Raising Capital for

Privately Held Companies

Private Company Options
For many small companies, issuing debt and
issuing shares to the public are not viable
options.
Using retained earnings may be possible for the
company.
External source options include:
1. Commercial bank or finance company loans,
2. Lease financing, and,
3. Venture capital funding.
Commercial Bank Loans
Commercial banks and commercial finance
companies offer long-term commercial loans for
long-term needs.
Term loans are loans that mature in more than one
year.
They are usually used to purchase fixed assets
such as equipment, but they can also be used
for other longer-term purposes.
A commercial real estate loan is secured by real
property.
Lease Financing
Leasing is an alternative form of financing for
a business.
A lease is a contractual agreement between a
lessor and a lessee that gives the lessee
the right to use specific property, owned by
the lessor, for a specified period of time in
return for stipulated, and generally periodic,
cash payments (rents).
Advantages of Leasing
• Convenience of short-term leases
• 100% financing at fixed rates
• Protection against obsolescence
• Flexibility
Lease vs. Purchase Analysis
To determine which is the better financing
vehicle for a particular transaction, a cash flow
analysis using discounted cash flow concepts
is needed.
Example: Cement Works Co. is considering whether to lease or
buy a cement mixing truck that will cost $100,000 to buy. The
truck dealer has offered to set up a lease instead of selling the
truck to Cement Works. The lease payments will be $24,000 per
year for five years, payable at the end of each year of the lease.
At the end of the lease, the truck would be returned to the lessor,
and the interest rate in the lease is 5%.
Alternatively, Cement Works can purchase the truck for cash for a
price of $100,000.
The decision will be made by calculating the present value of the
lease payments and comparing that to the cash price if the
company buys the truck without borrowing money.
The calculation of the present value of the lease payments is
done by finding the table value for a 5 year ordinary annuity at 5%
for 5 years, or by using a financial calculator. The table value for a
5 year, 5% ordinary annuity is 4.329.
The present value of the lease payments is
$24,000 x 4.329 = $103,896.

Since the present value of the lease payments is higher than the
cash purchase price of $100,000, Cement Works should
purchase the asset for $100,000 as it will save them $3,896 in
present value.
Venture Capitalists
A ompany that has gone through the capital provided
by the original stockholders and requires additional
financing may turn to venture capitalists.
In exchange for the money, the venture capitalists
receive a percentage of ownership in the business
and seats on the board of directors.
Venture capitalists seldom provide all the cash the
new business will need in its first-stage financing.
Venture capital is a very expensive form of capital.
Role of Venture Capitalists
Venture capitalists are not passive investors.
 Raising Capital for
Publicly Held Companies
Types of Equity Issuances
• The first time a company sells shares is called an
initial public offering (IPO).
• A subsequent offering is an offering of additional
shares to the public after the issuing company has
had its initial public offering.
• When newly issued shares are offered for sale, it is
a primary offering.
• A secondary offering is a sale of existing
securities by one or more major stockholders who
want to liquidate all or part of their holdings.
A Primary Market
When newly-issued securities are first offered
to the public by a company, they are issued
in the primary market.
Usually through an investment bank.
Investment Banks
Investment banks are intermediaries that
bring together businesses in search of new
capital with investors in search of new
investments.
The investment bank plays three roles:
1. It helps its customer to design the deal and
the securities.
2. It underwrites it or buys the new issue.
3. It then markets the issue to the public.
Underwriting
If the investment bank underwrites the new
issue of securities, it purchases some or all
the new securities in order to resell them.
The new issue is usually not purchased
entirely by the original investment bank in
the deal but rather is syndicated among
several other institutions.
Types of Underwriting
In a firm commitment, the underwriter
agrees to purchase the entire issue and
absorb any securities that they are not able
to resell.
In a best effort, the investment banker will act
as an agent rather than as a principal and
will simply market the new issue without
underwriting it.
Underwriter’s Profit
In the underwriting process, part of the negotiation
is the price at which the underwriters will
purchase the securities.
The underwriters will purchase the securities from
the company at one price and sell them at a
higher price, called the offering price.
The underwriting fee, or the underwriting spread,
is the difference between the offering price to
the public and the price at which the underwriter
will purchase the securities from the company.
Debt Issuances
A company can issue bonds as a source of
financing.
The role of the underwriter will be like that in
the issuance of shares.
The investment bank may underwrite the
entire issue or organize an underwriting
syndicate, or act as an agent in a best-
efforts agreement.
Private Placement
An issuer may also sell bonds in a private
placement without the use of an
investment bank to avoid the underwriting
fee.
Private placements are more commonly used
for bonds than for stocks.
Financial Markets
Secondary Markets
After the initial issue of securities, the issued
securities are traded in the secondary
markets, which facilitate the trading of
existing securities.
Stock Exchanges
For a company to qualify for listing on an
exchange, it must apply to the stock exchange
and maintain certain requirements relating to
its market capitalization, number of shares
outstanding, share price, financial strength,
and corporate governance.
Types of Financial Markets
Financial markets are diverse.
The term capital markets refers to markets
where long-term debt and equity
instruments are traded. Short-term debt
instruments with maturities of less than one
year are traded in money markets.
Market Efficiency
According to the Efficient Market Hypothesis, financial
markets are efficient.
“Market efficiency” means that market prices of
securities take into consideration all knowledge
available about that market, including public
information about the economy, the specific
security, and the market in which the security is
traded.
This means that the price will be a “fair price” and it is
difficult to add value to a project by finding a
mispriced (cheap) source of financing.
New Information in the Market
As a result of the efficient market, security
prices are said to fluctuate randomly about
their intrinsic values because adjustments to
the price are constantly taking place in
response to new information received.
1. Past patterns in prices and trading volume.
2. All other published information.
3. Private or inside information.
Three Types of Efficiency
There are three “forms” based on what is
considered to be able to be taken into account
by the market
1. Weak
2. Semi-strong
3. Strong
1. Weak Form Efficiency
Market prices of securities reflect all
historical information: price movements
and trading volume
Investors will not be able to “beat the market”
by basing their analysis and strategy solely
on past price movements.
2. Semi-Strong Form Efficiency
Security prices reflect not only historical price
and trading volume information but also all
other published information.
An efficient market will adjust immediately to
earnings announcements and other
information released by a company or that
could affect a company.
3. Strong From Efficiency
Suggests that security prices reflect all
possible information, including the private
information known only to insiders.
Insider Trading
When a person who is in possession of material
information that is not public trades in the
securities they have the non-public information
about.
Insider trading is illegal because it is a
violation of the fiduciary duty owed to the
shareholders.
Penalties for insider trading can include a fine of
up to three times the trading profits received or
three times the losses avoided and can even
include prison time.