CASE DESCRIPTION:-

Growth Ltd., a budding technology firm, is looking to raise funds to finance its expansion plans. The company produces state-of-the-art software solutions for organizations and has recently landed its first international contract with a Dubai-based firm that requires a significant R&D investment. Growth Ltd. has decided to investigate several investment banking possibilities in order to raise the necessary funds.

 

BACKGROUND:-

Growth Ltd. is currently worth $50 million, with 10 million shares outstanding at $5 each. The management of the company has a plan to raise $20 million to fuel its expansion plans. They have approached Beta Partners, YOUR investment bank, for assistance in raising the necessary funds. What will you do??
 

OPTIONS:-

There are three primary ways to raise the required capital:

1. IPO (Initial Public Offering)

  • Growth Ltd. can go public by offering new shares to the public through an IPO. Your investment bank will serve as the book-running lead manager and set the issue price based on the demand for the shares.
  • IPO costs are estimated to be 10% of the money raised.
  • Share demand is expected to be 4 million at a price of $5.50 per share.
  • Underwriting fees are estimated to be 7% of the cash raised.

2. Private Placement

  • Growth Ltd. can raise funds by privately issuing additional shares to a small group of accredited investors. This strategy saves all the time needed for regulatory approvals, and IPO set-up, and gets the company funds in a more timely manner.
  • Private placement costs are estimated to be 5% of the capital raised.
  • Share demand is expected to be 3 million shares at $5.75 apiece. 

3. Debt Financing

  • Growth Ltd. can obtain debt funding by issuing fixed-rate corporate bonds. These are interest-paying bonds that must be repaid after 5 years.
  • Debt issuance costs are estimated to be 3% of the cash raised.
  • The bond coupon rate is 6% each year.

 

ANALYSIS:-

To determine the most cost-effective capital-raising strategy, perform the following numerical computations for each option:

IPO:

  • IPO: $20 million in capital raised.
  • IPO costs: $2 million (10% percent of $20 million).
  • Underwriting fees: $1.4 million (7% of the total amount raised).
  • Total cost = 17% of funds raised 
  • The net proceeds were $16.6 million.
  • 3.64 million new shares (20 million / $5.50) are issued.

Private Placement:

  • $20 million in capital has been raised.
  • The cost of a private placement is $1 million (5% of $20 million).
  • The net proceeds were $19 million.
  • 3.48 million new shares (20 million / $5.75) were issued.

Debt funding:

  • $20 million in capital has been raised.
  • The cost of issuing debt is $600,000 (3% of $20 million).
  • Bond coupon payments: $1.2 million per year (6% of $20 million).
  • Total interest payments over a five-year period: $6 million.
  • The total repayment amount over five years is $26 million.

Growth Ltd. is a growing company which is valued at $50 million. However, the company has received its first-ever international order and is planning to undertake an expenditure of $20 million for R&D, which is 40% of its worth! Since the company’s scale is small, an IPO would be detrimental to a young company like Growth Ltd. 

So, the most rational advice Beta Partners could give would be to consider a mix of Debt and Equity (via Private Placement). Not fully committing to one would allow the company to have lower interest payments and maintain significant control in its hands.

For the sake of simplicity, let's consider the following three mixes:-

  • 15:5 = Equity:Debt
  • 10:10= Equity:Debt
  • 5:15= Equity:Debt

Let’s break down the cost for these alternatives:-

1] $15 million by Private Placement and $5 million by Debt.

Cost: ($15 million X 5%) + ($5 million X 3%) + ($5 million X 6% X 5years)

= $750,000 + $150,000 + $1,500,000

= $2,400,000

2] $10 million by Private Placement and $10 million by Debt.

Cost: ($10 million X 5%) + ($10 million X 3%) + ($10 million X 6% X 5years)

= $500,000 + $300,000 + $3,000,000

= $3,800,000

3] $5 million by Private Placement and $15 million by Debt.

Cost: ($5 million X 5%) + ($15 million X 3%) + ($15 million X 6% X 5years)

= $250,000 + $450,000 + $4,500,000

= $5,200,000

 

CONCLUSION:-

Thus, the most cost-effective choice will be 15:5=Equity:Debt. 

As the component of debt increases, the cost of capital surges, resulting in a higher cost of raising funds, making higher debt an unattractive choice. However, by opting for this mix with minimum debt, the company avoids high-interest payments at the cost of diluting a small portion of its control.

Were you able to solve it?

Think you can make it as an Investment Banker? No??

No worries. Click the link below to join thousands of other aspiring individuals, students to working professionals, to learn from investment bankers who have been in the industry for almost 10 years! Learn industry-relevant skills and create flawless projects to become an Investment Banker on Wall Street!!

Join our latest cohort NOW!!

[Disclaimer: This case study is entirely hypothetical and unrelated to real-world situations. It's designed for educational purposes to illustrate theoretical concepts and potential scenarios within a given context. Any similarities to actual events or individuals are purely coincidental.]