Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVI. Cost of Capital and
Long−Term Financial
Policy(^556) 16. Raising Capital © The McGraw−Hill
Companies, 2002
Conclusion
If a start-up succeeds, the big payoff frequently comes when the company is sold to an-
other company or goes public. Either way, investment bankers are often involved in the
process. We discuss the process of selling securities to the public in the next several sec-
tions, paying particular attention to the process of going public.
SELLING SECURITIES TO THE PUBLIC:
THE BASIC PROCEDURE
There are many rules and regulations surrounding the process of selling securities. The
Securities Act of 1933 is the origin of federal regulations for all new interstate securities
issues. The Securities Exchange Act of 1934 is the basis for regulating securities already
outstanding. The Securities and Exchange Commission, or SEC, administers both acts.
There is a series of steps involved in issuing securities to the public. In general terms,
the basic procedure is as follows:
- Management’s first step in issuing any securities to the public is to obtain approval
from the board of directors. In some cases, the number of authorized shares of
common stock must be increased. This requires a vote of the shareholders. - The firm must prepare a registration statementand file it with the SEC. The
registration statement is required for all public, interstate issues of securities, with
two exceptions:
a.Loans that mature within nine months
b.Issues that involve less than $5 million
The second exception is known as the small-issues exemption. In such a case, sim-
plified procedures are used. Under the basic small-issues exemption, issues of less than
$5 million are governed by Regulation A, for which only a brief offering statement is
needed. Normally, however, a registration statement contains many pages (50 or more)
of financial information, including a financial history, details of the existing business,
proposed financing, and plans for the future. - The SEC examines the registration statement during a waiting period. During this
time, the firm may distribute copies of a preliminary prospectus. The prospectus
contains much of the information put into the registration statement, and it is given
to potential investors by the firm. The preliminary prospectus is sometimes called a
red herring, in part because bold red letters are printed on the cover.
A registration statement becomes effective on the 20th day after its filing unless the
SEC sends a letter of comment suggesting changes. In that case, after the changes are
made, the 20-day waiting period starts again. It is important to note that the SEC does
not consider the economic merits of the proposed sale; it merely makes sure that various
rules and regulations are followed. Also, the SEC generally does not check the accuracy
or truthfulness of information in the prospectus.
CONCEPT QUESTIONS
16.1a What is venture capital?
16.1bWhy is venture capital often provided in stages?528 PART SIX Cost of Capital and Long-Term Financial Policy
For more VC
info and links, see
http://www.globaltechnoscan.
com.
16.2
registration statement
A statement filed with
the SEC that discloses
all material information
concerning the
corporation making a
public offering.
Regulation A
An SEC regulation that
exempts public issues of
less than $5 million from
most registration
requirements.
prospectus
A legal document
describing details of the
issuing corporation and
the proposed offering to
potential investors.
red herring
A preliminary prospectus
distributed to
prospective investors in
a new issue of securities.