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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364

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BuyFindarrow_forward

Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

Answer these three questions about early-stage corporate finance:

a. Why do very small companies tend to raise money from private investors instead of through an IPO?

b. Why do small, young companies often prefer an IPO to borrowing from a bank or issuing bonds?

C. Who has better information about whether a small firm is likely to earn profits, a venture capitalist or a potential bondholder, and why?

a)

To determine

The reason for small companies raising funds from private investors instead of IPO is to be determined.

Explanation

The small companies tend to raise money from private investors instead of through an IPO because of the fact that small companies are new, and they do not have any image in the market as a new entrant. Public will buy shares in IPO only when public knows about the company. Therefore, primarily they approach private investor than they start their business and establish name in the market.

Concept

Early-Stage Financial Capital: the firms which have just started their business often have an idea for the product and services to sell. Since the firm is new in the market, hence have only a few customers or no customers at all. Thus, firms face difficulties in raising funds at an early stage.

b)

To determine

The reason for small and young companies preferring an IPO then borrowing from a bank or by issuing bonds is to be determined.

Explanation

Prefer an IPO is a low-cost funding as compared to banks or issuing bonds banks will charge high interest rates and issuing bonds will make a permanent liability to pay coupon payment in a period of time. Hence IPO is the Best route.

Concept

Early-Stage Financial Capital: the firms which have just started their business often have an idea for the product and services to sell. Since the firm is new in the market, hence have only a few customers or no customers at all. Thus, firms face difficulties in raising funds at an early stage.

c)

To determine

Whether a venture capitalist or a potential bondholder has better information about whether a small firm is likely to earn profits.

Explanation

The Venture Capitalist will have better knowledge because he knows all the ins and outs of business model, profitability of operations, intent of the management.

Concept

Early-Stage Financial Capital: the firms which have just started their business often have an idea for the product and services to sell. Since the firm is new in the market, hence have only a few customers or no customers at all. Thus, firms face difficulties in raising funds at an early stage.

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