Question

Financing Goals Small firms tend to raise funds from private investors and venture capitalists. As these firms grow larger, they focus more on raising capital from the organized capital markets. Explain why this occurs.

Answer 1

To raise funds from capital market, a business has two options at their disposal:

1. Debt Market : They can issue corporate bonds and can raise money for investment.

2. Equity Market : They can sell their fraction of ownership and can raise money

Now if we take case of small business, they are not very keen on exploring these options. The reasons for that :

1. Bond price and interest which needs to be paid on the bond depends upon the stability and profitability of the business. Small business and new business does not have much reputation in the market, so any investor who will buy their bonds will require relatively higher rate to compensate the risk he is taking by investing in that business.

2. Secondly, the interest rate on the bond is fixed, so whether the business will make money of not, they have to pay interest anyways. So that is the risk to small businesses who are new in the market and not stable

3. For equity market, not every company can come and raise money from equity market. There are are set guidelines and requirements by the market regulators like SEC, SEBI etc, which company needs to fulfill and then only they will become eligible to list their shares. Small businesses usually are not able to met those requirements and it becomes difficult for them to choose this path

So small businesses choose private investor and venture capitalists to raise funds. These investors are high risk takers and they invest in small business, help them grow for few years and reap benefits afterwards. Also, these investors does not ask for immediate return and they take long term picture into consideration. So firms get funds and guidance from them also to succeed.

When they grow larger, these investors want to gain out of their investment and that they do but going public and selling their shares to public. Also, once the firm started growing, they will gain some market and they will have access to debt and equity market easily.

I hope this is clear now

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