Question

Discuss how best to evaluate methods of raising capital (both startup and operating), and the steps you would take in that process. To what extent would you consider an Initial Public Offering, if not immediately, then possibly later?

Answer 1

At the time of startup, the most important source of capital would be contribution from own sources (also known as owner's capital). It is because, banks and other financial institutions may not be interested in lending money to a new business. Depending on the risk aptitude of the business owner, he/she may decide to approach venture capitalists for obtaining funds for starting the business. However, this approach might involve dilution to owner's equity as the owner might have to share the equity with the venture capitalist. Additionally, venture capitalist may demand a substantial portion of business earnings in the form of return on investment. Therefore, it is extremely important for the business owner to perform/undertake a cost benefit analysis of using different sources of finance.

With the passage of time, as the business grows, it may become easier for the company to obtain funds from banks and other financial institutions. In such a case, it is essential to approach different types of lending institutions to obtain an understanding on the types of loans, rates of interest and methodology of getting finance through them. The company can also consider issuing bonds to raise capital from outside sources. Again, it is important for the company to identify the risks associated with the inclusion and use of debt in its day to day operations. Debt (in any form) increases the financial risk of the company because of fixed interest obligation.

Initial public offering involves issuance of equity to general public. This method is generally used when the company is planning to undertake expansion/growth projects in the near future. However, this form of financing would result in distribution of ownership to external parties who may nfluence the functioning of the company. Also, the company becomes subject to various rules and regulations and the management is required to ensure that the investors wealth is protected at all the times and they are provided with adequate returns either in the form of regular dividends or capital appreciation of their holdings in the company. Therefore, initial public offering should be considered as a means of raising capital only when the company is in need of large amount of funds, has been profitable in previous years and is in a position to provide investors with decent returns in the near future.