Is the issue only because of the existing shareholders?

Minicase: was founded in 2009 by two graduates of the University of Wisconsin with help fro Show more Minicase: was founded in 2009 by two graduates of the University of Wisconsin with help from Georgina Sloberg who had built up an enviable reputation for backing new start-up businesses. Mutt.coms user-friendly system was designed to find buyers for unwanted pets. Within 3 years the company was generating revenues of $3.4 Million a year and despite racking up sizable losses was regarded by investors as one of the hottest new e-commerce businesses. The news that the company was preparing to go public therefore generated considerable excitement. The companys entire equity capital of 1.5 million shares was owned by the two founders and ms. Sloberg. the initial public offering involved the sale of 500000 shares by the three existing shareholders together with the sale of a further 750000 shares by the company in order to provide funds for expansion. The company estimated that the issue would involve legal fees auditing printing and other expenses of $1.3 million which would be shared proportionately between the selling shareholders and the company. In addition the company agreed to pay the underwriter a spread of $1.25 per share (this cost also would be shared). The roadshow had confirmed the high level of interest in the issue and indications from investors suggested that the entire issue could be sold at a price of $24 a share. The underwriters however cautioned about being to greedy on the price. They pointed out that indications from investors were not the same as firm orders. Also they argue it was much more important to have a successful issue than to have a group of disgruntled shareholders. They therefore suggested and issue price of $18 a share. That evening Mutt.coms financial manager decided to run through some calculations. First she worked out the net receipts to the company and the existing shareholder assuming that the stock was sold for $18 a share. Next she looked at the various costs of the IPO and tried to judge how they stacked up against the typical costs for similar IPOs. That brought her up against the question of underpricing. When she had raised the matter with the underwriters that morning they had dismissed the notion that the initial days return on an IPO should be considered part of the issue costs. One of the members of the underwriting team had asked: The underwriters want to see high return and a high stock price. Would prefer a low stock price? Would that make the issue less costly? Mutt.coms financial manager was not convinced but felt that she should have a good answer. She wondered whether underpricing was only a problem because the existing shareholders were selling part of their holdings. Perhaps the issue price would not matter if they had not planned to sell. Please show the figures that the financial manager came up with. Then answer the financial managers question. When is underpricing a problem? Is the issue only because of the existing shareholders? Would the issue price not matter if they had not planned to sell? Show less


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