Introduction To: Corporate Finance
Introduction To: Corporate Finance
Discuss the main capital Explain the process of Compare debt financing with
investment activities and mergers and acquisitions, equity financing and explain
valuation techniques and key considerations for the optimal capital structure
the deal
CorporateFinance
Corporate Finance InstituteⓇ
InstituteⓇ
Introduction
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.
Public
Bonds or shares
accounting
$
firms
“Sell side”
$
Contacts Contacts “Buy side”
Fund
Manager
$
Capital
Any investment for which the economic benefit is greater than one year.
Debt
Assets
Equity
Whether such investments are worthwhile depends on the approach that the company uses
to evaluate them. A company may value the projects based on:
Future Cash Flows $100 $100 $100 $100 $100 $100 $100 $100 …
2019 2020 2021 2022 2023 2024 2025 2026 …
Future Cash Flows $100 $100 $100 $100 $100 $100 $100 $100 …
Forecast Period
Terminal Value: Value of free cash flow beyond the forecast period
Terminal value
• Business strategy
• Revenue
• Cost structure • Organic growth?
• Asset utilization • What’s sustainable?
Market value
of net debt
22% IRR is economically equivalent to earning a 22% compound annual growth rate.
10
9 Integration
8 Financing
7 Purchase &
6 Sales Contract
Due
5 Diligence
Negotiation
4 Data & Detailed
3 Approaching Valuation
2 Targets
Searching
1 Acquisition
for Target
Criteria
Acquisition
Strategy
Strategic buyers
VS Financial buyers
• Sales growth
1. Value the target • EBIT margin
as stand-alone
• Operating tax
• Working capital requirements
Enterprise value
• Capital expenditures
1 2 3 4 5 6
Soft Transaction
synergies costs
Hard Net Value created
synergies synergies
Stand-alone Consideration
enterprise Stand- (price paid)
value alone value
Market Environment
Strategic Competing
plan bidders
Capital
structure
Corporate
Tax
Law
Market
conditions
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.
Any type of funding that is used to finance the purchase of an asset/project (an investment).
Equity Debt
Debt
Capital Capital
investment financing
(spending Assets (where the
money to money
purchase comes from)
assets) Equity
Debt
Capital Capital
investment financing
(spending Assets (where the
money to money
purchase Equity comes from)
assets)
Sales
Cash flow
Profit
Time
Debt funding
Business risk
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.
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.
Companies are usually looking for the optimal combination of debt and equity to
minimize the cost of capital.
Weighted Average Cost of Capital (WACC) is the proportion of debt and equity a firm has,
multiplied 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.
Assets
Market
value % equity x Cost of equity = Contribution
of equity
Cost of capital
Example
$225bn
8.2%
Senior debt
Subordinated debt
Equity
Senior debt
Subordinated debt
S/holder loans S/holder loans Higher liquidation position; no dividend but pays interest
Equity
Pref. shares Pref. shares Higher liquidation and higher dividend priority (vs Common)
Common shares Common shares Last liquidation position and last dividend position
Terms Issues
Typically the majority of a • Last level of priority (highest
firm’s equity capital: risk) for investors
• Proportional share of
residual value of the business
• Proportional payment of
common dividends
• Voting rights (or not)
Terms Issues
The ‘norm’ is for private equity Preferred shares are
to subscribe for preferred becoming less attractive as:
shares which are: • More costly than Common
• Liquidity preference shares
• Have a fixed dividend • Even if company has cash,
• Anti-dilution rights payment may not be made if
lack of distributable reserves.
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
Management $2m
Founders Institutional
Private Equity
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.
Venture capital funds typically invest in Buyout or LBO funds typically invest in more mature businesses,
1 early stage or expanding businesses that have
limited access to other forms of financing.
2 usually taking a controlling interest and leveraging the equity
investment with a substantial amount of external debt. Buyout funds
tend to be significantly larger than venture capital funds.
• Sequoia Capital
• Blackstone
• Y Combinator
• KKR
• Andreessen Horowitz
• Carlyle Group
Private Corporate
Sale to Strategic Sale to Sponsor
Placement Restructuring
Flotation/IPO
Corporation: (1) to lower the cost of Investor: to increase their equity return
capital, and (2) avoid equity dilution
Weighted Average
Cost of Capital (WACC)
Senior debt
Equity
Debt/Total Capital
(Leverage)
Term loan A
Senior debt Term loans: have a fixed schedule where they repay
Term loan B or are amortized, and have a final principal
repayment. Can be stacked.
Term loan C
Increasing Increasing
subordination return
Senior debt
Vendor notes
Equity
Mezzanine debt:
• Non-traded
• Subordinated to senior debt
• Repaid as a bullet (not amortized)
• Combination of cash and accrued interest
built into return
Warrants
3% to 10%
of post
exit value
Total
Mezzanine
Accrued Return
Contractual
interest
return
(IRR 14%
to 20%)
Cash pay
interest
Senior Debt
Warrants IRR <10%
3% to 10%
of post
exit value
Total
Mezzanine Subordinated
Accrued Return Debt
Contractual
interest Mezzanine
return
(IRR 14%
to 20%)
investors
IRR 14-20%
Cash pay
interest
Equity
IRR 20-30%
time
Institutional Price is
Book of
Indicative price investor set to
demand Allocation
range commitment ensure
built
at firm price clearing
Price stability
IPO
discount
Full
value
IPO
pricing
IPO
discount Indicative maximum
10 to 15%
pricing range
Indicative minimum
Full
value IPO
pricing
IPO
discount Indicative maximum
10 to 15%
pricing range
Indicative minimum
Full
value
IPO
pricing
IPO
discount Indicative maximum
10 to 15%
pricing range
Indicative minimum
Full
value
IPO
pricing
You will be pricing the deal based on:
• Relative valuation
• Intrinsic valuation
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.
Assets
Market
value % equity x Cost of equity = Contribution
of equity
Return Capital
(Dividend or Buyback)
Balance Sheet
Retained earnings /
Cash balance
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.