Question

Answer 2 of the following 4 discussion questions below. thanks

1. Discuss the benefits of a public company vs a private company.
2. Explain the process in determining if the company should buy or lease its new building.
3. As an investor, when would convertible preferred stock be an attractive investment?
4. Explain the use of futures contracts in limiting your risk in a sale of equipment to a German buyer

Answer 1

1.The common theme of these advantages is that a liquid market for its shares “unlocks” value that the company could not otherwise access. By having publicly traded stock, the discount attached to stock of private companies no longer applies.

• Cash Infusion: The result of an IPO is a significant and immediate infusion of cash into the company. This cash is typically “earmarked” for specific uses described in the IPO disclosure documents. These uses of the proceeds can be for a variety of purposes. For example, the company may use the money to expand its inventory, property and equipment base, to reduce debt, further research and development or expand its services.

• “Minting of Coin” Having an established value and liquid market for its stock creates additional “coin” for the company through issuance of additional shares. This “coin” may be used as consideration to acquire other businesses and to compensate both current and future employees.

The ability to utilize the company’s stock for an acquisition significantly decreases its need for cash and allows it to engage in transactions without tapping into its “war chest” of IPO proceeds, which can be put to use to fund future growth. In addition, acquisitions using the company’s stock as consideration may be structured as a “tax-free” reorganization, which can allow the sellers to defer taxes on gains associated with the sale of their business. Using stock as consideration for acquisitions also provides sellers an opportunity to participate in the future growth of the combined organization.

Another benefit of a liquid market for a public company’s shares is that its stock may be used to compensate both its existing and future officers and employees through the grant of options or direct issuance of shares. Grants of options or stock provide a means to share the company’s success and are a great tool for attracting talented management and employees.

• Access to Capital Markets: Being a public company enhances access to both equity and debt markets. After the company has been a reporting company for 12 months, it may engage in follow-on offerings using a “short form” registration process. The ability to use this process reduces both the time and expense of future equity financings.

As a reporting company, the transparency of its financial position and operations makes it better suited to obtain debt financings. The infusion of cash from an IPO also enhances the balance sheet and makes the company a much stronger candidate for debt financings.

• Liquidity: An IPO provides liquidity to the company’s founders, employees and pre-IPO investors holding the company’s stock, i.e., they can sell their shares. While the liquidity may not be realized right away due to “lockup” requirements imposed by underwriters and other SEC rules, being a public company provides a means for the pre-IPO stockholders to monetize the value of their stock at some point in the future.

Institutionalization: Being a publicly traded company adds to the company’s stature as an institution, which can enhance its competitive position. The IPO process itself generates publicity that may enhance the company’s recognition in the marketplace. As a result, suppliers, vendors and lenders often perceive the company as a better credit risk and customers may perceive it as a better source of products or services. The stature of a public company can also enhance its ability to attract top level executives and employees.

While going public can have many positive effects on a company and its operations, these positive effects must be balanced against the disadvantages, particularly in light of the alternatives. Going public drastically changes a company’s culture and has an ongoing impact on business operations.

3. Convertible Preferred Stock

Your business is expanding rapidly and you need to purchase new equipment. Your personal savings are depleted and you have asked the bank to increase your credit line. Unfortunately, the meeting did not go as well as you hoped. The banker was very impressed with your company's potential but was concerned your company is undercapitalized. In other words, increased debt loads would over-leverage the company and increase its risk profile.

Since you do not have additional funds at your disposal, you may look to friends and family for additional investors. Unfortunately, your friends and family may be over-leveraged as well and be unable to provide the capital infusion you need. You were not wild about having a minority shareholder anyway. You like the being the sole owner. In this situation, you will need to use equity financing to raise capital.

Wishing to maintain management control often hinders fundraising for small privately held corporations. Outside investors often want a say in corporate management to protect their investment. Minority shareholders in a private company can be outvoted by the majority shareholder on every vote, so they have no real control over management. Also, there is no easy way for a minority investor to sell his shares since the company is not publicly traded.

After consulting with your financial advisor, you decide preferred stock is the best way to raise new capital. Preferred stock is somewhat different than common stock. Preferred stock shareholders do not vote to elect directors or in other corporate matters, so management retains control of the company. Preferred stock shareholders receive set dividend payments, somewhat like interest payments for a bond. However, no one can force a board of directors to declare a dividend. If cash flow does not support dividends the board can forego the dividend payment at its discretion. There can be a great variation in characteristics among preferred stock issues. You can attempt to tailor the characteristics of the preferred stock to what makes sense for your company.