Structured capital resources are a fundamental requirement for the success of any business. Capital is needed when starting a new company or when there is need to expand an existing one (Clayman 2011, p. 25). There are two main types of business capital that are normally used to begin a new company or expand an existing on. The first type of business capital is the debt capital (Clayman 2011, p. 25). Banks and other financial institutions can extend credit to a company under certain terms and conditions agreed upon by the two parties. The repayment terms of capital borrowed from financial institutions must be adhered to by the borrowing company (Clayman 2011, p. 25). It is the obligation of a company to ensure that all the capital borrowed is well invested and paid back without default (Clayman 2011, p. 29). The second type of capital is equity capital. In this case, investors invest their money in a particular company in exchange of shares and dividends. Equity offering has got its terms and conditions that must be followed by the company issuing the equity and shareholders.
There are five major instruments or methods through which companies use to raise capital (Clayman 2011, p. 37). Issuing of bonds in the first method where bondholders invest their money in a company with a promise of receiving interest payments at a particular fixed rate. There are specified dates in bond issuing but bondholders have an option of waiting until the bonds are due or selling the bonds to other investors before they are due (Clayman 2011, p. 37). Companies benefit a lot from issuing bonds because the interest rates paid to investors are relatively small. The second method of raising capital is through issuing preferred stock. In this case, a company issues a special stock to the public with the buyers of this type of shares enjoying protection in instances where a company fails to perform well financially (Clayman 2011, p. 37). The shareholders in this type of arrangement are paid their dividends before dividends for other common shareholders are released. In a preferred stock issuing, the interest payment for bondholders are first made before preferred-stock owners are paid by their dividends (Clayman 2011, p. 37).
The third instrument of raising capital by existing companies is selling common stock (Megginson 2008, p. 318). This happens only when a company is in a good financial position. The process of issuing common stock is facilitated by investment banks which issue stocks and at the same time negotiate the buying price by investors. Investment banks or underwriters always buy shares from companies at the set minimum price even if the public decline the price (Megginson 2008, p. 318). Common shareholders always come after preferred-stock holders and bondholders when it comes to payment of dividends. Each company has its specific strategies of attracting investors according to its objectives and goals (Megginson 2008, p. 318). Common shareholders can be attracted to a company because of the prospect of earning high dividends. A company can struggle to increase its profitability through being out low dividends to shareholders and in the process attract new investors (Megginson 2008, p. 358). The value of shares is largely dependant on a company’s profitability. The higher the profit, the higher the earnings from shares.
The fourth method of raising capital is through the use of profits (Megginson 2008, p. 318). A certain percentage of the total profit earned by a company can be used to fund internal operations. A company can decided to use part of its annual profits for expansion rather than paying out the entire profit to shareholders through dividends (Megginson 2008, p. 318). This strategy may have long-term benefits to shareholders because the value of shares is bound to rise through reinvesting a company’s income. Borrowing from banks and other lenders is the fifth and final method through which existing companies can use to raise capital.
The Facebook Company is an example of companies that conducted equity issuing recently (Megginson 2008, p. 456). The procedure of through equity issuing is universal except for a few variations based on financial laws of a particular country. Equity issuing is normally done through an initial public offering (IPO). A company that is ready to offer its shares to the public does so with the help of an investment bank. A private company enters into a contract with an investment bank that sells the shares to the public on behalf of the company (Megginson 2008, p. 456). It is the duty of investment banks to look for investors to buy a particular company’s shares. The pricing and allocation of shares in an IPO takes place in different forms that include firm commitment contracts, best efforts contacts, bought deals and all-or-none contracts (Megginson 2008, p. 456). The investment bank commonly referred to as the underwriter is entitled to a certain proportion of investment proceeds as a fee for the services rendered in selling shares (Megginson 2008, p. 456). The underwriting spread includes the underwriting fee, the management fee and the concession fee that goes to stock brokers (Megginson 2008, p. 456).
The share value of a given company is a clear indicator of the company’s financial position (Megginson 2008, p. 457). The underwriters buy shares from companies at the minimum value possible with an intention of selling them to investors. The share price can be lowered to attract small-scale investors. Facebook was registered and approved for listing on the NASDAQ by the U.S Securities and Exchange Commission for the first time in February 2012 (Sherman 2012, p.134). The value of Facebook’s Class A common stock is $ 0.000006 per share. The total volume of shares offered by Facebook was 357.42 million shares. 180 million shares of the total shares were offered by the Facebook Company with the remaining 157.42 million shares being offered for the IPO by selling stockholders (Sherman 2012, p.134). The IPO price range of Facebook is from $ 28 to around $ 35.
The Morgan Stanley Group is the official underwriter given the responsibility of managing Facaebook’s IPO (Sherman 2012, p.134). There are other 32 investment banks that have been hired by Facebook in addition to the Morgan Stanley Group. Facebook has managed to raise $16 billion in its IPO but the underwriters collected a lower than average fee of 1.1 % of the total amount collected by the company (Sherman 2012, p.134). The value of Facebook is estimated to be $104.2 billion and this made underwriters to take a small percentage fees because the company issued a large IPO. The larger the IPO the smaller the amount of fee paid to underwriters. A substantial amount of the IPO fees paid to underwriters went to the Morgan Stanley Group since it was the leading underwriter in the Facebook equity offering (Sherman 2012, p.134).
There is always a possibility of over-subscription or under-subscription in an equity offering (Megginson 2008, p. 460). This is basically influenced by the information that potential investors receive from underwriters. It is disappointing for an investor to apply for shares and fail to get them (Megginson 2008, p. 460). This scenario is referred as over-subscription and the reverse of this is known as under-subscription. The company concerned comes up with the lowest and highest share prices and presents the shares for bidding in the allotment process (Megginson 2008, p. 460). The bidding in the allotment process determines the actual share price in a case of over-subscription or under-subscription. Bidding is the most transparent share allotment method when dealing with over-subscription and under-subscription from investors (Megginson 2008, p. 460). The probability of share allotment depends on the number of shares that an investor applies for (Megginson 2008, p. 460).
There are many advantages that a company being listed on the stock exchange enjoys (Sherman 2012, p. 245). To begin with, public listing gives a company the right platform to market its shares and in the process raise some new capital. The financial standing of a company is improved in a great way through listing (Sherman 2012, p. 245). The public is able to learn more about a particular company through public listing and this also serves as a marketing platform. The public image of a company is improved through listing and therefore generating a public interest in the company’s products (Sherman 2012, p. 245). The investments of shareholders within a particular company can be realized through listing. Public listing of shares gives the company a sense of future financial security because the company can be able to obtain additional funding through issuing of shares. As a way of motivating employees, a company can arrange for share options schemes for them through public listing. Acquisition opportunities are normally difficult to come by and therefore public listing helps a great way in facilitating such opportunities (Sherman 2012, p. 245). Public listing promotes transparency within a company because all the business and financial information of a company must be provided as listing requirements (Sherman 2012, p. 245). Listing gives an existing company a good opportunity to raise new capital for expansion (Sherman 2012, p. 247). Public awareness is important if a company needs to attract investors. The awareness created by public listing is essential in attracting investors to a particular company (Sherman 2012, p. 247).
Clayman, M 2011, Corporate finance: A practical approach, John Wiley & Sons, New York, NY.
Megginson, W 2008, Introduction to corporate finance, Cengage Learning, New York, NY.
Sherman, A 2012, Raising capital: Get the money you need to grow your business, AMACOM Div American Management Association, New York, NY.