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All three of these terms refer to the degree of ownership that a parent
company holds in another company. In most cases, the terms affiliate and associate
are used synonymously to describe a company whose parent only possesses a
minority stake in the ownership of the company.
A subsidiary, on the other hand, is a company whose parent is a majority
shareholder. Consequently, in a wholly owned subsidiary the parent company owns
100% of the subsidiary. For example, the Walt Disney Corporation owns about a
40% stake in the History Channel, an 80% stake in ESPN and a 100% interest in the
Disney Channel. In this case, the History Channel is an affiliate company, ESPN is a
subsidiary and the Disney Channel is a wholly owned subsidiary company.
In many cases of foreign direct investment, companies create subsidiaries and
affiliates in host countries in order to prevent any negative stigma associated with
foreign ownership or negative opinion associated with being owned by a
controversial parent company.
In the banking industry, affiliate and subsidiary banks are the most popular setups
for foreign market entry. Although affiliate and subsidiary banks must follow the
host country's banking regulations, these styles of banking offices allow banks
to underwrite securities.
WHAT IS 'UNDERWRITING'
Underwriting is the process by which investment bankers raise investment capital
from investors on behalf of corporations and governments that are issuing
either equity or debt securities. The word "underwriter" originally came from the
practice of having each risk-taker write his name under the total amount of risk he
was willing to accept at a specified premium. This centuries-old practice continues,
in a way, as new issues are usually brought to market by an underwriting syndicate,
in which each firm takes the responsibility, as well as the risk, of selling its
specific allotment.
UNDERWRITING RISK
Insurance is the most common example of underwriting that most people
encounter. In order for insurance to work well, risk has to be spread out among as
many people as possible. Underwriting helps insurance companies manage the risk
that too many policyholders will file claims at once by spreading out the risk among
outside investors. Once an underwriter has been found for a given policy, the
capital the underwriter puts up at the time of investment acts as a guarantee that
the claim can be paid, which allows the company to issue more insurance to other
customers. In exchange for taking on this risk, the underwriter is entitled to
payments drawn from the policyholder's premiums.
Secondary Market
The initial offering of a new stock takes place in
the primary market. Investment banks typically handle these
transactions. Investors in the primary market are usually very
large institutional buyers who buy millions of shares at a time.
Proceeds from transactions in the primary market flow to the
issuing company that is raising capital.
The secondary market refers to all transactions of a security that
happen after the initial offering. It can also refer to the exchanges
themselves, where these transactions take place. The New York
Stock Exchange and the NASDAQ are examples of secondary
market exchanges.
In the secondary market, the issuing company is no longer
involved. These transactions take place between investors, and
the money transacted flows between investors, not back to the
issuing company.
For example, BamCo decides to sell $500 million in new stock. It
retains an investment bank that manages the offering. The bank
finds large institutional buyers to purchase the stock in massive
blocks. This is the primary market.
Minutes after the primary sale takes place, some of the buyers
start selling their shares on the secondary market, aiming to
make a profit. This happens on the public exchanges where any
size investor can get involved.
In the primary markets, the initial price is set by the bank. In the
secondary markets, the price is determined by the supply and
demand of buyers and sellers.
SETTING A MARKET
Making a market for securities is the chief function of an underwriter. Every
insurance policy or debt instrument, such as a mortgage, carries a certain risk that
the end customer will either default or file a claim. This potentially represents a loss
to the insurer or the lender. A big part of the underwriter's job is to weigh the known
risk factors and investigate the truthfulness of an applicant's application for
coverage in order to determine the minimum price for providing coverage. In this
way, underwriters help find the true market price of risk by deciding on a case-bycase basis which policies they are willing to cover and what rates they need to
charge to make a profit. They also help exclude unacceptably risky applicants, such
as people in very poor health who want life insurance or unemployed people asking
for expensive mortgages, by rejecting coverage in some cases. This substantially
lowers the overall risk of expensive claims or defaults and allows the agent to offer
more competitive rates to the less risky members of the risk pool.
What is an 'Initial Public Offering - IPO'
An initial public offering (IPO) is the first sale of stock by a private company to the
public. IPOs are often issued by smaller, younger companies seeking the capital to
expand, but can also be done by large privately owned companies looking to
become publicly traded.
In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it
determine what type of security to issue (common or preferred), the best offering
price and the time to bring it to market.
BREAKING DOWN 'Initial Public Offering - IPO'
IPOs can be a risky investment. For the individual investor, it is tough to predict
what the stock will do on its initial day of trading and in the near future because
there is often little historical data with which to analyze the company. Also, most
IPOs are of companies going through a transitory growth period, which are subject
to additional uncertainty regarding their future values.
What is a 'Portfolio'
A portfolio is a grouping of financial assets such as stocks, bonds and cash
equivalents, as well as their mutual, exchange-traded and closed-fund counterparts.
Portfolios are held directly by investors and/or managed by financial professionals.
BREAKING DOWN 'Portfolio'
Prudence suggests that investors should construct an investment portfolio in
accordance with risk tolerance and investing objectives. Think of an investment
portfolio as a pie that is divided into pieces of varying sizes representing a variety of
asset classes and/or types of investments to accomplish an appropriate risk-return
portfolio allocation.
For example, a conservative investor might favor a portfolio with large cap value
stocks, broad-based market index funds, investment-grade bonds and a position in
liquid, high-grade cash equivalents. In contrast, a risk loving investor might add
some small cap growth stocks to an aggressive, large cap growth stock position,
assume some high-yield bond exposure, and look to real estate, international,
and alternative investment opportunities for his or her portfolio.
What is a 'Bond'
A bond is a debt investment in which an investor loans money to an entity (typically
corporate or governmental) which borrows the funds for a defined period of time at
a variable or fixed interest rate. Bonds are used by companies, municipalities, states
and sovereign governments to raise money and finance a variety of projects and
activities. Owners of bonds are debtholders, or creditors, of the issuer.
BREAKING DOWN 'Bond'
Bonds are commonly referred to as fixed-income securities and are one of the three
main generic asset classes, along with stocks (equities) and cash equivalents. Many
corporate and government bonds are publicly traded on exchanges, while others are
traded onlyover-the-counter (OTC).
How Bonds Work
When companies or other entities need to raise money to finance new projects,
maintain ongoing operations, or refinance existing other debts, they may issue
bonds directly to investors instead of obtaining loans from a bank. The indebted
entity (issuer) issues a bond that contractually states theinterest rate (coupon) that
will be paid and the time at which the loaned funds (bond principal) must be
returned (maturity date).
The issuance price of a bond is typically set at par, usually $100 or $1,000 face
value per individual bond. The actual market price of a bond depends on a number
of factors including the credit quality of the issuer, the length of time until
expiration, and the coupon rate compared to the general interest rate environment
at the time.
Example
Because fixed-rate coupon bonds will pay the same percentage of its face value
over time, the market price of the bond will fluctuate as that coupon becomes
desirable or undesirable given prevailing interest rates at a given moment in time.
For example if a bond is issued when prevailing interest rates are 5% at $1,000 par
value with a 5% annual coupon, it will generate $50 of cash flowsper year to the
bondholder. The bondholder would be indifferent to purchasing the bond or saving
the same money at the prevailing interest rate.
If interest rates drop to 4%, the bond will continue paying out at 5%, making it a
more attractive option. Investors will purchase these bonds, bidding the price up to
a premium until the effective rate on the bond equals 4%. On the other hand, if
interest rates rise to 6%, the 5% coupon is no longer attractive and the bond price
will decrease, selling at a discount until it's effective rate is 6%.
Because of this mechanism, bond prices move inversely with interest rates.
Characteristics of Bonds
Face value is the money amount the bond will be worth at its maturity, and is
also the reference amount the bond issuer uses when calculating interest
payments.
Coupon rate is the rate of interest the bond issuer will pay on the face value
of the bond, expressed as a percentage.
Coupon dates are the dates on which the bond issuer will make interest
payments. Typical intervals are annual or semi-annual coupon paymets.
Maturity date is the date on which the bond will mature and the bond issuer
will pay the bond holder the face value of the bond.
Issue price is the price at which the bond issuer originally sells the bonds.
Two features of a bond credit quality and duration are the principal determinants
of a bond's interest rate. If the issuer has a poor credit rating, the risk of default is
greater and these bonds will tend to trade a discount. Credit ratings are calculated
and issued by credit rating agencies. Bondmaturities can range from a day or less to
more than 30 years. The longer the bond maturity, or duration, the greater the
chances of adverse effects. Longer-dated bonds also tend to have lowerliquidity.
Because of these attributes, bonds with a longer time to maturity typically
command a higher interest rate.
When considering the riskiness of bond portfolios, investors typically consider
the duration (price sensitivity to changes in interest rates) and convexity (curvature
of duration).
Bond Issuers
There are three main categories of bonds.
Municipal bonds are issued by states and municipalities. Municipal bonds can
offer tax-free coupon income for residents of those municipalities.
U.S. Treasury bonds (more than 10 years to maturity), notes (1-10 years
maturity) and bills (less than one year to maturity) are collectively referred to
as simply "Treasuries."
Varieties of Bonds
Zero-coupon bonds do not pay out regular coupon payments, and instead are
issued at a discount and their market price eventually converges to face
value upon maturity. The discount a zero-coupon bond sells for will be
equivalent to the yield of a similar coupon bond.
Convertible bonds are debt instruments with an embedded call option that
allows bondholders to convert their debt into stock (equity) at some point if
the share price rises to a sufficiently high level to make such a conversion
attractive.
Some corporate bonds are callable, meaning that the company can call back
the bonds from debtholders if interest rates drop sufficiently. These bonds
typically trade at a premium to non-callable debt due to the risk of
being called away and also due to their relative scarcity in today's bond
market. Other bonds are putable, meaning that creditors can put the bond
back to the issuer if interest rates rise sufficiently.
The majority of corporate bonds in today's market are so-called bullet bonds, with
no embedded options whose entire face value is paid at once on the maturity date.
What is a 'Security'
A security is a financial instrument that represents
an ownership position
In the United States, the U.S. Securities and Exchange Commission (SEC) and other
self-regulatory organizations (such as the Financial Industry Regulatory Authority
(FINRA)) regulate the public offer and sale of securities.
The entity (usually a company) that issues securities is known as the issuer. For
example, the issuer of a bond issue may be a municipal government raising funds
for a particular project. Investors of securities may be retail investorsthose who
buy and sell securities on their own behalf and not for an organizationand
wholesale investorsfinancial institutions acting on behalf of clients or acting on
their own account. Institutional investors include investment banks, pension
funds, managed funds and insurance companies.
Security Functions
fixed
term, at the end of which, they can be redeemed by the issuer. Debt
securities only receive principal repayment and interest, regardless of
rights under the terms of the issue. They are typically issued for a
gain and profits. This is to say that equity holders maintain voting
equity
warrants
(options issued by the company itself that give holders the right to
purchase stock within a certain timeframe and at a specific
price), convertibles (bonds that can be converted into shares of common stock in
the issuing company) and preference shares (company stocks whose
payments of interest, dividends or other returns of capital can be prioritized over
those of other shareholders).
Market Placement
Money for securities in the primary market is typically received from
investors during an initial public offering (IPO) by the issuer of the securities.
Following an IPO, any newly issued stock, while still sold in the primary market, is
referred to as a secondary offering. Alternatively, securities may be
transparency and accessibility of stock prices and other financial data have opened
up the markets to these alternative buying and selling options.
Classifications
Bearer securities
Preferred Stock
What is a 'Preferred Stock'
A preferred stock is a class of ownership in a corporation that has a higher claim on
its assets and earnings than common stock. Preferred shares generally have
a dividend that must be paid out before dividends tocommon shareholders, and the
shares usually do not carry voting rights.
Preferred stock combines features of debt, in that it pays fixed dividends,
and equity, in that it has the potential to appreciate in price. The details of each
preferred stock depend on the issue.
Companies in Distress
If a company is struggling and has to suspend its dividend, preferred shareholders
may have the right to receive payment in arrears before the dividend can be
resumed for common shareholders. Shares that have this arrangement are known
as cumulative. If a company has multiple simultaneous issues of preferred stock,
these may in turn be ranked in terms of priority: the highest ranking is called prior,
followed by first preference, second preference, etc.
Preferred shareholders have prior claim on a company's assets if it is liquidated,
though they remain subordinate to bondholders. Preferred shares are equity, but in
many ways they are hybrid assets that lie between stock and bonds. They offer
more predicable income than common stock and are rated by the major credit
rating agencies. Unlike with bondholders, failing to pay a dividend to preferred
shareholders does not mean a company is in default. Because preferred
shareholders do not enjoy the same guarantees as creditors, the ratings on
preferred shares are generally lower than the same issuer's bonds, with the yields
being accordingly higher.
Voting Rights, Calling and Convertability
Preferred shares usually do not carry voting rights, although under some
agreements these rights may revert to shareholders that have not received their
dividend. Preferred shares have less potential to appreciate in price than common
stock, and they usually trade within a few dollars of their issue price, most
commonly $25. Whether they trade at a discount or premium to the issue price
depends on the company's credit-worthiness and the specifics of the issue: for
example, whether the shares are cumulative, their priority relative to other issues,
and whether they are callable.
If shares are callable, the issuer can purchase them back at par value after a set
date. If interest rates fall, for example, and the dividend yield does not have to be
as high to be attractive, the company may call its shares and issue another series
with a lower yield. Shares can continue to trade past their call date if the company
does not exercise this option.
Some preferred stock is convertible, meaning it can be exchanged for a given
number of common shares under certain circumstances. The board of directors
might vote to convert the stock, the investor might have the option to convert, or
the stock might have a specified date at which it automatically converts. Whether
this is advantageous to the investor depends on the market price of the common
stock.
Typical Buyers of Preferred Stock
Preferred stock comes in a wide variety of forms. The features described above are
only the more common examples, and these are frequently combined in a number
of ways. A company can issue preferred shares under almost any set of terms,
assuming they don't fall foul of laws or regulations. Most preferred issues have
no maturity dates or very distant ones.
Due to certain tax advantages that institutions enjoy with preferred shares but
individual investors do not, these are the most common buyers. Because these
institutions buy in bulk, preferred issues are a relatively simple way to raise large
amounts of capital. Private or pre-public companies issue preferreds for this reason.
Preferred stock issuers tend to group near the upper and lower limits of the creditworthiness spectrum. Some issue preferred shares because regulations prohibit
them from taking on any more debt, or because they risk being downgraded. While
preferred stock is technically equity, it is similar in many ways to a bond issue;
some forms, known as trust preferred stock, can act as debt from a tax perspective
and common stock on the balance sheet. On the other hand, several established
names like General Electric, Bank of America and Georgia Power issue preferred
stock to finance projects.
For more on this interesting hybrid security, read A Primer on Preferred
Stocks and Valuation of Preferred Stocks.
What is a 'Fiduciary'
A fiduciary is responsible for managing the assets of another person, or of a group
of people. Asset managers, bankers, accountants, executors, board members, and
corporate officers can all be considered fiduciaries when entrusted in good
faith with the responsibility of managing another party's assets.
BREAKING DOWN 'Fiduciary'
A fiduciary's responsibilities are both ethical and legal. When a party knowingly
accepts a fiduciary duty on behalf of another party, they are required to act in the
best interest of the party whose assets they are managing. The fiduciary is
expected to manage the assets for the benefit of the other person rather than for
his or her own profit, and cannot benefit personally from their management of
assets. This is what is known as a prudent person standard of care, a standard that
originally stems from an 1830 court ruling. This formulation of the prudent-person
rule, required that a person acting as fiduciary was required to act first and
foremost with the needs of beneficiaries in mind, and that they must work to
preserve the estate or corpus of a trust, as well as the amount and regularity of
income.
Types of Relationships
While the most common types of fiduciary relationships are between a trustee and a
beneficiary, fiduciary duties appear in a wide variety of common business
relationships.
The way the relationship between a trustee and beneficiary would work is that the
trustee, while legally owning property or assets, is bound by both equity and
their fiduciary duty to manage the assets in accordance with the best interests of
the beneficiary. A similar fiduciary duty can be held by corporate directors, seeing
as they can be considered trustees for stockholders if on the board of a corporation,
or trustees of depositors if service as director of a bank.
Politicians often set up blind trusts in order to avoid conflict of interest scandals. A
blind trust is relationship in which a trustee is in charge of the investment of a
beneficiary's corpus without the beneficiary knowing how the corpus is being
invested. Even while the beneficiary has no knowledge, the trustee has a fiduciary
duty to invest the corpus according to the prudent person standard of conduct.
Other types of relationships where fiduciary duties are involved include:
Regulation
The Department of the Treasury's agency, the Office of the Comptroller of the
Currency is in charge of regulating federal savings associations and their fiduciary
activities. Multiple fiduciary duties may at times be at conflict with one another, a
problem that often occurs with real estate agents and lawyers. Two opposing
interests can at best be balanced; however, balancing interests is not the same as
serving the best interest of a client.
A fiduciary cannot profit from their position, according to an English High Court
ruling, Keech vs. Sandford (1726). All profits made by the fiduciary as result of their
position must be reported to the principal, and if the principal provides consent,
then the fiduciary can keep whatever benefit they received. These benefits can be
either monetary or defined more broadly as an "opportunity."
What is 'Convexity'
Convexity is a measure of the curvature in the relationship between bondprices
and bond yields that demonstrates how the duration of a bondchanges as the
interest rate changes. Convexity is used as a risk-management tool, and helps to
measure and manage the amount of market risk to which a portfolio of bonds is
exposed.
What is 'Fungibility'
Fungibility is a good or asset's interchangeability with other individual goods/assets
of the same type. Assets possessing this property simplify the exchange/trade
process, as interchangeability assumes that everyone values all goods of that class
as the same.
BREAKING DOWN 'Fungibility'
Many diverse types of assets are considered to be fungible. For example, specific
grades of commodities, such as No.2 yellow corn, are fungible because it does not
matter where the corn was grown - all corn designated as No.2 yellow corn is worth
the same amount.
Cross-listed stocks are considered fungible as well because it doesn't matter if you
purchased a share of XYZ stock in its home country or in a foreign country; it should
be accepted at either location as XYZ stock.
What is 'Collateral'
Collateral is a property or other assets that a borrower offers a lender to secure a
loan. If the borrower stops making the promised loan payments, the lender can
seize the collateral to recoup its losses. Because collateral offers some security to
the lender in case the borrower fails to pay back the loan, loans that are secured by
collateral typically have lower interest rates thanunsecured loans. A lender's claim
to a borrower's collateral is called a lien.
BREAKING DOWN 'Collateral'
If you get a mortgage, your collateral would be your house. If you stop making your
monthly house payments, the lender can take possession of the home through a
process called foreclosure and sell it to get back the principal it lent you. In margin
trading, the securities in your account act as collateral in case of a margin call.
Similarly, if you were to stop making your payments on an auto loan, the lender
would seize your vehicle. When you borrow money with a credit card, however,
there is no collateral, so credit card debt carries a significantly higher interest rate
than mortgage debt or auto loan debt.
Subsidiary Company
Definition: A subsidiary company is a business entity that is controlled by another
organization through ownership of a majority of its voting stock. This separate legal
structure may be used to gain certain tax benefits, track the results of a separate
business unit, segregate risk from the rest of the organization, or prepare certain
assets for sale. A larger business may own dozens or even hundreds of subsidiary
companies.
What is a 'Debenture?'
A debenture is a type of debt instrument that is not secured by physical
assets or collateral. Debentures are backed only by the general creditworthiness
and reputation of the issuer. Both corporations and governments frequently issue
this type of bond to secure capital. Like other types of bonds, debentures are
documented in an indenture.
BREAKING DOWN 'Debenture'
Debentures have no collateral. Bond buyers generally purchase debentures based
on the belief that the bond issuer is unlikely to default on the repayment. An
example of a government debenture would be any government-issued Treasury
bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are generally considered
risk free because governments, at worst, can print off more money or raise taxes to
pay these types of debts.
Debentures are the most common form of long-term loans that can be taken out by
a corporation. These loans are normally repayable on a fixed date and pay a fixed
rate of interest. A company normally makes these interest payments prior to paying
out dividends to its shareholders, similar to most debt instruments. In relation to
other types of loans and debt instruments, debentures are advantageous in that
they carry a lower interest rate and have a repayment date that is far in the future.
Convertible and Non-Convertible Debentures
There are two types of debentures as of 2016: convertible and non-convertible.
Convertible debentures are bonds that can convert into equity shares of the issuing
corporation after a specific period of time. These types of bonds are the most
attractive to investors because of the ability to convert, and they are most
attractive to companies because of the low interest rate.
Non-convertible debentures are regular debentures that cannot be converted into
equity of the issuing corporation. To compensate, investors are rewarded with a
higher interest rate when compared to convertible debentures.
Features of a Debenture
All debentures have specific features. First, a trust indenture is drafted, which is an
agreement between the issuing corporation and the trust that manages the interest
of the investors. Next, the coupon rate is decided, which is the rate of interest that
the company will pay the debenture holder or investor. This rate can be either fixed
or floating and depends on the company's credit rating or the bond's credit rating.
For non-convertible debentures, the date of maturity is also an important feature.
This date dictates when the issuing company must pay back the debenture holders.
However, the company has a few options for how it will repay. The most common
form of repayment is called a redemption out of capital, in which the issuing
company makes a lump sum payment on the date of maturity. A second option is
called a debenture redemption reserve, in which the issuing company transfers a
specific amount of funds each year until the debenture is repaid on the date of
maturity.
What is a 'Placement'
A placement is the sale of securities to a small number of private investors instead
of to the general investing public. A placement is exempt from registration with the
Securities and Exchange Commission. Because of this exemption, a placement can
be a simpler and less expensive way for a company to raise capital than a public
offering.
BREAKING DOWN 'Placement'
Unlike with a public offering, a formal prospectus does not have to be provided for a
private placement, though the information that would be contained in a prospectus
must still be available. The buyers in a private placement will usually be
large, sophisticated investors such as investment banks, investment funds and
insurance companies. The public may not be aware of a placement until it has been
completed.
What is a 'Syndicate'
A syndicate is a temporary professional financial services group formed for the
purpose of handling a large transaction that would be hard or impossible for the
entities involved to handle individually. Syndication allows companies to pool their
resources and share risks. There are several different types of syndicates,
including underwriting syndicates, banking syndicates and insurance syndicates.
riter may evaluate the potential health risks for each of the firms employees. The
underwriters actuary uses statistics to assess the risk of illness for each employee
in the companys workforce. If the potential risk of providing health insurance is too
great for a single insurance firm, that company may form a syndicate to share the
insurance risk.
How Companies Combine Available Expertise
Some projects are so large that no single company has all of the expertise needed
to efficiently complete the project. This is often the case with large construction
projects, such as a stadium, highway or railroad project. Companies form a
syndicate so that each firm can apply a specific area of expertise to the project. In
addition, subcontractors are assigned specific components of the project, such as
lighting or concrete work. Each subcontractor obtains financing for its portion of the
contract.
What is a 'Trustee'
A trustee is a person or firm that holds or administers property or assets for the
benefit of a third party. A trustee may be appointed for a wide variety of purposes,
such as in the case of bankruptcy, for a charity, a trust fund or for certain types of
retirement plans or pensions. They are trusted to make decisions in the
beneficiary's best interests.
What is a 'Custodian'
A custodian is a financial institution that holds customers' securities
forsafekeeping so as to minimize the risk of their theft or loss. A custodian holds
securities and other assets in electronic or physical form. Since they are responsible
for the safety of assets and securities that may be worth hundreds of millions or
even billions of dollars, custodians generally tend to be large and reputable firms.
BREAKING DOWN 'Custodian'
In addition to holding securities for safekeeping, most custodians also offer a variety
of other services including account administration, transaction settlements,
collection ofdividends and interest payments, tax support and foreign exchange.
The fees charged by custodians vary, depending on the services desired by the
client. Many firms charge custody fees payable quarterly that are based on the
aggregate value of the holdings.
What is 'Divestment?'
Divestment is the process of selling an asset. Also known as divestiture, it is made
for either financial or social goals. Divestment is the opposite of investment.
Venture capital firms began posting some of their first losses in the mid 1980s after
the industry had become flush with competition from firms both in and outside the
U.S. looking for the next Apple (AAPL) or Genentech. As IPOs from VC backed
companies were looking increasingly unremarkable, venture capital funding of
companies slowed. It wasnt until about mid 1990s that venture capital investments
started back with any real vigor only to take a hit in the early 2000s when so many
tech companies fell apart prompting venture capital investors to sell off what
investments they had at a substantial loss. Since then, venture capital has made a
substantial comeback, with $47 billion dollars invested into startups as of 2014.
Structure
A Venture capital firm, along wealthy individuals, insurance companies, pension
funds, foundations, and corporate pension funds among others pool money together
into a fund to be controlled by a VC firm. All partners have part ownership over the
fund, but it is the VC firm that controls where the fund is invested, usually into
businesses or ventures that most banks or capital markets would consider too risky
for investment. The Venture capital firm is the general partner, while the pension
funds, insurance companies, etc. are limited partners.
Compensation
Payment is made to the venture capital fund managers in the form of management
fees and carried interest. Depending on the firm, roughly 20% of the profits are paid
to the company managing the private equity fund while the rest goes to the limited
partners who invested into the fund. General partners are usually also due an
additional 2% fee.
Positions Within a VC Firm
The general structure of the roles within Venture Capital firm vary from firm to firm,
but they can be broken down to roughly three position.
Principals are on a partner track, and depending on the returns they can
generate from the deals they make. Partners are primarily focused on
What is a 'Merger'
A merger is a deal to unite two existing companies into one new company. There are
several types of mergers and also several reasons why companies complete
mergers. Most mergers unite two existing companies into one newly named
company. Mergers and acquisitions are commonly done to expand a companys
reach, expand into new segments, or gain market share. All of these are done to
please shareholders and create value.
BREAKING DOWN 'Merger'
In 2015, there was a record $4.30 trillion worth of mergers and acquisitions
announced. Deal making continues to be a popular way to grow revenue and
earnings for companies of varying size. Mergers are most commonly done to gain
market share, expand to new territories, and unite common products.
Types of Mergers
There are five main types of company mergers:
Conglomerate: nothing in common for united companies
Horizontal: both companies are in same industry, deal is part of consolidation
Market Extension: companies sell same products but compete in different markets
Product Extension: add together products that go well together
Vertical Merger: two companies that make parts for a finished good combine
Examples of Mergers
Anheuser-Busch InBev is an example of how mergers work and unite companies
together. The company is the result of multiple mergers,
consolidation, and market extensions in the beer market. The newly named
company is the result of the mergers of three large international beverage
companies. Anheuser-Busch InBev is the end result of uniting Interbrew (Belgium),
Ambev (Brazil), and Anheuser-Busch (United States). Ambev merged with Interbrew
uniting the number three and five largest brewers in the world. When Ambev and
Anheuser-Busch merged, it united the number one and two largest brewers in the
world. This example represents both horizontal merger and market extension as it
was industry consolidation but also extended the international reach of all the
combined companys brands.
The largest mergers in history have totaled over $100 billion each. In 2000,
Vodafone acquired Mannesmann for $181 billion to create the worlds largest mobile
telecommunications company. In 2009, AOL and Time Warner merged in a $164
million deal that is considered one of the biggest flops ever. In 2014, Verizon
Communications bought out Vodafones 45% stake in Vodafone Wireless for $130
billion.
Due to the large number of mergers, there is even a mutual fund that gives
investors a chance to profit from the deals. The fund captures the spread, or
amount left between the offer price and trading price. The Merger Fund from
Westchester Capital Funds has been around since 1989. The fund invests in
companies that have publicly announced a merger or takeover. To invest in the
fund, a minimum amount of $2,000 is required, and the fund does charge a higher
1.7% expense ratio. Since its inception, the fund has returned an average of 6.3%
annually.
What is an 'Acquisition'
An acquisition is a corporate action in which a company buys most, if not all, of the
target company's ownership stakes in order to assume control of the target firm.
Acquisitions are often made as part of a company's growth strategy whereby it is
more beneficial to take over an existing firm's operations and niche compared to
expanding on its own. Acquisitions are often paid in cash, the acquiring company's
stock or a combination of both.