Fall 2022 Finance Midterm Test on the Launch of IPOS- George Mason University
Here are the correct solutions prepared by our experts for the midterm test on the launch of IPOs done at George Mason University. The test covered campaigns done during the launch of companies and the procedure of dealing with investor applications. Use this blog to learn how to tackle any future tests on IPOs and equity financing. You can also hire our finance exam helpers to do any difficult test for you.Exam Question:
As the time for the publication of the prospectus draws near, a detailed campaign leading to the launch of the company must be organized. State and explain two important aspects that the campaign covers.
Exam Solution: The campaign has two aspects, general publicity, marketing efforts, and the behind-the-scenes arrangements of a sub-underwriting syndicate.
- General publicity and marketing efforts
- Underwriting and sub-underwriting
The objective of the publicity campaign is to increase the investing public's awareness of the company and its attractions as an investment. The more familiar the public is with the name of the company, the more comfortable they are likely to be with an investment. In some cases, for example, in a company with a famous brand name or a well-known retail chain, the name itself will have already been extensively advertised and this is a distinct advantage. However, the publicity may need to be redirected from the company's customers towards the investment community, from the glossy magazines towards the inky financial press. assuming these two constituencies do not overlap extensively.
As a general rule, companies seeking an initial listing are not likely to be very well known before flotation, and carefully orchestrated promotional efforts will be needed. This may be done in various ways over the months before the launch. The promoters may engage the services of a public relations firm specializing in financial matters. A corporate advertising campaign may be undertaken. New products or services being launched by the company may be publicized more widely than usual. Opportunities will be taken to bring senior executives of the company to the attention of the public through speaking engagements and other public appearances. Profiles in the newspapers and interviews on radio or television will be engineered. If the company has a significant anniversary, moves its head office, or opens a new branch, this may be made the occasion for more visible celebrations than would normally be the case.
As well as general publicity, the merchant bank may approach target investors with a detailed presentation of the company in advance of the issue. This can be quite a snappy affair, accompanied by charts, slides, and sometimes a company film and other visual effects. This presentation may be given in several financial centers and has become irreverently known as a ‘road show’.
At the time of publication, depending on the regulations of the market centers and has become irreverently known as a 'road show’ concerned, the prospectus is likely to be fully advertised in at least one prominent newspaper. A summarized version (referred to as abridged particulars) will appear in several other publications. In addition, there will be an editorial comment on the company and the merits of the issue. It would be entirely natural for those publications in which the prospectus is advertised to consider that flotation is a newsworthy event.
The use of radio and television for publicity purposes carries some potential dangers. It may not be possible to give all relevant details in the short time available and an interview, it is difficult to stick to a carefully prepared script Off-the-cuff remarks may lead to information being presented or implied which has not been fully checked. If such information is given by the company's management or its advisers and cannot be fully substantiated it may have to be publicly withdrawn. This causes embarrassment for the individuals concerned and may damage the chances of a successful issue.
Coverage of the flotation is encouraged by holding a pre-launch press conference with plenty of time for a question and answer session. Senior executives of the company should be available to lend authenticity to the rehearsed presentations of the advisers.
The information which is presented to the press must be extracted from the prospectus and be fully consistent with it. Care must be taken when answering questions and entering into discussions where no additional information is released. Suggestions that the prospectus figures are deliberately conservative may be tempting.
It may prove helpful for management to organize a visit to the headquarters of the company or selected facilities for key institutional investors and brokers. The brokers then have sufficient information to put together a circular on the company if they consider it appropriate. They are unlikely to take the trouble to circularize clients with a negative reaction which generates no potential business so there is a reasonable chance that their recommendations will be positive.
Under stock exchange rules, a certain percentage of an issue (say 10%) may be reserved for priority applications from the company's employees. Management may take steps to publicize the procedures for application within the company. Some directors have felt so strongly that employees should be encouraged to participate that they have made arrangements either personally or with the company's bankers for finance to be available to allow employees to take up their allocations.
Companies offering a consumer product or service may give shareholders some special concession or discount. This may serve as an incentive for investors not only to apply for shares but to remain as long-term holders. Product loyalty may be increased by having customers as shareholders. Although sometimes dismissed as gimmicky and expensive, this tactic appears to be highly effective where the product or service is a suitable one.
As the level of investor awareness of an issue grows, a general view is likely to emerge as to whether the issue will be a success or a failure. This tends to be very much a self-feeding process. If applicants feel the issue will be over-subscribed, they will be inclined to increase their level of applications in anticipation of receiving less than the number of shares they apply for. On the other hand, if an issue is thought likely to be under-subscribed, investors may hesitate to apply at all, not necessarily because they dislike the company, but in anticipation of being able to buy the shares at a cheaper price after dealings start in the market. A good share is even better if it can be purchased at a discount.
Shortly before or just after the signature of the underwriting agreement, the lead underwriter will normally offer the major part of the issue for sub-underwriting in the market. The number of sub-underwriters approached will vary but may exceed 100 in a large issue.
In some markets, the sub-underwriting syndicate is organized directly by the lead underwriter, which is usually an investment or merchant bank. In other markets, a stockbroker will serve as the intermediary to contact the sub-underwriters. One of the functions of the stockbroker to the company is to sound out in advance the pricing of the issue and the level of investment interest in the shares. Based on this research, the stockbroker will have already identified institutions that have expressed some intention to subscribe and therefore are a logical choice for sub-underwriting.
The sub-underwriting syndicate is normally comprised of other merchant banks, stockbrokers, investment and unit trusts, fund managers, and other professionals in the market. These institutions may be investors themselves or maybe partly, or wholly, intermediaries, passing on portions of their allocation to their clients. In this way, the risk of the issue being unfavorably received is widely spread through the market. Even if there is a disappointing level of public response, there will through the sub-underwriting syndicate be a reasonable spread of shareholders.
The company itself and its management are not usually involved in the sub-underwriting process. Indeed, often they may be entirely unaware of who the sub-underwriters are. The promoters may of course express a desire for certain institutions or major investors to be included and these wishes would be taken into account by the lead underwriter.
Sub-underwriters receive a fee based on the money amount of risk they have assumed. The level of this fee depends on market practice and the length of time of exposure but is common in the region of 14 to 1%. If they pass the risk on to their clients they would keep some portion of the fee for themselves and re-allow the remainder to their clients. The split is standardized as institutions prefer to avoid criticism which might arise if different tiers of sub-underwriting commissions were circulating in the market.
If the lead underwriter has sufficient financial muscle and is confident enough about the company, market conditions, and the reception of the issue, it may commit itself to sign the underwriting contract for the issue before it has formal replies from the institutions invited to sub-underwrite. A more cautious approach is to await the reaction of sub-underwriters before entering into a formal underwriting commitment although, of course, a withdrawal at this stage would be deeply embarrassing to the institution involved, is likely to enrage the client, and would be widely known in the market. The promoters prefer a firm underwriting commitment before any approach is made to sub-underwriters with the inevitable publicity leak. Sometimes a lead underwriter will encourage a certain vagueness about the precise stage an issue has reached during this sensitive period.
If the issue is fully subscribed, the sub-underwriters are released from their sensitive period. obligation to subscribe and are paid their fee. They do not normally receive any preferential allotment of shares and, if they apply, are treated on an equal footing with all other applicants. In special circumstances, particularly where the issue is very large and may be difficult for the market to absorb, sub-underwriters may be offered the incentive of being permitted some preferential allotment.
If the issue is under-subscribed, sub-underwriters will be called to subscribe for the shortfall pro rata to their commitments. Arrangements will have normally been put in place by the merchant bank to ensure that any applications generated by the sub-underwriter would be counted against their commitment should they be called upon.
The system of sub-underwriting has some inherent weaknesses. In a successful issue, sub-underwriters (except as noted above) are not preferred to any other applicant. Consequently, they cannot 'protect' their clients' position, that is, guarantee them any allotment. This acts as a disincentive to develop a distribution network as compared to a system where investment banks know they have a certain number of shares available to sell to their customers.
If the issue is under-subscribed, the opening market price is likely to be weak and the sub-underwriters are not going to be thanked by their clients for 'stuffing them with over-priced shares. If sub-underwriters retain the risk on their book, the loss on a single unsuccessful issue can wipe out the fees received from ten successful ones. Only the capital profits from obtaining a preferred position in good issues can compensate for the losses incurred in bad ones.
The sub-underwriting system described above is based on UK practice or practice in markets based on the UK model. In the US, the underwriting syndicate functions much more effectively as a selling syndicate. Applications are generated by dealers who are granted concessions on price and allowances rather than relying on a more direct appeal to retail investors. A longer period is allowed for selling and a preliminary prospectus is more widely circulated. It would seem that this system has some advantages.
Explain the process of application and allotment of shares of a public company under the tender method.
Exam Solution: Applicants state the number of shares they wish to apply for and fill in the price per share they are prepared to pay. The company may state or have in mind the minimum amount it wishes to raise. The maximum number of shares to be issued or sold is also stated. Once the applications have been received, a price will be fixed, called the 'striking price', at which sufficient applications have been received to cover at least the amount intended to be raised.
The striking price will not necessarily be the highest price at which sufficient applications are received to cover the target amount. Factors such as the number and distribution of shareholdings will also be taken into account because of the need to establish a satisfactory market for the shares.
Applicants who tender at below the striking price receive no shares and their cheques are returned to them.
All the shares will be sold or issued at a striking price. Applicants who tender at or above the striking price may be subject to a ballot or may be scaled down. In some issues, applicants at prices above the striking price are favored. The application form may also allow applicants to apply at whatever striking price is set, leaving the actual price blank at the time of application.
If the issue is underwritten, it will be underwritten at the minimum price for the issue stated by the company.
What are the procedures that a company uses to deal with investor applications during the launch of a public company?
Exam Solution: The procedure for application should be kept as simple as possible. Even minor complications can confuse and make the difference between whether a wavering subscriber applies or not. The application procedures will be set out fully in the prospectus and again on the application form. The investor states the number of shares he is applying for and attaches a cheque for the cost of the investment. The total amount will be made up of the price for the shares, plus any associated costs such as taxes and brokerage. There is normally a minimum size for applications. In markets where a board lot system of trading is used, the minimum application will be for one board lot. Applications for greater than the minimum may be in some specified multiple of the minimum in which case the application form will include a table showing the amount payable for the number of shares which may be applied for.
Practice varies as to whether all cheques accompanying application forms are presented for payment. Whenever an issue is under-subscribed, all cheques will be presented. In the case of a heavy over-subscription requiring a ballot, in some markets, the ballot is held before cheques are cashed so that wholly unsuccessful applicants are not out of funds. This procedure also greatly decreases the number of refund cheques that need to be prepared and dispatched. A reserve list is required in case cheques accompanying successful applications are dishonored.
Applications from the public must normally be made within a few days of the publication of a prospectus. After the deadline for receipt of applications, the application list opens and closes in a very short period, sometimes only a few minutes.
Applications must be delivered to the receiving bank. This bank designates certain of its branches to process applications, which may be sent by post. Many. however, are delivered by hand close to the deadline to give applicants the chance to assess market reaction to the issue. Applications once made will be irrevocable during the period of issue.