The Differences Between Ipo and Private Financing and Advantages and Disadvantages

MGMT Financing

Eric Johnson

MGMT E-2700 Section 1

Table of Contents

Executive Summary – pg. 3

Question 1 – pg. 4-5

Question 2 – pg. 5-6

Question 3 – pg. 6-7

Question 4 – pg. 8-9

Question 5 – pg. 9-10

Question 6 – pg. 10-11

Question 7 – pg. 12-13

References – pg. 14

Executive Summary

This assignment, Final Exam Part B, will go answer the questions assigned to review the different investment proposals for MGT 2700, Inc. (MGMT). The assignment will go through the differences between IPO and private financing along with advantages and disadvantages of both. It will include calculations to show the cash flows they both provide. By answering the questions at hand, this assignment will provide a comprehensive report to the senior leadership of Raju Technology, Inc.  

1. When undertaking financing, there are always both advantages and disadvantages to any method you choose. In the case of MGMT, they are choosing between private equity financing and undertaking an IPO. One of the main advantages of private equity financing rather than an IPO is the potential to bring in far more cash with the ability to fund and launch and survive. (Cremades, 2018) This is not the case with an IPO which usually has a capped number of shares and while the value of those shares can go up there is no actual operating cash coming in to use besides the initial wave of cash from the sale. Another advantage to private equity compared to an IPO is keeping the pool of potential investors smaller since they have to be accredited. (Fontinelle, 2018) This means you are having informed members with ownership stake in your company rather than anyone who can purchase stocks through a broker. By having informed investors, you can typically feel more comfortable when they are voting on key company decisions. The final advantage is not being under as much scrutiny compared to when a company goes through an IPO and is then listed on an exchange. When a company becomes public, its financial statements are available to view by anyone, so the company has pressure to constantly perform well to increase the value of its shares. When using private equity financing, the only people who can see the financial statements are the investors, so the company does not have to change its strategy due to a Wall Street analyst’s report. (Fontinelle, 2018)

In contrast to these, one of the disadvantages to private equity financing is giving up some control of the company. With an IPO, the founders can keep a certain percent of the shares to maintain a majority stake and can keep the board of directors very similar to how the company was run beforehand. However, with private equity some of the terms and conditions that a potential investor may want could include a board seat and voting power. (Cremades, 2018) This could ultimately force the founders out of their own company if they lose too much power from this type of financing. Another disadvantage of private equity rather than IPO is the investors typically require a certain rate of return on their investment or a hurdle rate. This means that when a company starts making profits the investors will be getting paid out their investment plus the rate of return they require before anyone else receives a share of the profit. On the other hand, an IPO issues shares which are treated the same for the most part. The final disadvantage to private equity is the limited liquidity a company would have in comparison to one that has gone through an IPO and is publicly traded. If the private company does not have much liquidity and needs to get operating cash they do not have the option of easily trading more shares to get cash.

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1. After reviewing all of the investment bank’s assumptions, I do believe they are reasonable. That being said, there are a couple of the projections that I think could end being a bit off from the assumptions based on how the business is run. One of the assumptions in question is the sales growth rate of 20% for the next five years followed by operating cash flow to grow at 4% indefinitely. I do believe that the 4% is reasonable, however, I am questioning the 20% growth for the next five years as the growth rates for 2016 and 2017 were 15.12% and 12.67%, respectively. Very rarely is there that type of jump and then consistency in sales growth but with the right strategy or if GY Apps is as profitable as MGMT thinks then it may be possible. Two assumptions that are reasonable and I do not think will have much deviance are the gross margin and R&D expense percentages of sales. With the previous three years having a gross margin of close to 80% you can expect it will remain the same over the next five years due to the fact that as sales grow so will the cost of good sold, typically at the same rate.

As for R&D, one would assume that you would have higher expenses upfront and once the product got launched then the expense would be dialed back. This is not the case for MGMT as they are a technology company and they need to be constantly researching and developing to products and concepts to remain up-to-date with the industry. The investment bank took this into account and made a reasonable assumption that 10% of sales would go towards R&D to help continue the sales growth. Another expense that might be expected to decrease or stay consistent over time, but in the case of a technology company is the opposite, is depreciation. I believe the 20% growth in the depreciation expense is reasonable because if MGMT does decide to buy GY apps then each time a new app is released then it will start adding to the depreciation expense. The only issue that may arise is the depreciation expense past the next five years as it is stated that after ten years GY Apps will be obsolete which should decrease the depreciation expense drastically then.