When it comes to companies one important factor they have to
consider is how they are going to raise capital to fund projects and activities
that will generate wealth and value for the company. They have the option of
debt finance, funding from bank loans, bonds and syndicated loans (for large
sums of capital). However, another option for companies to raise capital is
equity finance. This form of funding can come from listing on the stock
exchange through an initial public offering of company shares. The problem is,
with so many options which one do they take? Which one has the most benefits
and drawbacks?
Facebook is a prime example in the current market of a
company who has made its decision to raise money through equity finance. The
economist (February 4th 2012) reported that Facebook announced its IPO
on February 1st, which could value the company between $75-$100bn. This
seems like an astronomical amount of money, however as the Jones, R (2012) from
the BBC reported the shares were trading privately at $80bn last week and with
the IPO being announced it looks as though the price will climb to $100bn. When
considering the excitement and price tag that has been placed on Facebook it does
appear to be an excellent option for raising capital. However, did they have
other options? Was this the right one?
http://www.youtube.com/watch?v=vjkXNcyDvQI (video about Facebooks IPO)
When it comes to large corporations, who are reporting good
revenue figures and net profit, as Facebook has, ‘Last year it generated
$3.7billion in revenue and $1billion net profits.’ The choices for generating
capital would appear to be endless, so why have Facebook chosen to list on the
stock exchange and publically offer shares? When raising capital, all forms of
funds have their benefits and drawbacks, so it is understandable therefore,
that listing on the stock exchange will also have pros and cons. When a company
decides to list, one major drawback is the high costs such as the cost of issue;
the yearly fee to the stock exchange e.g. NYSE and also the required rate of
return for shareholders once the company is listed. In addition, to these high
costs, companies also have to consider that there will be a loss of control, as
they are effectively selling ownership (this is only a major issue with
concentrated shareholders). However, this form of financing hosts a major advantage
over debt finance, the company doesn’t have any obligation to pay back the
money or to pay dividends, sounds like a good idea to me!
Although debt finance contains both advantages and
disadvantages, listing on the stock exchange does seem incredibly desirable.
Yes there are high costs but in the end the finance the company raises doesn’t
have to be paid back, as it would if it was a bank loan. Although debt
financing can be a great way to raise capital, such as through bonds, an IPO
does seem like the best option for such a large firm, because debt finance is
still an available method to raise additional capital while they are offering
shares, therefore the company really has nothing to lose by raising capital
through an IPO.
With so many choices for companies in terms of raising
capital, any form of either debt or equity would be an acceptable choice.
However, when companies are doing so well and are wanting to increase in size
and profitability such as Facebook, listing on the stock exchange is an
excellent and logical form of raising capital, not just because it raises so
much but because it allows the company to become more recognised on a worldwide
basis and it borrows the prestige of that stock market.
Facebook, if the IPO
goes the same way as Google, will raise an unprecedented amount of money which will
allow them to invest in projects that help the company grow. Although Facebook
will have no obligation to pay dividends to shareholders, I have complete
confidence that they will because it is such a highly desirable business with a
massive level of popularity across the globe. This IPO isn’t to raise finance
for a company who is in trouble, it’s to raise finance for a company that is
clearly becoming one of the largest websites in the world with huge amounts of
users and companies advertising there, this money will help them grow and
hopefully generate larger profits and as a result reward its shareholders with
generous dividends. Good choice Facebook!
Sources used: The economist (February 4th-10th 2012) and bbc.com (http://www.bbc.co.uk/news/technology-16835116) http://www.youtube.com/watch?v=vjkXNcyDvQI
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