Raising Capital...

When a company (listed on a stock market) has potential investment opportunities yet does not have enough internal capital, it has two main options; Equity finance or Debt finance.  This raises one of the most challenging decisions facing financial managers.  With both options presenting pros and cons, which one should a manager choose and why? 

Equity finance, this raises capital by obtaining capital from investors in exchange for an ownership share of the business.  This capital can come from a wide variety of investors, such as competitors, banks, capital investors, wealthy individuals etc.  The beauty of raising capital in this way is that businesses are not obligated to repay the money back.  However, there is the small issue of handing over a percentage of the business for this capital, thus giving investors ‘a say’ in business decisions.  The use of apostrophes around the words, a say, is because it depends on a certain factors.  Including what type of shares owned by the investor, the percentage of shares owned by the company etc.  51 per cent ownership gives control of the business, so as long as the company itself owns 51 per cent of the majority then they can continue to make the key business decisions.  An additional drawback includes the topic of tax.  In the UK, capital gains tax can apply to investors.  Firstly, the company is taxed on its profits, after this the business is left with its net profit, which it can decide whether to use to issue dividends.  However, once dividends are paid to the investors, this is then taxed again under income tax, and finally, if an investor wishes to sell his/her shares they will be subject to capital gains tax.  Is all this taxing of the same money necessary? That’s a topic for another day…

Back in December 2011, Zynga, a US game company, announced plans for a stock market floatation.  According to the BBC, the firm plans to sell 100 million shares (14.3% of the company), valuing the company as much as $9.04bn.  Zynga have opted to raise capital in order to pursue future investment opportunities.  The minimal 14.3% is no way near enough to risk a takeover, thus still leaving Zynga with the controlling power. 

Having only been listed on the NASDAQ stock exchange for 3 months, Zynga have seen their share price climb to $14.55, a $4.55 premium over the IPO in December.  However, on the day the social games developer reported record revenues in its first earning report as a public traded company, its shares fell 17.8 per cent. Why is this? Record profits yet a fall in share price?  The main reason being is the stock market had expected more.  The stock market had obviously overreacted in relation to the share price, and when the announcement came about regarding record profits, this was not what the stock market were expecting, thus the fall in share price.  Zynga, have performed well and this fall in share price is not their fault.  The stock market has therefore begun to deflate the share price, moving it closer to the ‘fair value’ price.  In regards to ‘Efficient Market Hypothesis’, does this show semi strong form efficiency?  Well yes, course the mistake initially does not help the argument, however upon the news regarding profits; the market reacted quickly and rationally.

Malcolm Walker, CEO of Iceland, has 42 days (from 2^nd Feb 2012) until he and his management team lose their pre-emption rights to purchase additional shares.  Malcolm Walker and his management team currently own 23 per cent of Iceland, yet could lose controlling power of their corporation if they do not match the final offer from one of two private equity firms (Bain Capital and BC Partners).  This is all down to Landsbanki (Iceland’s largest bank) coming into financial difficulty, thus selling its 67 per cent stake in Iceland.  How will Malcom Walker and team raise capital? The equity finance option is unavailable, due to by releasing more shares, he will dilute his percentage held.  Therefore, he is turning to his friends and family, and asking them to purchase shares and in turn hand over voting rights/control back to the CEO and managers.

The raising of capital will always be a difficult decision for owners and managers.  No one likes the thought of debt and the main way of avoiding debt, is by selling percentages of your company, thus losing some control.