EAST COAST YACHTS GOES PUBLIC
Larissa Warren and Dan Ervin have been discussing the future of East Coast Yachts. The company has been experiencing fast growth, and the future looks like clear sailing. However, the fast growth means that the company’s growth can no longer be funded by internal sources, so Larissa and Dan have decided the time is right to take the company public. To this end, they have entered into discussions with the investment bank of Crowe & Mallard. The company has a working relationship with Robin Perry, the underwriter who assisted with the company’s previous bond offering. Crowe & Mallard have helped numerous small companies in the IPO process, so Larissa and Dan feel confident with this choice.
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Robin begins by telling Larissa and Dan about the process. Although Crowe & Mallard charged an underwriter fee of 4 percent on the bond offering, the underwriter fee is 7 percent on all initial stock offerings of the size of East Coast Yachts’ initial offering. Robin tells Larissa and Dan that the company can expect to pay about $1,800,000 in legal fees and expenses, $15,000 in SEC registration fees, and $20,000 in other filing fees. Additionally, to be listed on the NASDAQ, the company must pay $100,000. There are also transfer agent fees of $8,500 and engraving expenses of $525,000. The company should also expect to pay $75,000 for other expenses associated with the IPO.
Finally, Robin tells Larissa and Dan that to file with the SEC, the company must provide three years’ worth of audited financial statements. She is unsure of the costs of the audit. Dan tells Robin that the company provides audited financial statements as part of its bond indenture, and the company pays $325,000 per year for the outside auditor.
At the end of the discussion Dan asks Robin about the Dutch auction IPO process. What are the differences in the expenses to East Coast Yachts if it uses a Dutch auction IPO versus a traditional IPO? Should the company go public with a Dutch auction or use a traditional underwritten offering?
During the discussion of the potential IPO and East Coast Yachts’ future, Dan states that he feels the company should raise $75 million. However, Larissa points out that if the company needs more cash soon, a secondary offering close to the IPO would be potentially problematic. Instead, she suggests that the company should raise $100 million in the IPO. How can we calculate the optimal size of the IPO? What are the advantages and disadvantages of increasing the size of the IPO to $100 million?
After deliberation, Larissa and Dan have decided that the company should use a firm commitment offering with Crowe & Mallard as the lead underwriter. The IPO will be for $85 million. Ignoring underpricing, how much will the IPO cost the company as a percentage of the funds received?
Many of the employees of East Coast Yachts have shares of stock in the company because of an existing employee stock purchase plan. To sell the stock, the employees can tender their shares to be sold in the IPO at the offering price, or the employees can retain their stock and sell it in the secondary market after East Coast Yachts goes public (once the 180-day lockup period expires). Larissa asks you to advise the employees about which option is best. What would you suggest to the employees?
| Chapter 20 | ||||
| East Coast Yachts Goes Public | ||||
| Input area: | ||||
| Underwriter fee | 7.00% | |||
| Legal fees and expenses | $ 1,800,000 | |||
| SEC registration fees | $ 15,000 | |||
| Filing fees | $ 20,000 | |||
| NASDAQ listing fee | $ 100,000 | |||
| Transfer agent fee | $ 8,500 | |||
| Engraving expenses | $ 525,000 | |||
| Other expenses | $ 75,000 | |||
| Audit cost/year | $ 325,000 | |||
| IPO size | $ 85,000,000 | |||
| Output area: | ||||
| Underwriter fees | $ 5,950,000 | |||
| Total fees excluding underwriter fees | $ 2,543,500 | |||
| Total fees | $ 8,493,500 | |||
| Net amount raised | $ 79,050,000 | |||
| Fee as a percentage of funds raised | 10.74% | |||
EXPERT ANSWER
1.
Young companies, like East Coast Yachts, use Dutch auction because of lower fees. Instead of just investment banks and their top clients, also small investors can participate in public offering process with Dutch auction. Dutch auction is advantageous for small investors because the final bidding price become the market value of a company and they can purchase the share easily. But there are not much information’s about the company who is selling its share by Dutch auction. In traditional IPO, a company has to give full information to the public and investors can make decisions about purchasing the share with more information which is dependable than Dutch auction.
However in traditional auction there are too many legal fees and additionally, underwriter’s top clients will purchase shares instead of many small investors. In traditional IPO, underwriter will get commission for every per share and it’s expensive than the fees charged in Dutch auction. However, the investment return is likely to be substantially less than it would be for a traditional IPO. In my opinion, East Coast Yachts company should use Dutch Auction because of lower underwriting fees.
2.
The advantages of raising $80 million is; company can receive required financial amount for its investments if demand for it’s shares suddenly increase. The price of per share will increase (of course it depends of number of shares) and it will increase value of the company.
Disadvantages can be: underwriter does not benefit from a higher stock price on open market because it only receive the IPO subscription fees. Because of the company is unknown, do not have reputation, this price will be too high for investors and they do not prefer to buy these shares.
3.
The underwriter fee should be around 7 percent of the amount raised:
Underwriter fee = $70,000,000(.07)
Underwriter fee = $4,900,000
The company should currently provide audited financial statements due to the bond covenants. The audit costs are not incremental costs and should not be included in the calculation of the fees. The sum of the other fees are as followed:
Total other fees = $1,500,000 + 15,000 + 20,000 + 100,000 + 8,500 + 525,000 + 75,000
Total other fees = $2,243,500
Total cost = $4,900,000 + 2,243,500
Total cost =$71,43,500
4.
East Coast Yachts shares’ can have high demand by investors and this will increase the prices and the value of the firm. I’m thinking a company like Face book, young and famous, which offered it’s shares to public and attracted intensive attention by investors. But as we know right now, Face book share price is $19.50 and it’s fluctuating every week. If I was an employee in Face book, in very first day of the public offering, I try to sell my Face book shares, because there were no negative comments, criticism or speculations exist in the market and the value of a firm is still high and I can make profit from very beginning of the IPO process.
East Coast Yachts employees can sell their shares at the beginning of the IPO because prices will decrease during those 180 days and they may not get any profit from their arranged investment.
But!
If employees sell their shares: There will be too many East Coast Yachts shares in the market
Many East Coast Yachts shares: Decrease the price of per share (indirect effect)
If prices are decrease: Value of East Coast Yachts will also decrease
A firm with low value: Decrease demand for the firm’s shares
Low level of demand: Mismatching between cash outflows and inflows