Initial Public Offering (IPO): this is where a company lists its shares on a stock exchange for the first time (hence the phrase initial public offering) in order to sell those shares through the equity capital markets. Listing through a stock exchange also facilitates the subsequent trading of those shares.
Pros:
- Cost Savings: no interest payments are required, thus preserving cash flow. In addition, if the company goes bankrupt, the loss is spread across all shareholders.
- No Security: no security is required, meaning a company will not risk having its assets seized as a result of it issuing shares and subsequently failing to generate sufficient profit.
- Complementary Skills: some investors (e.g. business angels and private equity firms) may contribute skills, experience, expertise and contacts that benefit the company.
- Profile: listing on a stock exchange can enhance a company’s profile. This can increase its access to the market for capital and enable it to negotiate more preferential terms with suppliers and creditors.
Cons:
- Control: equity represents a stake of ownership and thus control among existing owners is diluted as additional shareholders join. Shareholders are afforded certain rights including the right to vote and significant company decisions may be subject to shareholder approval. A company may also become vulnerable to a hostile takeover as it can do little to prevent existing shareholders from selling their shares to investors that are attempting to acquire a controlling stake.
- Demand: if insufficient demand exists, a company may be unable to raise all the capital it requires.
- Costs: profits must usually be shared between more people, although paying dividends is typically discretionary.
- Administration: share sales can be time consuming, complicated and costly to administer and once a company is publicly listed, it is subject to continuing disclosure requirements (e.g. the requirement to publish financial statements).
Security: taking security over a borrower’s assets can increase a lender’s chance of receiving back its money if the borrower defaults on the loan. There are many types of security, including mortgages, fixed and floating charges and guarantees. Security can give a lender the legal right to claim and sell the asset(s) over which security was taken (in order to recover the funds loaned out) in instances where a loan not been repaid in accordance with the terms under which the security was taken. A mortgage over a house is a form of security. It typically entitles the lender to sell the house and recover money it is owed if the borrower fails to meet its repayment obligations.
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By Jake Schogger - City Career Series