Equity financing is a crucial method for companies to raise capital by selling ownership stakes. This section explores the differences between common and preferred stock, as well as the impact of issuing new equity on existing shareholders and company control.

The topic also covers the process of going public through IPOs, raising additional capital through SEOs, and the role of investment banks in equity issuance. It concludes by examining stock repurchases and their effects on company performance and shareholder value.

Common Stock vs Preferred Stock

Ownership and Voting Rights

• Common stock represents ownership in a company and typically carries voting rights
• Preferred stock usually does not have voting rights but has priority in dividend payments and liquidation
• Common stockholders have potential for higher returns through capital appreciation (stock price increases)
• Preferred stockholders have more stable, bond-like returns with fixed dividend rates

Dividend Characteristics

• Preferred stock often has a fixed dividend rate set at issuance
• Common stock dividends are variable and determined at the discretion of the board of directors
• Preferred dividends must be paid before common stock dividends
• Some preferred stock is cumulative, requiring unpaid dividends to accumulate and be paid before common dividends

Financial Considerations

• Cost of preferred stock generally lower than common stock due to debt-like characteristics
• Preferred stock dividends receive preferential tax treatment for corporate investors
• Common stock considered permanent capital without maturity date
• Preferred stock may have call provisions or specific redemption dates
• Some preferred stock convertible to common stock, offering potential upside to investors
• Convertible preferred stock provides companies with lower initial dividend obligations

Equity Issuance Impact on Ownership

Dilution Effects

• Issuing new equity dilutes ownership percentage of existing shareholders
• Dilution potentially reduces existing shareholders' control and claim on future earnings
• Degree of dilution depends on number of new shares issued relative to existing shares outstanding
• Price at which new shares are issued affects dilution impact (lower prices cause more dilution)
• Market reaction to new equity issuance can impact company's stock price, affecting wealth of existing shareholders

Governance and Control Implications

• New equity issuance can alter balance of power among major shareholders
• Changes in ownership structure potentially affect corporate governance and decision-making processes
• In closely held companies, new equity issuance may introduce stakeholders with different objectives
• Introduction of new stakeholders can potentially change company's strategic direction
• Companies must consider trade-off between raising capital and maintaining control when deciding on size and timing of new equity issues

IPOs vs SEOs: Costs and Benefits

Initial Public Offerings (IPOs)

• IPOs provide access to public capital markets, enabling companies to raise substantial funds
• Funds from IPOs can be used for growth, debt repayment, or other strategic initiatives
• IPOs increase company's visibility and credibility, potentially leading to better terms with suppliers, customers, and lenders
• Costs of an IPO include underwriting fees, legal and accounting expenses, and ongoing compliance costs
• Post-IPO, companies face increased scrutiny from regulators, analysts, and shareholders
• Increased scrutiny can affect management decision-making and corporate strategy

Seasoned Equity Offerings (SEOs)

• SEOs allow already-public companies to raise additional capital
• SEOs may face less favorable pricing due to signaling effect and potential market saturation
• Both IPOs and SEOs can result in stock price pressure due to increased supply of shares
• Timing of IPOs and SEOs is critical, as market conditions significantly impact success and pricing of offerings
• SEOs may be easier to execute than IPOs due to existing public company infrastructure and investor familiarity

Investment Banks in Equity Issuance

Underwriting and Risk Management

• Investment banks serve as underwriters, managing issuance process
• Underwriters assume risk of selling new equity to investors
• Investment banks often provide price stabilization services immediately following an IPO
• Price stabilization supports newly issued stock and helps create a liquid market
• In some cases, investment banks offer bridge financing to companies preparing for equity offering
• Bridge financing provides short-term capital until issuance is completed

Advisory and Due Diligence

• Investment banks provide crucial advisory services for equity issuances
• Advisory services include determining optimal offering size, timing, and pricing strategy
• Banks conduct due diligence on issuing company to ensure regulatory compliance
• Due diligence verifies accuracy of information provided to investors
• Investment banks organize and lead road shows to generate investor interest
• Road shows gather feedback on proposed offering from potential investors

Distribution and Placement

• Investment banks leverage network of institutional investors to place shares
• Placement of shares helps create a liquid market for new equity
• Banks use their expertise to match issuing companies with appropriate investors
• Distribution efforts aim to achieve broad ownership base and stable aftermarket trading

Stock Repurchases: Performance and Value

Financial Metrics and Signaling

• Stock repurchases reduce number of outstanding shares, potentially increasing earnings per share (EPS)
• Repurchases can improve return on equity (ROE) metrics
• Buybacks signal management's confidence in company's future prospects
• Repurchases often indicate management believes stock is undervalued
• Market's reaction to repurchase announcements can impact short-term stock price performance
• Repurchase executions can affect trading volumes and stock liquidity

Capital Allocation and Shareholder Value

• Repurchases can be efficient way to return excess cash to shareholders
• Stock buybacks may be more tax-efficient than dividends for some investors
• Use of cash for repurchases may reduce company's financial flexibility
• Reduced financial flexibility can impact ability to invest in growth opportunities
• Timing and price of repurchases are critical for creating shareholder value
• Poorly timed or overpriced repurchases can destroy shareholder value
• Stock repurchases help offset dilution from employee stock options and equity-based compensation