Venture Capital Funds and ADRs: Investing and Trading Insights

VENTURE CAPITALS Funds

Goal: Invest in start-up/young companies with high growth potential and depend on the stage at which capital is provided (early-stage firms demand higher returns)

Formative-stage financing:

firm is in process of being formed and is financed with ordinary/convertible preferred shares. Management retains control.

Financing steps:

1. Angel investing: “idea stage”, so funds are used to transform the idea into a business plan and to assess market potential
2. Seed-stage financing: supports product development and/or marketing efforts including market research
3. Early-stage financing: firms move towards operation but before commercial production and sales occur

Later-stage financing: funds are used for the initial expansion of a company already producing and selling a product or for major expansion

Mezzanine-stage financing: funds are used to prepare firms to go public (bridge between expansion and IPO)

ADRs:

The first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges. Shares of many non-U.S. companies trade on U.S. stock exchanges through ADRs. ADRs are denominated and pay dividends in U.S. dollars and may be traded like regular shares of stock

ETFs:

First ETF was issued in 1989, an S&P 500 proxy that traded on the American Stock Exchange and the Philadelphia Stock Exchange. This product, however, was short-lived after a lawsuit by the Chicago Mercantile Exchange was successful in stopping sales in the United States.

Why ETFs? (i) easy diversification, (ii) low expense ratios, and (iii) tax efficiency of index funds, while still maintaining all the features of ordinary stock, such as (iv) limit orders, (v) short selling, and (vi) options. ETFs on: equity, bonds, commodities, real estate, etc.

Why Go Public?

To raise cash (quite a lot of it)

To open (many) financial doors: Because of the increased scrutiny, public companies can usually get better rates when they issue debt. As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal. Trading in the open markets means liquidity. This makes it possible to put in place employee stock ownership plans, for example, which help attract top talent. Being on a major stock exchange carries a considerable amount of prestige. In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn’t easy to get listed survey

Factors affecting the decision to go public Highly probable during equity market growth. Less probable when the stock market falls. Economic cycle affects the company decision of going public (used to finance long-term investments which fluctuate with the business cycle). To finance the acquisition of another company (by using the cash from the IPO or by issuing shares that will be exchanged for shares of the target company)

Public Offering:

If the public offering does not imply increasing capital, but issuing shares for the first time in the market: IPO (Initial Public Offering). If the public offering implies a capital increase for a firm that is already listed on the market: SEO (Seasoned Equity Offering)