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DAX, IPO, Initial Public Offering, private equity, Frankfurt Stock Exchange, Deutsche Boerse,
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Whether you are a company thinking about an Initial Public Offering (IPO), seeking private equity investors, thinking about a capital raise there are a few important things to consider.
Having been around the investment banking and public listing arena in the USA, Australasian markets, or the Frankfurt Stock Exchange (Deutsche Boerse or DAX) has taught me a few things.
The purpose of this article is to assist you in evaluating the types of capital funding solutions you should be seeking from the various private equity institutional investors you are in contact with.
If you arranging a capital raise or talking with investment bankers one thing to consider is: should you raise all the cash now or over time? Like many things in equity capital markets, the answer is: It depends. Cash raised all at once from private equity investors is sometimes referred to as “fixed pricing” or a “conventional equity raise” by investment banks. Cash raised over time is sometimes referred to as “variable pricing”, “equity line” or “special purpose placements”.
Which format you choose really depends upon the capital raising situation of the issuer in terms of both their stock and business operations. Research based on Case studies of hundreds of companies in over 25 countries discovered that variable pricing for an equity issue works very well in certain circumstances and does not work well in others.
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When Variable Pricing Works
Variable Pricing works best when:
1. The issuer is using the proceeds to grow the business and it’s EBITDA.
2. The funds are not spent all on the first day but rather over a developmental period, typically 12 to 18 months.
3. There are significant milestones that can be accomplished during the developmental period that can be announced to the public.
4. The stock price is likely to increase due to business progress during the period of the use of funds.
5. The issuer determines when they take the capital.
6. The issuer needs the capital committed as soon as possible.
Fixed Pricing works better when:
1. All the capital is expended at closing.
2. The use of proceeds is to restructure fixed price debt.
3. The issuer’s future business prospects are not positive.
4. The issuer does not need the capital for several months and has enough time to identify appropriate institutional investors and have them conduct due diligence.
Example of Cost Savings
Variable Pricing can offer substantial savings to the issuer in terms of cost of capital under the proper circumstances.
My friend and colleague is retired RCMP Inspector, Bill Majcher. Bill is one of the most celebrated undercover officers in the history of North America and has gone from infiltrating Colombian cocaine cartels, to taking down Russian mob owned banks to spending time in jail with terrorists accused of the most horrific crimes.
At the time he left public service he was responsible for overseeing the protection and integrity of Canada’s capital market system on the Canadian West Coast.
Like my friend Bill Majcher always says “just do the math”. A numerical example perhaps best demonstrates this:
Assumptions
$40 million market cap $5 stock price at time of funding (8 million shares outstanding) $10 million funding Proceeds used over 18 months Proceeds result in EBITDA increase of 40% in ~18 months Increase in share price proportionate to increase in EBITDA, so share price at the end of 18 months is $7.
Fixed Price Financing
At 15% discount to current price, fixed price for $10 million is $4.25 per share 2,353,000 new shares issued in financing at $7 per share in 18 months, cost of newly issued shares is $16,471,000 ($7 * 2,353,000 shares)
Variable Price Financing
Assume proceeds drawn quarterly and progress towards 18 month target announced quarterly with stock appreciating proportionately. Stock issued in the financing at a 10% discount to market price. Thus, stock issuance price is:
Q1=$4.50
Q2=$4.86
Q3=$5.22
Q4=$5.58
Q5=$5.94
Q6=$6.30
Average price of stock issuance is therefore $5.40 1,852,000 shares issued to finance the $10 million at $7 per share in 18 months, cost of newly issued shares is $12,964,000 ($7 * 1,852,000 shares) Thus, in this simplified example, the issuer saved $3,507,000 in cost by using a variable price format.
This represents 35% of the total amount funded in the transaction. These savings do not include the savings from lesser warrant coverage with variable pricing. The total savings can be even greater if the stock of the issuer is undervalued to start with and/or appreciates more rapidly.
Why Variable Pricing Works
Variable Pricing works because of the stock market’s uncertainty about the issuer actually delivering future results. Typically with Fixed Pricing, the funds are delivered up front and then the positive benefits from utilizing the funds appear later over a period of time, say 12-24 months.
At the time of funding, the delivery of these future benefits is uncertain to outside investors. So the stock price at the time of funding reflects this uncertainty discount, and the issuer pays the cost of the discount.
With Variable Pricing, the stock price at the time of funding is after interim results have occurred and closer in time to immediately pending results, so the uncertainty discount is less, presumably reflected in a rising stock price.
Because of the higher stock prices during the development period, the issuer by using a Variable Pricing structure is in effect selling stock at a higher average price.
The important components to a Variable Pricing structure are that
(i) the funds are absolutely committed up front so the issuer and the market knows the issuer has the funds to complete its development program, and
(ii) the issuer determines when to draw the funds in its sole discretion, which inhibits short traders as they are potentially trading against favorable interim results and further do not know when or if additional stock would be coming to the market to cover their position.
How To Take Advantage
For issuers whose stock price is likely to appreciate during the period of the use of funds because of progress in the underlying business, a Variable Pricing structure can be ideal.
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