investment in Buffalo Wild Wings, Roark Capital Group has also
invested in Arby’s, Jimmy John’s, Corner Bakery, and Carl’s Jr
1. Private equity

The Argument
▫ Many PE takeovers are success stories:
Blackstone’s buyout of Hilton returned the iconic
hotel brand to glory, while KKR saved retailer
Dollar General, a vital part of many rural U.S.
communities
▫ However, its techniques can bring “creative
destruction” of capitalism into high relief. Some
studies have shown that takeover targets shed
jobs at a faster rate than similar firms, but then
hire workers faster when the company is returned
to health. Some lawmakers argue that PE firms
are exploiting a loose regulatory regime
1. Private equity

PE Fund vs Mutual Fund and Hedge Fund

▫ Similar to a Mutual Fund or a Hedge Fund, a PE
fund is a pooled investment vehicle where the
adviser pools together the money invested in the
fund by all the investors and uses that money to
make investments on behalf of the fund
▫ Unlike mutual funds or hedge funds, however, PE
firms often focus on long-term investment
opportunities in assets that take time to sell with
an investment time horizon typically of 5 or more
years
1. Private equity

PE vs Hedge Fund
▫ Typically, PEs are geared towards long-hold,
multiple-year investment strategies in illiquid
assets where they have more control and
influence over operations or asset management to
influence their long-term returns
▫ Hedge funds usually focus on short or medium
term liquid securities which are more quickly
convertible to cash, and they do not have direct
control over the business or asset in which they
are investing
1. Private equity

PE vs Hedge Fund
▫ Both PE firms and hedge funds often specialize in
specific types of investments and transactions. PE
specialization is usually in specific industry sector
asset management while hedge fund
specialization is in industry sector risk capital
management
▫ PE strategies can include wholesale purchase of
a privately held company or set of assets or
leveraged buyout
▫ Finally, PE firms only take long positions, for short
selling is not possible in this asset class
1. Private equity

PE Fund of Funds
▫ A "fund of funds" (FOF) is an investment strategy
of holding a portfolio of other investment funds
rather than investing directly in securities. This
type of investing is often referred to as multi-
manager investment
▫ There are different types of FOF, each investing in
a different type of collective investment scheme,
for example a mutual fund FOF, a hedge
fund FOF, a private equity FOF
1. Private equity

PE Fund of Funds
▫ PE FOF are investment vehicles that pool capital
from people to invest in several different PE funds
▫ Through these funds, investors can create a
highly-diversified and comprehensive portfolio of
indirect investments in several companies from
some or all of the categories of PE
▫ PE FOF helps to spread the risk of the
investments made whilst maintaining healthy
returns. Smaller investors, who do not have
access to larger PE funds due to capital
constraints, often invest into PE FOF to increase
their exposure to the asset class
1. Private equity

PE Fund of Funds
▫ A PE FOF holds the shares of many private
partnerships that invest in private equities. In this
way, it increases cost effectiveness and thereby
reduces the minimum investment requirement.
This also allows scope for greater diversification
▫ PE FOF has the potential to offer less risk than an
individual PE investment

▫ However, it may bring to some investors an

additional fee to the PE FOF manager
2. Venture Capital (VC)
▫ VC is a broad subcategory of PE that refers to
equity investments made, typically in less mature
companies, for the launch of a seed or startup
company, early stage development, or expansion
of a business. These companies are expected to
have high growth potential but have limited
access to other forms of capital
▫ Venture investment is often found in the
application of new technology, new marketing
concepts and new products that do not have a
proven track record or stable revenue streams
2. Venture Capital (VC)
▫ The VC market includes the merchant banking
subsidiaries of large institutions such as
investment banks, financial holding companies,
industrial companies and insurance companies.
The VC industry also has many independent,
specialized investment entities
▫ The VC sets up partnerships pooling funds from
investors. They seek out fledgling companies to
invest in and work with these companies as they
expand and grow to become publicly traded
companies. By going public or selling out to other
businesses, the VC realizes its returns
2. Venture Capital (VC)

History of VC
▫ While the roots of PE can be traced back to the 19th century, VC
only developed as an industry after the WWII. Harvard Business
School professor Georges Doriot is generally considered the
"Father of Venture Capital". Georges Doriot, a Frenchman who
moved to the U.S. to get a business degree, became an
instructor at Harvard’s business school and worked at an
investment bank. He started the American Research and
Development Corporation (ARDC) in 1946 and raised a $3.5
million fund to invest in companies that commercialized
technologies developed during WWII. ARDC's first investment
was in a company that had ambitions to use x-ray technology for
cancer treatment. The $200,000 that Doriot invested turned into
$1.8 million when the company went public in 1955
2. Venture Capital (VC)
▫ Top VC Firms
2. Venture Capital (VC)

VC life cycle
▫ VC fund typically raises its capital from a limited
number of sophisticated investors in a private
placement and has a life about 10 years
▫ The investor base includes wealthy individuals,
pension plans, insurance companies and other
institutional investors
▫ VC firm receives income from 2 sources: the
annual management fee and profit allocation of
the fund (main source of income)
2. Venture Capital (VC)

VC life cycle
▫ A VC fund passes through 4 stages
 Fundraising: It usually takes the general partner
several months to obtain capital commitment from
VC investors
 Investment: This phase typically lasts for about 3 to
7 years
 Growth: This stage helps portfolio companies grow,
lasts until the closing of the fund
 Closing: The VC firm liquidate its position in all of its
portfolio companies by the expiration date of the
fund. Liquidatiion takes 1 of 3 forms: an IPO, a sale
of the company or bankruptcy
2. Venture Capital (VC)

Characteristics of VC investing
▫ The VC actively involve in sourcing portfolio
company candidates, negotiating and structuring
the transaction and monitoring the companies
▫ VC investing is generally intended for a period of
several years
▫ VC investments have high rates of failure. The
venture capitalist's need to deliver high returns to
compensate for the risk of the investments makes
venture funding an expensive capital source for
companies. VCs typically expect a target rate of
return in the 30% to 50% range
2. Venture Capital (VC)

Characteristics of VC investing
▫ The securities purchased are generally privately
held
▫ The VC funds will often take interest in a target
only if the company has superior management
▫ The venture capitalists frequently seek board-level
representation or control. Regardless of whether
VCs demand a majority, they seldom are silent
investors
2. Venture Capital (VC)

Compensation
▫ Venture capitalists are compensated through a
combination of management fees and incentive
fees (carried interest / performance fees) – often
referred to as a “2 and 20” arrangement
 Management fee: most charge 1.5 to 2.5 percent of
capital commitments per year, payable to the GP
every quarter
 Carried interest: fund’s profits (in excess of a
threshold rate of return) are generally split with 20%
of profits going to the fund GP as a carried interest
and the remaining to the LPs in proportion to their
contributed capital
2. Venture Capital (VC)

Compensation
▫ For loss allocation, losses are allocated in the
same manner as profits were previously allocated
until such losses have offset all prior allocated
profits and the GP’s capital contribution
▫ Then losses exceeding this amount are allocated
100% to LPs, but subsequent profits are allocated
to the LPs until the excess losses are recovered
2. Venture Capital (VC)

The VC Funding Process

▫ Typically involves 4 phases in the company’s
development
 Idea generation
 Start-up
 Ramp up
 Exist
2. Venture Capital (VC)

The VC Funding Process

▫ Step 1 - Idea generation and submission of the
Business Plan: The company submits a business
plan
▫ Step 2 - Introductory Meeting: Once the
preliminary study is done by the VC and they find
the project as per their preferences, there is a
one-to-one meeting that is called for discussing
the project in detail
2. Venture Capital (VC)

The VC Funding Process

▫ Step 3 - Due Diligence: varies depending upon
the nature of the business proposal. The process
involves solving of queries related to customer
references, product and business strategy
evaluations, management interviews
▫ Step 4 - Term Sheets and Funding: contains a
summary of the agreed-on financial and legal
terms of the transaction. The term sheet is
generally negotiable and must be agreed upon by
all parties, after which on completion of legal
documents and legal due diligence, funds are
made available
2. Venture Capital (VC)

Types of VC funding
▫ VC is sub-divided by the stage of development of
the company ranging from early stage capital
used for the launch of startup companies to late
stage and growth capital that is often used to fund
expansion of existing business that are generating
revenue but may not yet be profitable or
generating cash flow to fund future growth
2. Venture Capital (VC)
Types of VC funding
▫ The various types of VC are classified as per their
applications at various stages of a business. The
three principal types of venture capital are early
stage financing (Startup phase transactions),
expansion financing (growth stage transactions)
and acquisition/buyout financing
▫ The VC funding procedure gets complete in 6
stages of financing corresponding to the periods
of a company’s development
2. Venture Capital (VC)
Types of VC funding
 Seed money: Low level financing for proving and
fructifying a new idea
 Start-up: New firms needing funds for expenses related
with marketing and product development
 First-Round: Manufacturing and early sales funding. This
is typically when VCs come in
 Second-Round: Operational capital given for early stage
companies which are selling products, but not returning a
profit
 Third-Round: Also known as Mezzanine financing, this is
the money for expanding a newly beneficial company
 Fourth-Round: Also called bridge financing, 4th round is
proposed for financing the "going public" process
2. Venture Capital (VC)
▫ Cycle
2. Venture Capital (VC)
Types of VC funding
▫ Early Stage Financing - has three sub divisions
seed financing, start up financing and first stage
financing
 Seed financing is defined as a small amount that an
entrepreneur receives for the purpose of being
eligible for a start up loan
 Start up financing is given to companies for the
purpose of finishing the development of products
and services.
 First Stage financing: Companies that have spent all
their capital and need finance for beginning business
activities at the full-scale are the major beneficiaries
of the First Stage financing
2. Venture Capital (VC)
Types of VC funding
▫ Expansion Financing - may be categorized into
second-stage financing, bridge financing and third
stage financing or mezzanine financing
 Second-stage financing is provided to companies for
the purpose of beginning their expansion. It is
provided for the purpose of assisting a particular
company to expand in a major way
 Bridge financing may be provided as a short term
interest only finance option as well as a form of
monetary assistance to companies that employ the
Initial Public Offers as a major business strategy
2. Venture Capital (VC)
Types of VC funding
▫ Acquisition or Buyout Financing - is
categorized into acquisition finance and
management or leveraged buyout financing
 Acquisition financing assists a company to acquire
certain parts or an entire company
 Management or leveraged buyout financing helps a
particular management group to obtain a particular
product of another company
3. Buyout Funds
▫ A buyout is the acquisition of a controlling interest
in a company and is used synonymously with the
term acquisition. If the stake is bought by the
firm’s management, it is known as a management
buyout (MBO), and If high levels of debt are used
to fund the buyout, it is called a leveraged buyout
(LBO)
▫ Buyouts occur when a buyer acquires more than
50% of the company, leading to a change of
control. Firms that specialize in funding and
facilitating buyouts, act alone or together on deals,
and are usually financed by institutional investors,
wealthy individuals, or loans
3. Buyout Funds
▫ The companies involved in are typically mature
and generate operating cash flows
▫ Contrary to VC funds, which is commonly used for
relatively new and small companies where the
current owners need cash but do not want to give
up control; BO funds invest in more mature
businesses, usually taking a controlling interest
3. Buyout Funds
▫ Leveraged buyout (LBO) - LBO are exactly how
they sound: a target firm is bought out by a PE
firm. The purchase is financed (or leveraged)
through debt, which is collateralized by the target
firm's operations and assets. The acquirer (the PE
firm) seeks to purchase the target with funds
acquired through the use of the target as a sort
of collateral
3. Buyout Funds
▫ In a LBO, acquiring PE firms are able to purchase
companies with only having to put up a fraction of
the purchase price. By leveraging the investment,
PE firms aim to maximize their potential return
▫ This kind of financing structure leverage benefits
an LBO's financial sponsor in two ways:
 (1) the investor itself only needs to provide a fraction
of the capital for the acquisition
 (2) the returns to the investor will be enhanced (as
long as the ROA exceeds the cost of the debt)
▫ LBOs mostly occur in private company, but can
also be employed with public companies
3. Buyout Funds
▫ Leveraged buyout (LBO)
3. Buyout Funds
▫ Leveraged buyout (LBO)
▫ In a typical LBO, a PE firm will acquire a $500 million company
by investing $250 million of their fund's cash and $250 million of
debt sourced from banks and other lenders
▫ Let's assume that over the 5 years after the LBO, the company
grows and manages to pay off all of its $250 million in debt owed
to banks. With the debt paid off, the PE fund sells the company
for $1 billion. Since the company has already paid of its debt, the
PE fund keeps the full $1 billion of proceeds from the sale
realizing a cash on cash return of 4.0x [$1,000 M / $250 M]. If
they had acquired the company using only their own cash, their
cash on cash return would've only been 2.0x [$1,000 M / $500 M]

▫ Note: Buy-out operations can go wrong and in such cases the

loss is increased by leverage, just as the profit is if all goes well
3. Buyout Funds

Characteristics
 Stable cash flows - The company being acquired in
a leveraged buyout must have sufficiently stable
cash flows to pay its interest expense and repay
debt principal over time. So mature companies with
long-term customer contracts and/or relatively
predictable cost structures are commonly acquired
in LBOs. LBOs generally involve low-tech
businesses with a history of consistent profitability
and lots of tangible assets
 Relatively low fixed costs - Fixed costs create
substantial risk for PE firms because companies still
have to pay them even if their revenues decline
3. Buyout Funds

Characteristics
 Relatively little existing debt - The "math" in an LBO
works because the PE firm adds more debt to a
company's capital structure, and then the company
repays it over time
 Valuation – PE firms prefer companies that are
moderately undervalued to appropriately valued;
they prefer not to acquire companies trading at
extremely high valuation multiples because of the
risk that valuations could decline
 Strong management team - Ideally, the executives
work together for a long time and have some vested
interest in the LBO
3. Buyout Funds

Financing Structure
 Virtually all LBOs are financed with a combination of
senior debt, subordinated debt and equity. The
amount of equity required is determined by the
amount of debt that can be borrowed
 50% to 70% of an LBO’s funding takes the form of
senior financing, generally obtained from banks
 15% to 30% of an LBO is in the form of subordinated
financing, generally raised from insurance
companies, subordinated debt funds or with a public
offering of high-yield bonds
 10% to 20% is equity. Management usually invests
in the equity of an LBO company together with an
LBO fund and investors
3. Buyout Funds
▫ In a management buyout (MBO), the incumbent
management team (that usually has no or close to
no shares in the company) acquires a sizeable
portion of the shares of the company. Similar to an
MBO is an MBI (Management Buy In) in which an
external management team acquires the shares
▫ In most situations, the management team does
not have enough money to fund the equity needed
for the acquisition (to be combined with bank debt
to constitute the purchase price) so that
management teams work together with financial
sponsors to part-finance the acquisition
3. Buyout Funds
▫ Reasons for MBO
 Ownership wishes to retire and chooses to sell the
company to trusted members of management
 Ownership has lost faith in the future of the business
and is willing to sell it to management (which
believes in the future of the business) in order to
retain some value for investment in the business
 Management sees a value in the business that
ownership does not see and does not wish to pursue
4. Equity Underwriting & IPOs
▫ Securities underwriting is the process by
which IBs raise investment capital from investors
on behalf of corporations and governments that
are issuing securities (both debt and equity). The
services of an underwriter are typically used
during a public offering in a primary market
▫ Risk is the underlying factor in all underwriting.
Creating a fair and stable market for financial
transactions is the chief function of an underwriter
4. Equity Underwriting & IPOs
▫ Underwriting and advisory
activities earn IBs billions
of dollars every year
▫ The IB that wins the
mandate to run an issue
of new securities is
referred to as the lead
manager or the
bookrunner. Other houses
participate as members of
the underwriting syndicate
or the selling group
4. Equity Underwriting & IPOs

Debt securities
▫ A debt security describes income a company or
government borrows that must be repaid. The
debt security has a set amount, a specific maturity
date and, typically, a specified interest rate
▫ The borrower uses the loan from the debt security
to finance its operations, while the debt security
holder earns interest income
▫ Different types of debt securities have different
interest rates, with low-risk government bonds
carrying a lower interest rate than high-risk
corporate bonds
4. Equity Underwriting & IPOs

Underwriting Debt
▫ Underwriters purchase debt securities from the
issuer with the goal of selling the debt securities at
a profit, known as the "underwriting spread." The
underwriters can resell the debt securities either
directly to the marketplace or to dealers who will
distribute the securities to other buyers
4. Equity Underwriting & IPOs

Equity securities
▫ An equity security gives the holder an ownership
position in a corporation. These securities come in
the form of common or preferred stock and
symbolize a claim on a relative percentage of
ownership of the corporation's assets and profits
▫ Shareholders make their profits in equity
securities either by selling their shares for more
than the purchase price or by receiving a portion
of the company's profits in the form of dividend
payments
4. Equity Underwriting & IPOs

Underwriting Equity
▫ Underwriting equity works much the same way as
underwriting debt. The major difference is when a
company makes its first attempt at issuing equity
securities, a process known as an initial public
offering, or IPO. The underwriter helps the
company determine how much capital it needs,
how many shares it will issue in the IPO and the
starting share price. The underwriter also assists
the issuer in following rules for registering the
stock and placing it in the marketplace
4. Equity Underwriting & IPOs
▫ Successful IBs need to have a strong perception
of client capacities and financial position, and a
keen awareness of market conditions
▫ There are 2 basic types of agreements between
the issuing company and the IB. The first type is
the firm commitment, in which IB agrees to
purchase the entire issue and distribute it to both
institutional and retail investors. The second type
is known as a best effort agreement, in which IB
agrees to sell the securities but does not
guarantee the price
4. Equity Underwriting & IPOs
▫ Underwriting fees - are the fees earned by
an IB to help bring a company public or to conduct
some other offering
▫ Underwriting fees are collected by underwriters
who administer the issuing and distributing of
certain financial instruments
▫ Typically 3% to 7% of the amount of capital being
raised
▫ The fees compensates the underwriter
and syndicate for three things: negotiating and
managing the offering, assuming the risk of
buying the securities if nobody else will, and
managing the sale of the shares
4. Equity Underwriting & IPOs

Phases of underwriting advisory services

▫ There are 3 main phases: planning, assessing the
timing and demand for the issue, and issue
structure
▫ Planning - It is important to identify the investor
themes in the planning phase, understand the
rationale for the investment, and get a preliminary
view of investor demand or interest in this type of
offering
4. Equity Underwriting & IPOs

Phases of underwriting advisory services

▫ Timing and Demand - They are crucial to a
successful capital raising. Here are some factors
that influence the assessment of an offering
 Current market condition: Is it hot or cold issue market?
 Current investor appetite: What is the current investor
risk profile and appetite? Is it aggressive or
conservative?
 Investor experience: What are the investors’
experiences?
 Precedents and benchmark offerings: Has a similar
company issued an IPO in the past?
 Current news flow: What is the current news flow on
the company? Is it a positive or a negative flow?
4. Equity Underwriting & IPOs

Phases of underwriting advisory services

▫ Issue Structure - Deciding the structure of an
offering is the final phase of underwriting advisory
services. Here are some factors that influence the
issue structure:
 Is it going to be a domestic or an international issue?
Are the investor demands located domestically, or
overseas? Would investors from other countries be
interested in this offering?
 Is the focus on institutional or retail investors?
 How will the sale occur?
4. Equity Underwriting & IPOs
▫ The process includes the sale of securities in the
form of IPO or follow-on offerings (Seasoned
Equity Offering – SEO)
▫ There are basic differences between IPOs and
secondary offerings
 Different motivations: additional funding
requirements are the primary reason for SEO while
the founder’s requirement for liquidity and
diversification and PE’s exist are reasons for IPO
 Size: sizes of IPOs are smaller but more lucrative for
underwriters
 Faster pace: The process for SEO is faster because
some steps are already in place
4. Equity Underwriting & IPOs
▫ IPO
4. Equity Underwriting & IPOs

IPO
▫ The cost of going public
▫ Direct costs
 Legal, accounting and IB fees which are on average
around 10% of the offering proceedings
▫ Indirect costs
 First day underpricing
 Greater degree of disclosure and scrutiny
4. Equity Underwriting & IPOs

IPO
▫ IPO process – takes about 6 months to over 1 year
 Select underwriter
 Due diligence and filings
 Pricing
 Stabilization
 Transition
4. Equity Underwriting & IPOs
▫ Step 1: Select an investment bank - Choose an
IB to advise the company on its IPO and to
provide underwriting services. The IB is selected
according to the following criteria:
 Reputation
 The quality of research
 Industry expertise
 Distribution (i.e. if the IB can provide the issued
securities to more institutional investors or to more
individual investors)
 Prior relationship with the IB
4. Equity Underwriting & IPOs
▫ Step 2: Due diligence and regulatory filings –
Registration process & Marketing
▫ Due diligence: assess the value of the company
 Determine the offering size
 Choose the price bracket
 Prepare the regulatory filings and the marketing
material
▫ Engagement Letter
▫ Letter of Intent
▫ Underwriting Agreement
▫ Registration Statement
▫ Red herring document: an initial prospectus consists the
issuing company, the effective date, offer price
▫ Roadshow
4. Equity Underwriting & IPOs
▫ Step 3: Pricing – Refers to the setting the offering
price. The issuing company and the underwriter
decide the offer price and the number of shares
▫ IPOs are often underpriced to ensure that the
issue is fully subscribed/ oversubscribed by the
public investors, even if it results in the issuing
company not receiving the full value of its shares
▫ There is a difference between the price of an IPO
and the price when shares start trading in the
secondary market
4. Equity Underwriting & IPOs
▫ Step 4: Stabilization - After the issue has been
brought to the market, the underwriter has to
provide analyst recommendations, after-market
stabilization, create a market for the stock issued
▫ Step 5: Transition to Market Competition -
Investors transition from relying on the mandated
disclosures and prospectus to relying on the
market forces for information regarding their
shares