Question

Gonzales Food Stores, a family-owned grocery store chain headquartered in El Paso, has hired you to make recommendations concerning financing needs for the following two situations. Part I: Initial Expansion Gonzales is a closely held corporation considering a major expansion. The proposed expansion would require the firm to raise $10 million in additional capital. Because Gonzales currently has 50 percent debt and because the family members already have all their funds tied up in the business, the owners cannot supply any additional equity, so the company will have to sell stock to the public. The family wants to ensure that it will retain control of the company. This offering would be Gonzales’s first stock sale, and the owners are not sure exactly what would be involved. For this reason, they have asked you to research the process and to help them decide how to raise the needed capital. In doing so, you should answer the following questions:

a. What are the advantages to Gonzales of financing with stock rather than with bonds? What are the disadvantages of using stock?

b. Is the stock of Gonzales Food Stores currently publicly held or privately owned? Would this situation change if the company undertook a stock sale?

c. What is classified stock? Would Gonzales find any advantage in designating the stock currently outstanding as founders’ shares? What type of common stock should Gonzales sell to the public to allow the family members to retain control of the business?

d. If some members of the Gonzales family wanted to sell some of their own shares to diversify at the same time that the company was selling new shares to raise expansion capital, would this choice be feasible?

Answer 1

a) Stocks are the equity for raising capital from the public by issuing securities whereas bonds are debt instrument. By buying stocks, public will be buying part ownership of the company. in debt, investor loans out the money to the company for a fixed period and interest is compulsorily required to be paid periodically to an investor.

Advantages to the Gonzales of financing with stock are:

• One of the major advantage of issuing stock rather than bond is that company can escape regular interest payments. By issuing stock it is not compulsory to issue dividend regularly at the fixed rate.
• Another advantage is that the company would have fewer restrictions from investors in case of financing through stock.
• Equity shares can be issued without any charge on assets which is not possible in the case of financing through bonds.
• Credit rating of the company improves when stocks are issued inspite of bonds.

Disadvantages of using stock are:

• Equity shareholders put barriers in management by influencing decisions.
• Using stock financing involves floatation cost and lots of issue expenditures.
• There would be need to comply with many statutory formalities in this case.
• Existing shareholder's ownership stake dilutes and voting power diminishes.

b) Currently, stock of Gonzales food stores is privately owned.as it is already mentioned that it would be Gonzales first stock sale.

Yes, the situation would definitely change if stock is publicly sold. Selling stock would make the company publicly owned.

c) Classified stock

Dividing the stock into more than one category of stock. Special Privileges are accompanied with these type of stocks in the form of better dividend rights or voting rights.

Yes, Gonzales will have advantage by designating outstanding shares as founders shares.

To retain control of the business, Preference shares should be issued instead of equity shares. Unlike equity shares, it will not dilute ownership of the company. Further, there would be no charge over assets of the company.

d) No, choice is not feasible because the company is already issuing new stock to raise capital, so there is no need to sell shares on the part of members of Gonzales family. Moreover, ownership will drastically reduce if members will start selling their shares too.