BKF 3: Equity Financing: Shares & Fundraising

Equity Financing Overview

• Equity financing involves companies issuing shares to raise funds.
• This can be done by private companies or through a public offering of shares.
• The speaker highlights three main aspects: overview, private companies, and public offerings.

Why Companies Issue Shares

• Companies issue shares through equity fundraisings to raise capital.
• Initially, companies are funded by individuals, corporations, or parent companies.
• These initial funders become shareholders by investing their own money.
• When more funds are needed for expansion, debt or equity financing can be pursued.
• Debt Financing: Raising funds by borrowing money from banks
• Equity Financing: Raising funds by issuing new shares.

Equity Financing Details

• This form involves issuing shares to existing shareholders or new investors.
• New shareholders then become part-owners of the company.
• Equity fundraising has no repayment obligation, unlike debt financing.
• Shareholders give up a portion of their ownership for profits, diluting ownership.
• Debt financing requires repayment with interest; lenders do not gain ownership or control.
• Scenario: Consider a tech startup needing capital for product development. Instead of a bank loan, they issue shares to angel investors. The investors gain a stake in the company's future success, while the startup avoids debt repayment constraints.

Factors Influencing Debt vs. Equity Decisions

• Existing Debt: The amount of debt a company has affects attractiveness. It may be seen as less attractive for a company to be excessively leveraged.
• Borrowing Restrictions: Existing loan agreements affect ability to borrow. These restrictions can come from existing loan agreements, other debt instruments, or licensing requirements.
• Availability and Cost of Debt Finance: Lender willingness and interest rates matter. Lenders need to be prepared to lend out money, as well as consider what what are the reasonable interest rates to charge.
• Share Rating: How the market values company shares influences decisions. The reaction of shareholders to an issue of equity and the valuation of shares by the market needs to be considered.
• Scenario: A manufacturing company already has substantial long-term debt. Due to restrictive covenants imposed by its bank, the company is limited to take on additional debts. It decides to issue shares because it is rated quite highly by the market and its valuation is promising.

Equity Financing Options

• For smaller private companies, issue shares through a subscription agreement with a limited number of larger investors.
  • Startup companies obtaining venture capital funding are one example.
• Larger, more established companies will seek to do a public offering of its shares; this happens via an IPO in a stock exchange.
• Raises funds through secondary offerings, like placement or rights issues.
• Scenario A: A seed-stage software company secures $1 million from three venture capital firms in exchange for preferred shares, using a subscription agreement.
• Scenario B: A medium-sized retail chain, already operating for five years, initiates an IPO to raise $20 million for expansion, listing its shares on a stock exchange.

Funding Sources for Private Companies

• Friends and Family Fund raising rounds
• Angel investors
• Government schemes (such as Startup Singapore)
  • Startup Singapore provides mentorship and startup capital grants to qualifying applicants
• Singapore accredited startup incubators
• Corporate venture capital (VC) investors

Prospectus Requirements and Exemptions

• Companies offering shares must generally issue a prospectus as a protection for investors
• Prospectus Exceptions: Small offers, offers to limited people, offers to accredited investors
• Small Offer Exemption: Raising less than $5 million in 12 months
• Limited Persons Exemption: Offering to no more than 50 people in 12 months without advertisement
• Accredited Investors: Talk on debt capital markets, same definition applies here
• Scenario: A Singaporean agritech startup raising $3 million from angel investors within a year, without broad advertising, can avoid full prospectus requirements.

Singapore Code on Takeovers and Mergers

• Public limited companies with net tangible assets of $5 million or more are subject to the Singapore Code on Takeovers and Mergers.
• Issuing new shares dilutes existing shareholders, requiring their approval for fundraising.
• Scenario: A fast-growing e-commerce company, with a current net tangible asset value of $6.5 million, seeks to dilute existing shareholdings in exchange for a $2 million cash injection. For the fundraising to be successful, approval from its shareholders is required.

Documents for Equity Fundraising

• Involves a subscription agreement: Sets out the terms and conditions of the subscription.
• Involves a shareholders agreement: Regulates the management of the company and specifies the rights or obligations of shareholders.
• Warranties as to the business and financial status of the company.
• Investors can carry out legal due diligence to assure themselves as to these matters.
• Scenario: A Singaporean fintech company finalizes an investment round with a VC firm, executing both a subscription agreement detailing share price and a shareholders agreement outlining board seats and voting rights.

Minority Shareholder Protection

• Shareholder agreements contain protective provisions for the minority shareholders.
• Such provisions will include certain corporate governance rights.
  • Right to appoint directors or board observers.
  • Specification that certain matters will be reserved for the approval of shareholders generally or particular investors.
  • Anti-dilution mechanisms, preemption rights over the issuance of new shares
  • transfer restrictions, such as the right of first refusal
  • Exit mechanisms, such as the wholesale right enabling the minority investor to sell a pro rata portion of their shares to third-party buyers along with the selling shareholders.

Public Offering of Shares (IPO)

• Selling shares is a main method for shareholders to get their investment back.
• Selling shares is more difficult in a private company as there is no market for its shares.
• A popular exit route for investors is through an IPO.
  • An IPO is the process by which a private company is converted to a public company.
• Apply to list shares on the stock exchange, SGX
  • A successful IPO is contingent on external factors, market conditions, regulatory and listing approvals.

Two Main Boards in SGX

• Mainboard or Catalyst board
• The Main board listing caters to the needs of more established companies with higher entry and listing requirements.
• The Catalyst board caters to smaller fast growing issuers, and has a different model where approved sponsors assess whether an issuer is suitable for listing.

Catalyst Board

• Has no minimum quantitative entry criteria for listing.
• Catalyst boards need to be approved by certain sponsors or issue managers.
• A listing on Catalist board must be a primary listing.
• Scenario: A high-growth AI startup seeks an IPO on the SGX, but given it is still rather new, with higher entry requirements relating to profit or market capitalization, it seeks to list on the Catalist board.

Requirements for Main Board Listing

• A minimum one-year track record to satisfy one of the requirements as to the profitability or market capitalization.
• Tests are in place to ensure that a company or issuer listing on the main board is suitable for investment by the general public.
• A main board listing can be a primary or secondary listing.
  • Foreign issuers seeking dual primary listings in Singapore needs to ensure full compliance with the listing rules of both the SGX-ST and its home exchange.
• Issuers seeking a main board listing must satisfy one of the following requirements: Profitability Test or Market Capitalisation Test.
• For both mainboard and Catalist listings, all debts owing to the group by its directors, substantial shareholders/unitholders and companies controlled by the directors and substantial shareholders/unitholders must be settled before listing.

Critical Aspect of IPO

• The prospectus, contains all information reasonably required by investors to make an informed assessment of the shares.
• Prospectus is prepared by the issuer and its advisors.
• Before a prospectus, verification exercises are conducted to confirm the accuracy of key statements.
• Scenario: A Singaporean sustainable energy company prepares an IPO prospectus detailing its financials, market position, and future projects, undergoing rigorous audits to ensure all information is accurate and compliant.

Liability for False Statement in Prospectus

• There are criminal and civil liabilities for any false or misleading statements in the prospectus.
• There can be omissions of information that should ve been included in the prospectus.
• All persons that were involved can be prosecuted under criminal or civil laws, as well as the company itself.
• Scenario: A Singaporean healthcare company faces lawsuits and regulatory penalties when its IPO prospectus overstates its clinical trial results, misleading investors about the efficacy of a new drug.

Key IPO Steps

• Completing a substantial amount of diligence and prospectus drafting.
• Submit an application to the SGX, pre-clearing any issues with the exchange in terms of its suitability to list.
• Submit the prospectus to the MAS, Monetary Authority of Singapore.
• Issuer and the banks will then respond to queries received from SGX and MAS, incorporating the relevant comments.

Legal Documentation

• Negotiate legal documentation, underwriting agreement, legal opinions.

IPO Pricing and Registration

• banks would then price the IPO.
• register the final prospectus with MES.
• IPO is open for the public to subscribe for shares.
• issuer is then admitted on the official list of the SGX and the shares listed.
• An issuer that proposes to undertake a main board IPO without underwriting must consult with the SGX-ST on such a proposal.

IPO Timeline

• An entire IPO process takes about 6 months-year, depending on whether SGX or MAS raises issues, how long it takes for those issues to be resolved

IPO Marketing Methods

• Pre-IPO placements: For early investors, incentivize pre-IPO investors to persuade other investors to subscribe for the issuers securities.
• Cornerstone investors: Happens concurrently and separately from the IPO.
• Roadshows: Issuer and its banks will market to attract institutions.
• Advertising/publicity: Open to the public at large.

Post-Listing Obligations and Compliance

• Issuers have to comply with continuing obligations.
• Issuers must disclose any information necessary to avoid the establishment of a false market in its securities, or in circumstances where such information would likely materially affect the price of its securities.
• Promptly clarify or confirm rumours which have not been substantiated by the issuer and which are likely to have or have had an effect on the price of its securities.
• Periodic financial reporting, half-year, quarterly or full-year result at a certain period of time after the end of such financial periods.
• Disclose its interested person transactions with its related parties, directors, CEO or controlling shareholder.

Interested Person Transaction

• Any transaction between the issuer and its related parties, such as a director, CEO or controlling shareholder.
• Interested person transactions are subject to higher governance requirements.
  • Requires shareholders approval where the value of a transaction exceeds certain specified limits.
  • Listed issuers are also expected to comply or explain in relation to the governance.
• Comply or explain in relation to the governance corporate governance practices, governance code in their annual report.
  • Disclose any provisions of the code with an explanation of such deviation.

Debt Financing vs. Equity Funding in Scenarios

• Scenario 1: High-Growth Tech Startup. A tech startup needs funding for rapid expansion. Choosing equity funding, it issues shares to venture capitalists. This provides the startup with capital without immediate repayment obligations. However, founders' ownership is diluted, and future profits are shared with investors.
• Scenario 2: Established Manufacturing Company. An established manufacturing company needs funds for a new production line. Given its stable revenue and assets, it opts for debt financing, securing a low-interest loan. It retains full ownership and control without diluting equity.
• Scenario 3: Distressed Retail Chain. A retail chain, struggling with declining sales, has limited borrowing capacity. To avoid default, it issues emergency equity shares to a private equity firm, accepting tough terms, including significant equity dilution and board control.