Investment Banking - New Issues (Debt And Equity)

New Issues of securities may be used by a business to raise funds. They typically fall into two main types, those being debt and equity.

Debt covers offerings of securities which must be repaid by the company.

A bond is, put simply, a lending agreement between the bond issuer (in this case the company) and the lender (i.e. the person who 'buys' the bond).

A bond is just like a loan in that the bond issuer will pay back the price of the bond (i.e. the amount of money borrowed) at the end of an agreed fixed period of time (say 10 years). Also, like a loan, the bond will yield an amount of interest over that period. The rate of interest and the way in which that interest will be paid is set when the bond is first issued. The rate of interest is used to attract investors and is usually set higher than other, more traditional saving rates – such as those that a bank would offer.

Bonds can also be exchanged amongst lenders and are traded on the financial markets. As you will appreciate, a bond that has a high rate of interest is more popular in an economy that has low interest rates and is less popular when that economy has interest rates that are high.

The other way in which a company can raise money is through the use of its equity. Unlike debt, this does not involve the borrowing of funds from lenders.

Equity is where a company raises funds by selling shares in itself. The shareholders exchange funds for a stake in the company and become part owners. They do not expect those funds to be repaid, as a loan would be, rather they are "banking" on the company being successful and that their investment (i.e. the shares) will provide a profit by growing in value.

However this success, and hence profit, is not guaranteed.

A shareholder is not a lender but rather an investor in a company. Unlike secured lending, (where the money lent is secured by assets of an equal value) holding shares in a company does not guarantee the holder anything. It can be a risky business because not all companies do well and so the value of shares can go down as well as up. In other words, as a shareholder, you could lose all or part of the money that you have invested in shares.

A company that is issuing shares becomes answerable to those shareholders. For example, if the company managers are not operating to the shareholders liking then they can sell those shares or, if they have a big enough stock of shares, they can get those managers replaced with people more to their own choosing.

The price of the shares is normally a good indicator of how a business is being managed. If the share price is going up the signs are good, however if the price is dropping it could mean that the company is in trouble. Along with the price many shares will also pay a dividend – this is in simplistic terms a share of the profit that the company has made. Many people hold shares for the income that the dividends yield. Again a high dividend is a good indicator that the company is doing well.

How the value of shares will change is really dependant on basic economics. There are only a finite number of shares (in other words the company, like a cake, can only be divided up so many times). If the shares are popular – i.e. that company is expected to, or is doing, well then a lot of investors will want to buy those shares.

However, the people who already own the shares will not be in a hurry to sell them because, just as the potential investors have noticed, all the indicators are indicating that their shares will increase in value.

Therefore, there would be a lot of demand and very little supply. This lack of supply will drive up the price of the shares. People will be willing to pay more for them because they believe they are worth it and if the price goes high enough, then some of those people holding the shares will be willing to sell.

Likewise the opposite can be true and if the indicators are not good for a company then there may be more sellers than there are buyers. This lack of demand will cause the price to fall, until the price is attractive enough to pull in more buyers.

Shares are usually sold via stock markets. A market in which the majority of share prices are rising is known as a bull market. When the opposite is true, and the majority of share prices are falling, it is called a bear market

Companies are most interested in the scope for new issues, be they debt or equity, when they have a requirement to raise funds for normal business activities, major new investments or M&A transactions.

However, they may also consider taking advantage of attractive conditions in the financial markets to make an issue at a time when they have not earmarked the funds for new investment.

This is particularly true of the debt markets (where a company is raising funds) when timing can be critical to obtaining attractive terms. For example, it may be a good time to issue bonds when the economy's interest rates are low because the cost of that debt over the long term will be less than if a company were to try and sell bonds in an economy that has high interest rates.

As we know, the new issue will either be equity or debt based and, thus, within investment banks, you normally have two areas of expertise. Namely, those that focus on the debt capital markets (DCM) and those that focus on the equity capital markets (ECM).

In both markets an investment bank and its expertise is critical.

Not only can an investment bank determine the best price for new issues, be they equity or debt, by valuing the company and examining the market, but they can also find buyers for those new issues.

Those buyers are found either in the public or private domain. Issues sold in the public domain (i.e. direct to anyone in the public via the markets) are known as public offerings or underwriting, while those sold to private investors are known as private placements.

Firms wishing to raise capital often discover that they are unable to go public for a number of reasons. The company may not be big enough; the markets may not have an appetite for their issues or the company may simply prefer not to have its stock be publicly traded.

Such firms with solidly growing businesses make excellent private placement candidates. Private placements, then, are usually the province of small companies aiming ultimately to go public. The process of raising private equity, or debt, changes only slightly from a public deal.

Often, one firm will be the sole investor in a private placement. In other words, if a company sells stock through a private placement, usually only one firm or a small number of firms will buy the stock offered.

Conversely, in a public offering, shares of stock fall into the hands of literally thousands of buyers immediately after the deal is completed.

From an M&A point of view, a private placement is thus similar to a merger because it usually involves an institution (rather than numerous public investors) acquiring a stake (assets) in a company.

Indeed the investment banker's work involved in a private placement is quite similar to sell-side M&A representation. The bankers attempt to find a buyer by writing the Private Placement Memorandum and then contacting potential strategic or financial buyers of the client.

Because private placements involve selling equity and debt to a single buyer or a small number of buyers, the investor(s) and the seller (the company) typically negotiate the terms of the deal. Investment bankers function as negotiators for the company, helping to convince the investor(s) of the value of the firm.

Fees involved in private placements, like those in public offerings, are usually a fixed percentage of the size of the transaction. (Of course, as with all sell-side transactions, the payment of the fees depends on whether the deal is completed or not.)