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Intro to Business
Table of Contents
Unit 16 Overview: Financial Management and Securities Basics
16.1 The Role of Finance and the Financial Manager
16.2 How Organizations Use Funds
16.3 Obtaining Short-Term Financing
16.4 Raising Long-Term Financing
16.5 Equity Financing
16.6 Securities Markets
16.7 Buying and Selling at Securities Exchanges
16.8 Trends in Financial Management and Securities Markets

Equity financing is a crucial way for companies to raise capital. It involves selling ownership stakes to investors, ranging from initial public offerings to venture capital investments. This approach can provide significant funding and strategic benefits, but also comes with costs and potential loss of control.

Companies must carefully weigh the pros and cons of different equity financing options. Decisions about dividends, retained earnings, and types of stock offered can impact a company's financial position and growth potential. Understanding these choices is key for business success.

Equity Financing

IPO Process and Costs/Benefits

  • Initial Public Offering (IPO) process of offering shares of private company to public for first time company sells portion of ownership to public investors shares listed on stock exchange for trading
  • IPO process company selects investment bank (underwriter) to manage IPO due diligence and regulatory filings prepared underwriter sets initial price for shares shares allocated to investors and begin trading on stock exchange
  • Benefits of IPO raises significant capital for growth and expansion increases company's public profile and credibility provides liquidity for existing shareholders enables company to use stock as currency for acquisitions and employee compensation (stock options)
  • Costs of IPO underwriting fees paid to investment banks (7-10% of IPO proceeds) legal, accounting, and marketing expenses ($1-3 million) ongoing regulatory compliance costs (annual reports, audits) pressure to meet short-term expectations of public investors potential loss of control and increased scrutiny from shareholders

Dividends vs Retained Earnings

  • Dividends portion of company's profits distributed to shareholders represents return on investment for shareholders paid in cash or additional shares of stock reduces company's retained earnings and cash reserves
  • Retained earnings portion of company's profits not distributed as dividends reinvested in company for growth and expansion (research and development, capital expenditures) increases company's book value and shareholders' equity provides source of internal financing for future projects
  • Impact on financial position
    • Dividends reduce cash reserves and retained earnings may signal financial stability and attract income-seeking investors (retirees) excessive dividends may limit growth opportunities
    • Retained earnings increase assets and shareholders' equity provide cushion against future losses or economic downturns may be used to finance growth and expansion without additional debt or equity

Preferred Stock and Venture Capital

  • Preferred stock hybrid security with characteristics of both debt and equity provides fixed dividend payment, prioritized over common stock dividends lacks voting rights in most cases offers preference in asset claims during liquidation attractive to investors seeking stable income and lower risk compared to common stock (institutional investors)
  • Venture capital financing provided by venture capital firms to high-growth potential, early-stage companies venture capitalists invest in exchange for equity stake and often provide strategic guidance suitable for companies with innovative products or services and significant growth potential (technology startups) allows companies to scale quickly without relying on debt financing or going public venture capitalists typically aim for high returns (10x) and exit strategy within 5-7 years (IPO or acquisition)
  • Role in equity financing
    1. Preferred stock provides alternative to common stock for raising capital attracts investors with lower risk tolerance or income-seeking goals can be used to raise capital without diluting common shareholders' voting power
    2. Venture capital offers significant funding for early-stage companies with limited access to traditional financing (banks) provides strategic guidance and industry expertise to help companies grow enables companies to scale quickly and achieve key milestones before pursuing IPO or acquisition

Key Terms to Review (34)

Comcast: Comcast is a multinational telecommunications conglomerate that is one of the largest broadcasting and cable television companies in the world. It provides a range of services including cable TV, broadband internet, and telephone services, and it also engages in content production and distribution through its NBCUniversal division.
Cargill: Cargill is a global corporation that operates in the agribusiness sector, focusing on trading, purchasing, and distributing grain and other agricultural commodities. It also plays a significant role in food production, animal nutrition, and risk management services related to agricultural commodities.
Blue Apron: Blue Apron is a publicly traded company that delivers meal kits directly to consumers, offering them pre-portioned ingredients and recipes to prepare home-cooked meals. It represents an example of a company that has accessed capital markets for equity financing to grow its business.
Publix Super Markets: Publix Super Markets is a large employee-owned, American supermarket chain headquartered in Lakeland, Florida. Known for providing a variety of grocery items, it also represents an example of a company that has grown significantly through equity financing by offering shares to its employees.
SC Johnson: SC Johnson is a multinational privately held manufacturer of household cleaning supplies and other consumer chemicals. It is an example of a company that, although not publicly traded, can engage in equity financing through private investors or reinvestment of profits for expansion and development.
Bloomberg: Bloomberg is a global platform providing financial software tools, data services, and news to individuals and companies in the securities market. It includes analytics, real-time financial market data, and a communication network for professionals in equity financing.
Venture capital: Venture capital is a type of private equity financing that investors provide to startup companies and small businesses believed to have long-term growth potential. It typically comes from well-off investors, investment banks, and any other financial institutions.
Preferred stock: Preferred stock is a type of equity security that offers its holders priority over common stock in the distribution of dividends and assets during liquidation. It often comes with fixed dividend payments but generally does not carry voting rights.
Retained earnings: Retained earnings are the portion of a company's profits not distributed to shareholders as dividends but kept in the company to reinvest in its core business or to pay off debt. They are found under shareholders' equity on the balance sheet.
Angel investors: Angel investors are affluent individuals who provide capital for a business start-up, usually in exchange for convertible debt or ownership equity. They typically step in after the initial "seed" funding round and before venture capitalists.
Stock dividends: Stock dividends are payments made by a corporation to its shareholders in the form of additional shares, rather than cash. These dividends are distributed based on the proportion of shares each shareholder already owns.
Common stock: Common stock represents ownership shares in a corporation, giving shareholders the right to vote on corporate matters and receive dividends. It is a primary means of equity financing for companies.
Nasdaq: Nasdaq is a global electronic marketplace for buying and selling securities, as well as the benchmark index for U.S. technology stocks. It operates 24/7 and provides critical infrastructure for executing trades.
Equity Financing: Equity financing refers to the process of raising capital for a business by selling ownership shares or stocks to investors. It represents a long-term source of financing that provides companies with funds in exchange for an equity stake in the organization.
Dividends: Dividends refer to the distribution of a portion of a company's earnings to its shareholders. They represent a return on the shareholders' investment and are typically paid out in cash on a per-share basis.
IPO: An IPO, or Initial Public Offering, is the process by which a private company sells its shares to the public for the first time, transitioning from a privately-held to a publicly-traded company. This event allows the company to raise capital by selling equity shares on a stock exchange, while also providing an opportunity for early investors and employees to liquidate their holdings.
Preferred Stock: Preferred stock is a type of equity ownership in a corporation that provides the shareholder with a higher claim on the company's assets and earnings compared to common stockholders. It is a hybrid security that combines features of both debt and equity financing.
Common Stock: Common stock represents a type of corporate equity ownership that grants the holder a claim on the company's earnings and assets. It is the most basic and widely held form of ownership in a corporation, providing shareholders with voting rights and a residual claim on the firm's profits and assets.
Venture Capital: Venture capital refers to the financing provided by investors, typically firms or funds, to new or growing businesses that are perceived to have high growth potential. These investors provide capital in exchange for an equity stake in the company, aiming to generate significant returns through the company's success and eventual exit, such as an initial public offering (IPO) or acquisition.
Angel Investors: Angel investors are high-net-worth individuals who provide financial backing and mentorship to startup companies and entrepreneurs in exchange for ownership equity or convertible debt. They play a crucial role in the entrepreneurial ecosystem by supporting new businesses during their early stages of development.
Stock Options: Stock options are a type of financial instrument that give the holder the right, but not the obligation, to buy or sell a company's stock at a predetermined price within a specific time period. They are commonly used as a form of employee compensation and can also be traded on financial markets.
Retained Earnings: Retained earnings represent the portion of a company's net income that is retained or saved rather than distributed to shareholders as dividends. It is an important component of a company's balance sheet, reflecting the accumulation of its past profits over time.
SEC Form S-1: SEC Form S-1 is a registration statement required by the U.S. Securities and Exchange Commission (SEC) for companies seeking to raise capital through an initial public offering (IPO) or other securities offering. This form provides detailed information about the company, its business, financial statements, and the securities being offered to the public.
NYSE: The New York Stock Exchange (NYSE) is the world's largest stock exchange, where publicly traded companies list their shares and investors can buy and sell these securities. It serves as a central marketplace for equity trading, facilitating the exchange of stocks between buyers and sellers.
Sequoia Capital: Sequoia Capital is a renowned venture capital firm that has played a pivotal role in the growth and success of numerous technology companies. As a leading investor in the startup ecosystem, Sequoia Capital has been instrumental in providing equity financing to innovative businesses, helping them scale and achieve remarkable milestones.
Private Equity: Private equity refers to investment funds that acquire and manage private companies or public companies that are then delisted from the stock exchange. These funds raise capital from institutional and individual investors to invest in a variety of companies with the goal of generating high returns through active management and eventual sale or public offering of the companies.
Secondary Offerings: A secondary offering refers to the sale of additional stock by a company that has already gone public through an initial public offering (IPO). In a secondary offering, the company itself does not receive any of the proceeds from the sale, as the shares being sold belong to existing shareholders rather than the company.
Initial Public Offering: An Initial Public Offering (IPO) is the process by which a private company sells its shares to the public for the first time, allowing it to raise capital and become a publicly-traded company. This transition from a private to a public company is a significant milestone in a company's lifecycle and can have far-reaching implications for its future growth and development.
Andreessen Horowitz: Andreessen Horowitz is a venture capital firm that invests in technology companies, focusing on early-stage startups and growth-stage businesses. Founded by Marc Andreessen and Ben Horowitz, the firm has become one of the most prominent and influential players in the technology investment landscape.
NASDAQ: NASDAQ is a major American securities exchange that is home to many of the world's largest technology and growth companies. It operates as an electronic marketplace where stocks are traded through a network of computers and brokers rather than on a physical trading floor.
Shareholder Rights: Shareholder rights refer to the legal and contractual rights granted to individuals or entities that own shares in a publicly traded company. These rights empower shareholders to have a voice in the company's decision-making processes and protect their investments.
Sarbanes-Oxley Act: The Sarbanes-Oxley Act (SOX) is a federal law enacted in 2002 that established new standards for public company accounting and financial reporting. It was created in response to high-profile corporate scandals to help restore public confidence in the accuracy and reliability of financial information disclosed by public companies.
Equity Dilution: Equity dilution refers to the reduction in the ownership percentage of existing shareholders when a company issues new shares of stock. This occurs when a company raises additional capital by selling more equity, resulting in a decrease in the proportional ownership and voting power of current shareholders.
Payout ratio: The payout ratio is a financial metric that shows the proportion of earnings a company pays to its shareholders in the form of dividends. It is calculated by dividing the total dividends paid by the net income of the company, reflecting how much profit is being returned to shareholders versus being reinvested in the business. Understanding the payout ratio helps investors gauge a company's dividend sustainability and growth potential.