Question

a) Describe four feasible ways for small firms to raise capital. b) Describe two advantages and two disadvantages for firms to raise capital through debt instead of equity. (4 mark) c) Explain the difference between IPO underwriting spread and IPO underpricing.

Answer 1

a) Describe four feasible ways for small firms to raise capital.

1. Owner's capital: Nowadays boot-strapping is becoming more popular as it gives the entrepreneurs more freedom & comfort in knowing that that they have their skin in the game.

2. Small Business loans: Governments are trying to boost startups morale by giving more room to such firms to avail small business loans.

3. Angel investors: Angel investors (mostly venture capitalists) invest in small firms. This not only helps in bringing money but also with some expertise & experiance.

4. Crowdfunding: Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture

b) Describe two advantages and two disadvantages for firms to raise capital through debt instead of equity.

Advantages

1. Control: aking out a loan is temporary. The relationship ends when the debt is repaid. The lender does not have any say in how the owner runs his business.

2. Taxes: Loan interest is tax deductible, whereas dividends paid to shareholders are not.

Disadvantages

1. Collateral: Lenders will typically demand that certain assets of the company be held as collateral, and the owner is often required to guarantee the loan personally

2. Fixed payments: Principal and interest payments must be made on specified dates without fail. Businesses that have unpredictable cash flows might have difficulties making loan payments.

c) Explain the difference between IPO underwriting spread and IPO underpricing.

IPO Underwriting spread: The underwriting spread is the difference between the amount that a securities underwriter return to an issuer and the total proceeds gained from the issue.

IPO Underpricing: Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market.