How To Raise Company’s Capital : Method Of Equity Financing Research Paper

Introduction

Any company faces a need to get external financing when it achieves the stage of growth and market expansion. There are two primary methods of raising capital – debt financing and equity financing (Besley & Brigham, 2011). Each of these methods has its own pros and cons. Debt financing is based on borrowing money, but retaining ownership, while equity financing means that new common stock or shares are issued and offered to investors. Apex Printing, Inc. is planning an Initial Public Offering (IPO), so the focus of this paper will be on equity financing. The purpose of this paper is to identify the costs of issuing equity, to consider pros and cons of issuing equity and to discuss SEC compliance requirements associated with an IPO.

  1. Costs of Issuing Equity

For performing strategic financial planning associated with issuing new equity, it is necessary to calculate the costs of issuing this equity. In order to calculate the costs of issuing equity, one should determine flotation costs – the overall costs of issuing the securities. Flotation costs commonly include legal fees, underwriting costs, banker’s fees and the costs of filing (Besley & Brigham, 2011).

Furthermore, it is possible to estimate the cost of new equity using divided growth model and adjusting the model using the value of flotation costs. The formula of new equity costs is as follows: , where  is the cost of new equity,  is the value of dividends paid in one year,  is stock price, F is the value of flotation costs, and g is the expected dividend growth rate (Ehrhardt & Brigham, 2010). If the company has not become public yet, it is important to account for the costs of an IPO. These costs include underwriter’s discount, legal costs (costs associated with securities counsel operations), payments to external auditors, fees paid to financing reporting advisors, printing costs, registration expenses and the fees paid for exchange listing (PricewaterhouseCoopers, 2014).

  1. Pros and Cons of Issuing Equity

There are numerous benefits of equity financing compared to debt financing. Funds raised due to equity financing strengthen the company’s cash position and can be used for long-term projects and investments (Ehrhardt & Brigham, 2010). If the IPO is successful, the company’s value is likely to increase. Public companies can perform mergers and acquisitions more efficiently using stock (instead of spending cash). Using equity financing, the company might greatly improve its liquidity, develop new growth strategies, attract talented people and retain existing “stars”. The company’s reputation is also likely to improve. In addition, the company’s leveraging remains balanced, so financial position should generally strengthen after issuing equity.

At the same time, equity financing has many disadvantages. First of all, equity financing means that founders no longer have full control over the company’s strategy and development. Equity financing also incurs significant expenses such as the costs of an IPO and ongoing expenses of being public – external auditing costs, investor relations costs and administrative costs (PricewaterhouseCoopers, 2014). After an IPO, the company loses privacy and has to reveal sensitive financial information to the public. Public companies experience greater pressures for performance, as stock value is strongly related to financial indicators. Public companies have to manage investor relations. In addition, public companies face risks of takeover or litigation, and generally cannot return to being private (Ehrhardt & Brigham, 2010).

  1. Compliance Requirements

There are multiple SEC compliance requirements that should be satisfied before going public. SEC financial requirements became stricter when the Sarbanes-Oxley Act of 2002 (SOX) was enacted (Besley & Brigham, 2011). Two key provisions of SOX that require compliance prior to IPO are Section 302 and Section 404. Section 302 requires that senior officers certify the use of appropriate internal controls for ensuring the accuracy of data published in periodic reports. Section 404 demands that external auditors as well as the company’s management report on the adequacy of internal controls over financial reporting (PricewaterhouseCoopers, 2014).

Therefore, Apex Printing, Inc. should prepare beforehand to comply with SEC requirements for an IPO. In particular, the company’s management should document business processes that influence financial reporting, identify internal reporting risks and areas of internal reporting that should be improved, evaluate audit committee, its composition and role (PricewaterhouseCoopers, 2014). It is also important to identify reporting needs that are essential for public disclosure and reporting, and to adjust internal controls in the appropriate way (PricewaterhouseCoopers, 2014). In addition, the company needs to review its code of ethics, establish processes for proper whistleblowing and make the code of conduct and ethics available to the public.

 

References

Besley, S. & Brigham, E. (2011). Principles of Finance. Cengage Learning.

Ehrhardt, M. & Brigham, E. (2010). Corporate Finance. Cengage Learning.

PricewaterhouseCoopers. (2014). Roadmap for an IPO. PwC. Retrieved from http://www.pwc.com/us/en/transaction-services/assets/roadmap-for-an-ipo-a-guide-to-going-public.pdf

The terms offer and acceptance. (2016, May 17). Retrieved from

[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016.

[Accessed: March 28, 2024]

freeessays.club (2016) The terms offer and acceptance [Online].
Available at:

[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016

[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016

[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016

[Accessed: March 28, 2024]

"The terms offer and acceptance." freeessays.club, 17 May 2016

[Accessed: March 28, 2024]
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