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private equity firm； Charterhouse Capital Partners； paid ￡1。35 billion to
take control of the group and they pulled their IPO at the last minute。 The
acquisition was by way of a buyout； with Charterhouse taking an 80 per
cent stake and the management the remainder。 Charterhouse funded the
acquisition of Saga with ￡500 million of equity。 The remainder was funded
with debt； which it has since refinanced。
In January 2007； just three years later； the pany； then thought to be
worth between ￡2。5 billion and ￡3 billion； was again exploring its financing
strategy。 A sale or flotation could value the 20 per cent stake held by
staff and senior management at ￡500 million； with the 8 per cent stake of
Andrew Goodsell； Saga’s chief executive； worth about ￡200 million。 Mr
Goodsell stated； ‘We’ve smashed through all of our plans； repaid large
amounts of debt and ＇Charterhouse＇ has achieved what it wanted to
achieve。’ Once again stock…market flotation was on the cards； but a very
different opportunity emerged。 In June 2007 Permira and CVC； the two
private equity firms that owned the bulk of the AA； approached Saga’s
majority owner； Charterhouse； to ask it to consider a merger。 The result was
a ￡6。15bn surprise move that created one of the country’s largest privateequity…
backed panies。
Initial public offer （IPO） – criteria for getting a stock market listing
The rules vary from market to market but these are the conditions that are
likely to apply to get a pany listed on an exchange：
Finance 67
1。 Ge。。ing listed on a major stock exchange calls for a track record of making
substantial profits with decent seven…figure sums being made in the
year you plan to float； as this process is known。 A listing also calls for a
large proportion； usually at least 25 per cent； of the pany’s shares to
be put up for sale at the outset。 In addition； you would be expected to
have 100 shareholders now and be able to demonstrate that 100 more
will e on board as a result of the listing。
2。 As you draw up your flotation plan and timetable you should have the
following ma。。ers in mind：
– Advisers： You will need to be supported by a team which will include a
sponsor； stockbroker； reporting accountant and solicitor。 These should
be respected firms； active in flotation work and familiar with the
pany’s type of business。 You and your pany may be judged by
the pany you keep； so choose advisers of good repute and make
sure that the personalities work effectively together。 It is very unlikely
that a small local firm of accountants； however satisfactory； will be up
to this task。
– Sponsor： You will need to appoint a financial institution； usually a
merchant banker； to fill this important role。 If you do not already have
a merchant bank in mind； your accountant will offer guidance。 The job
of the sponsor is to coordinate and drive the project forward。
– Timetable： It is essential to have a timetable for the final months during
the run…up to a float – and to adhere to it。 The pany’s directors
and senior staff will be fully occupied in providing information and
a。。ending meetings。 They will have to delegate and there must be
sufficient backup support to ensure that the business does not suffer。
– Management team： A potential investor will want to be satisfied
that your pany is well managed； at board level and below。 It is
important to ensure succession； perhaps by offering key directors and
managers service agreements and share options。 It is wise to draw on
the experience of well…qualified non…executive directors。
– Accounts： The objective is to have a profit record which is rising but；
in achieving this； you will need to take into account directors’ remuneration；
pension contributions and the elimination of any expenditure
which might be acceptable in a privately owned pany but would
not be acceptable in a public pany； namely excessive perks such as
yachts； luxury cars； lavish expense accounts and holiday homes。
Accounts must be consolidated and audited to appropriate accounting
standards and the audit reports must not contain any major qualifications。
The auditors will need to be satisfied that there are proper
stock records and a consistent basis of valuing stock during the years
prior to flotation。 Accounts for the last three years will need to be
disclosed and the date of the last accounts must be within six months
of the issue。
68 The Thirty…Day MBA
AIM
London’s Alternative Investment Market （AIM） was formed in the mid…tolate
1990s specifically to provide risk capital for new rather than established
ventures。 AIM raised ￡15。7bn in 2007 – a 76 per cent leap from the previous
year – and a record number of panies floated on the exchange； bringing
the total to 1；634。
AIM is particularly a。。ractive to any dynamic pany of any size；
age or business sector that has rapid growth in mind。 The smallest firm
on AIM entered at under ￡1 million capitalization and the largest at over
￡500 million。 The formalities are minimal； but the costs of entry are high
and you must have a nominated adviser； such as a major accountancy
firm； stockbroker or banker。 The survey showed that costs of floating on
the junior market is around 6。5 per cent of all funds raised and panies
valued at less than ￡2m can expect to shell out a quarter of funds raised in
costs alone。 The market is regulated by the London Stock Exchange （
londonstockexchange 》 AIM）。
You can check out all the world stock markets from Australia to Zagreb
on Stock Exchanges World Wide Links （tdd。lt/slnews/Stock_
Exchanges/Stock。Exchanges。htm）； maintained by Aldas Kirvaitis of
Lithuania； and at World Wide Tax （worldwide…tax 》 World
Stock Exchanges）。 Once in the stock exchange website； almost all of which
have pages in English； look out for a term such as ‘Listing Center’； ‘Listing’
or ‘Rules’。 There you will find the latest criteria for floating a pany on
that particular exchange。
Share buyback
panies can buy back their shares； which reduces the number of shares
outstanding； giving each remaining shareholder a larger percentage ownership
of the pany。 This is usually considered a sign that the pany’s
management believes its share price is undervalued。 Other reasons for
buybacks include pu。。ing unused cash to use； raising earnings per share
and obtaining stock for employee stock option plans or pension plans。
HYBRIDS
A number of financing methods straddle the debt and equity boundary。
These try to mitigate taking a bit more risk for the potential of a bit more
return than would be usual with debt financing。 But they also limit the
upside that might be expected from pure equity； which would retain all of
any increase in value from the outset：
。 Convertible preference shares operate like preference shares； in that
their holders rank before ordinary shareholders for dividend payment；
Finance 69
or return of funds in the case of failure。 They also have the option； at
some specified date in the future； to convert to ordinary shares and so
enjoy all of any increase in value。
。 Mezzanine finance has one or all of these characteristics： It ranks a。。er
other forms of debt； but before equity； for any payout in the event of a
business failing； it pays higher； o。。en significantly higher； interest than
other debt； it can be held for up to 10 years； it can be converted into
ordinary shares。 It is popular with VCs for management buyouts。
Grants
Government agencies at both national and local government level as well
as some extra…governmental bodies such as the EU offer grants； effectively
free or nearly free money in return for certain behaviour。 It may be to encourage
research into a particular field； stimulate innovation or employment or
to persuade a pany to locate in a particular area。 Grants are constantly
being introduced （and withdrawn）； but there is no system that lets you
know automatically。 You have to keep yourself informed。
Business Link （businesslink。gov。uk 》 Finance and grants 》 Grants
and government support） has advice on how to apply for a grant as well
as a directory of grants on offer。 Microso。。 Small Business Centre （
microso。。/uk/businesscentral/euga/home。aspx） has a European Union
Grant Advisor with a search facility to help you find which of the 6；000
grants on offer might suit your business needs。 Grants。Gov （grants。
gov） is a guide to how to apply for over 1；000 federal government grants in
the United States。
COST OF CAPITAL
A business needs to keep track of how much it is paying for the capital it
uses； as that is the minimum hurdle rate for any investment it may make。
Also； it needs to be aware that if new money being raised is more costly
than that already in the business； it will only be profitable if it raises the
hurdle rate for new projects accordingly。
Cost of debt
This can be very straightforward。 If a pany takes out a bank loan at a
fixed rate of interest of say； 8 per cent； then this is the cost before any tax
relief。 Taking tax relief at 40 per cent into account； the net cost of debt es
down to 4。8 per cent。 In the case of a public offer for bonds or debentures；
the rate of interest which has to be paid on new loans to get them taken up
by investors at par can be regarded as the cost of borrowed capital。
70 The Thirty…Day MBA
Cost of equity
Put simply； the cost of equity is the return shareholders expect the pany
to earn on their money。 It is their estimation； o。。en not scientifically
calculated； of the rate of return that will be obtained both from future
dividends and an increased share value。
Dividend valuation model
One approach to finding the cost of equity is to take the current gross
dividend yield for a pany and add the expected annual growth。
Example
For example； XYZ plc has forecast payment of a gross equivalent dividend
of 10p on each ordinary share in the ing year。 The pany’s shares
are quoted on the Stock Exchange and currently trade at ￡2。00。 Growth of
profits and dividends has averaged 15 per cent over the past few years。 The
cost of equity for XYZ plc can be calculated as：
Cost of equity capital = Current dividend （gross） ％ ＋ Growth rate ％
Current market price = （￡0。10 × 100） ％ ＋ 15％ = 20％ = ￡2
With this method； dividends are assumed to grow in the future at the
constant rate achieved by averaging the last few years’ performance。
Capital asset pricing model （CAPM）
Before turning to the next method； we need to clarify some aspects of risk。
There are two broad types of risk：
。 Specific risk： This applies to one particular business。 It includes； for
example； the risk of losing the chief executive； the risk of someone else
bringing out a similar or be。。er product； or the risk of labour problems。
Shareholders are expected not to want pensation for this type of
risk as it can be diversified away by holding a sufficient number of
investments in their portfolios。
。 Systematic risk： This derives from global or macroeconomic events
that can damage all investments to some extent and therefore holders
require pensation for this risk to their wealth。 This pensation
takes the form of a higher required rate of return。
A slightly more plicated approach to the cost of equity tries to take the
systematic risk element into account。 It is known as the capital asset pricing
model or CAPM for short。 Put simply； CAPM states that investors’ required
rate of return on a share is posed of two parts： a risk…free rate similar
Finance 71
to that obtainable on a risk…free investment in short…term government
securities； and an additional premium to pensate for the systematic
risk involved in investing in shares。
This systematic risk for a pany’s shares is measured by the size of its
beta factor。 A beta the size of 1。0 for a pany means that its shares have
the same systematic risk as the average for the whole market。 If the beta is
1。4 then systematic risk for the share is 40 per cent higher than the market
average。 A pany’s share beta is applied to the market premium that is
obtained from the excess of the return on a market portfolio of shares over
the risk…free rate of return。 The formula to calculate cost of equity capital
using CAPM is：
Ke = Rf ＋ B（Rm – Rf）
Where： Ke = cost of equity； Rf = risk…free return； Rm = return on market
portfolio of shares and B = beta factor。
Example
If the risk…free rate of return is 5。5 per cent and the return on a market
portfolio is 12 per cent； then for a pany with a beta of 0。7 for its ordinary
shares calculate its cost of equity。
Ke = Rf ＋ B（Rm – Rf）
= 5。5％ ＋ 0。7（12％ – 5。5％）
= 10。05％
Of the two methods described for finding the cost of equity for a pany；
the la。。er CAPM method is the more scientific。 Ideally； the risk…free and
market rates of return should reflect the future； but current rates of return
are used as substitutes。 Beta factors measure how sensitive each pany’s
share price movements are relative to market movements over a period of
a few years。
The weakness of CAPM is that it assumes all investors are rational and
well informed； that markets are per