Introduction of Corporate Finance
Introduction of Corporate Finance
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Learning objectives
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Introduction
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Corporate finance overview
The ultimate purpose of corporate finance is to maximize the value of a business through planning and
implementing management resources while balancing risk and profitability.
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Players in corporate finance – primary market
Public
accounting
firms Bonds or shares
$
“Sell side”
$
Contacts Contacts “Buy side”
Fund
Manager
$
Capital
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Players in corporate finance – secondary market
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Types of participants
• High net worth • Mutual funds • Traded on stock • Owned and traded
• Individuals • Pension funds exchanges by a few private
investors
• Private equity firms
• Venture capital firms
• Seed / angel investors
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Types of transactions
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Capital Investments
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What is a capital investment?
Any investment for which the economic benefit is great than one year.
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Capital investment
Debt
Assets
Equity
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Techniques for valuing an investment
Whether such investments are worthwhile depends on the approach that the company uses
to evaluate them. A company may value the projects based on:
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Net Present Value (NPV)
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Net Present Value (NPV)
Discount Rate
(Cost of Capital)
745
Present Value 91 83 75 68 62
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Terminal value
Terminal Value: Value of free cash flow beyond the forecast period
x Multiple
Terminal value
= [i.e. Earnings, EBITDA, Revenue]
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Terminal value
Terminal value
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Unlocking the drivers of value
• Business strategy
• Revenue • Organic growth?
• Cost structure • What’s
• Asset utilization sustainable?
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Enterprise value vs. equity value
Market value
of net debt
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Internal Rate of Return (IRR)
22% IRR is economically equivelant to earning a 22% compound annual growth rate
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Mergers and Acquisitions (M&A)
Mergers and acquisitions is the process of companies buying, selling, or combining businesses.
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10 step acquisition process
10
9 Integration
8 Financing
7 Purchase &
Sales Contract
6 Due
Diligence
5 Negotiation
4 Data & Detailed
Valuation
3 Approaching
Targets
2 Searching
1 for Target
Acquisition
Criteria
Acquisition
Strategy
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Strategic versus financial buyers
Strategic buyers
VS Financial buyers
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Rival bidders
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Acquisition valuation process
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Best practice acquisition analysis
1 2 3 4 5 6
Soft Transaction
synergies costs
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Issues to consider when structuring a deal
Market Environment
Strategic Competing
plan bidders
Capital
structure
Corporate
Tax
Law
Market
conditions
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Capital Financing
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Corporate finance overview
The ultimate purpose of corporate finance is to maximize the value of a business through planning and
implementing management resources while balancing risk and profitability.
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What is a capital financing?
Any type of funding that is used finance the purchase of an asset/project (an
investment).
Equity Debt
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Capital financing
Debt
Assets
Equity
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The business life cycle
Sales
Cash flow
Profit
Time
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The corporate funding life-cycle
Debt funding
Business risk
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Capital structure
Capital Structure: the amount of debt and/or equity employed by a firm to fund its operations and finance its assets.
In order to optimize the structure, a firm will decide if it needs more debt or equity and can issue whichever it requires.
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Optimal capital structure
Having too much debt may increase the risk of default in repayment
Depending too heavily on equity may dilute earnings and value for original investors.
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Optimal capital structure
Companies are usually looking for the optimal combination of debt and equity to minimize the cost of capital.
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Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC) is the proportion of debt and equity a firm has multiple by their respective costs.
The optimal capital structure of a firm is often defined as the proportion of debt and equity that result
in the lowest weighted average cost of capital (WACC) for the firm.
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WACC formula
Assets
Market
value % equity x Cost of equity = Contribution
of equity
Cost of capital
Example
$225bn
8.2%
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Capital stack
How to optimally finance the capital investments through the business’ equity, debt, or a mix of both?
Senior debt
Subordinated debt
Equity
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Types of equity
Senior debt
Subordinated debt
Equity
Pref. shares Higher liquidation and higher dividend priority (vs Common)
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Common shares
Terms Issues
Typically the majority of a firm’s
equity capital: • Last level of priority (highest
• Proportional share of residual risk) for investors
value of the business
• Proportional payment of
common dividends
• Voting rights (or not)
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Preferred shares
Terms Issues
The ‘norm’ is for private equity to Preferred shares are becoming less
subscribe for preferred shares attractive as:
which are:
• More costly than Common
• Liquidity preference shares
• Have a fixed dividend • Even if company has cash,
payment may not be made if
• Anti-dilution rights
lack of distributable reserves.
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Shareholder loans
Shareholder loans are a means for private equity houses to invest sufficient equity into a buyout
situation, whilst still allowing management a significant equity stake.
Max debt
$30m
Enterprise
value
$50m
Shareholder
loan - PIK
Equity $16m
$20m
Private equity $2m
Management $2m
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Sources of equity
Founders Institutional
Private Equity
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Private equity and venture capital firms
Private equity firms manage funds or pools of capital that invest in companies that represent an opportunity for a high rate of return.
Private equity funds invest for limited time periods. Exit strategies include IPOs, selling to another private equity firm, etc.
1 2
Venture capital funds typically invest in Buyout or LBO funds typically invest in more
early stage or expanding businesses that have mature businesses, usually taking a controlling interest
limited access to other forms of financing and leveraging the equity investment with a substantial
amount of external debt. Buyout funds tend to be
significantly larger than venture capital funds.
• Y Combinator • KKR
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Typical exit routes for private equity
Private Corporate
Sale to Strategic Sale to Sponsor
Placement Restructuring
Flotation/IPO
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Why use debt
Corporation: (1) to lower the cost of Investor: to increase their equity return
capital, and (2) avoid equity dilution
Senior debt
Equity
Debt/Total Capital
(Leverage)
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Assessing debt capacity
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Senior debt overview
Revolver
Senior debt capacity
Senior debt
Term loan A 2.0x to 3.0x EBITDA
Commercial Insurance
Credit companies
Subordinated banks companies
debt
Equity
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Types of subordinated debt
Increasing Increasing
subordination return
Senior debt
Subordinated debt
Mezz warranted
Equity
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How much subordinated debt?
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Credit ratings and high yield debt
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Mezzanine debt characteristics
Bullet repaid
Convertible
Debt with warrants Convertible loan stock
preference shares
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Mezzanine returns
Warrants
3% to 10%
of post
exit value
Total
Accrued return
Contractual
Cash pay
interest
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Debt repayment profiles
time
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Tradeoffs between debt and equity
• Expects a high rate of return (dividends and capital appreciation) • Contains restrictions on operational flexibility
• Has last claim on the firm’s assets in the event of liquidation • Has a lower cost than equity
• Provides maximum operational flexibility • Expects a lower rate of return than equity
• Prevents dilution of equity
• Can push a company into default / bankruptcy
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Capital Raising Process
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Underwriting
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Types of underwriting
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Underwriting advisory services
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Underwriting - the book building process
Institutional Price is
Indicative price Book of set to
investor Allocation
range demand ensure
commitment
built clearing
@ firm price
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Underwriting - the road show
The roadshow is an opportunity for management to convince investors of the strength of the business cases
Management structure,
A thorough analysis of the industry/sector
governance and quality
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Pricing the issue
Price stability
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Pricing the issue
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Under-pricing
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The IPO pricing process
IPO
discount
Indicative maximum
Full value
10 to 15%
Pricing
range
Indicative minimum
• Relative valuation
• Intrinsic valuation
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Dividends and Return of Capital
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Corporate finance overview
The ultimate purpose of corporate finance is to maximize the value of a business through planning and
implementing management resources while balancing risk and profitability.
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Dividends and return of capital
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Internal Rate of Return (IRR)
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WACC
Assets
Market
value % equity x Cost of equity = Contribution
of equity
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Decision
Return Capital
(Dividend or Buyback)
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Retained earnings and excess cash
Balance Sheet
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Retained earnings / excess cash decision flowchart
Retained earnings /
Cash balance
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Dividend vs Share Buyback
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Corporate finance overview
The ultimate purpose of corporate finance is to maximize the value of a business through planning and
implementing management resources while balancing risk and profitability.
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Corporate Finance Careers
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Career map
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Roles in corporate finance
• Client facing / sales • Mix of client or inward focus • More internally focused • Internally focused
component • Hire from schools or from • Hire from banks • Hire from banks, accounting
• Capital Markets hire from other accounting firms • Hire grad schools students firms, institutions and schools
schools • Long / medium hours • Hire across all entry points
• Long hours
• Retail hires at various points • Competitive • Hours vary
• Competitive
• Long hours • Clear career path • Competitiveness varies by
• Quick career progression
• Competitive company
• Quick career progression • Career progression varies
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