Capital Infusion Case Study

Abstract

For expansion the company needed $200,000 and they have many options, this paper will provide a narrative about private debt, private transfer of partial ownership, private transfer of entire ownership, public debt issuance, and public equity offering. Then it we will discuss of the impact of each alternative which would include issues of structure and cost of capital. And finally we will discuss the impact of an infusion of capital of $200,000 on the financial statements

Keywords: IPO, corporate bonds

 

 

 

 

 

 

 

 

 

Private Debt financing –

Private debt and corporate bonds are different in a way that the private debt is usually held by intuitional investors, funds, insurance companies (Reicherter, n.d.). And these private debts are not as liquid as corporate bonds. The company needs to find a fund or company to get the private debt. This debt is similar otherwise. There is no change in ownership due to private debt. The company will have to make the interest payment and at the end of the loan term, they will have return the full amount due to the lender. In any case, the business does not do well or has to file for bankruptcy, they will have to liquidate the assets to pay back the lender.

This company has a current Debt t Equity ratio of 0.6, so based on a rating on rating agency, it will have to pay the interest on the debt. And the payment of interest on debts will go out from earnings. Most probably the company will have to pay a higher interest rate, although there will be a tax advantage since the interest payment happens from before-tax income, so the cost of capital will be less.

So, if we ignore the cost of finding the private debt, there will be few changes in the balance sheet, the current asset will increase as the cash will stand at $ 4,136,400. And long-term debt will increase to $3,970,300.

There will not be any change in shareholder equity. But the current ratio will change to 1.5 (rounding up 1.47). And Debt ratio will change to .67 (rounding up .666).

From next year there will be a cash outflow towards paying the coupon or interest on the bonds to the bondholder.

 

Private investor(s) who would be willing to share ownership –

            The owners of the company can sell there 50% stake to private equity firm or venture capitals. Once the ownership is shared, the private investor will be the single largest stakeholder. So any management decision will have to have the investors consent. But, it will not impact liability or anything else. And there won’t be any obligation such as a coupon or interest payment. The dividend is not mandatory. The major impact will be in management, other than that everything else will be almost same balance sheet wise.

Here one point to note, initially the company had 50 investors or shareholders, so when the company’s 50% stake is being sold, some of the investors can sell their stakes completely or each investor can give up 50% stake to the private investor for $200,000. The existing shareholders will lose the ability to control or even influence the decision as minority shareholders (Simpson, 2017).

Now let us see, how selling 50% stake in the company will impact the balance sheet. The existing common stock was worth $300,000, 50% of it being sold for $200,000. So the existing shareholders are making a profit worth $50000 on their holding, increase the common stock value and that will actually change the Total stockholder equity, too.

Shareholder’s equity = Total Assets – Total liabilities

And in this case where 50% stake is being sold, there would not be any change in total liabilities but the total assets will go up, since the amount in common stock would increase, resulting in increasing the shareholder equity. This signifies this amount would be returned to shareholders if all assets are sold to pay off all liabilities.(Investopedia, n.d.).

Private buy-out –

            The company can sell 100% share without going public. Private equity funds or venture capital funds can buy out 100% stake in the company for $200,000 they need. Although it will be a bad deal for the current shareholders as the common equity costs $300,000 and selling those shares for $200,000 will be a bad deal.

Selling full stake would mean that the management team or the previous shareholder will not have any control or say in the company anymore. But they will not be liable for any liability or asset the company may or may not have in future.

Private equity funds can go out and buy all the publicly traded stock to gain control of the company too. Or Private equity fund can borrow the money to buy out companies. In this case, for the shareholder of this company, the source of fund is not a problem, and it is private, so the private equity or venture capital fund which is essentially funded by high net worth individuals can just purchase the shareholder equity.

            If the buyout happens for $200,000, then there would not be much change in assets or liabilities or income statement, the shareholder equity will get reduced, as the common stock worth $300,000 will be sold for $200,000, so the total shareholder value will be reduced for the next owner of the company.       

Public debt (corporate bonds) –

The company can issue corporate bonds. Issuing corporate bond does not impact or change ownership structure. The corporate bonds have to be rated by the rating agency and based on rating the company will have to pay a coupon rate to the bond hold until maturity of the bond. Upon maturity, the par value or face value will have to be repaid to the bondholder.

While the regular coupon payments will impact earnings, since the bond is a debt and the coupon payment or par value payment on maturity cannot be deferred, on the positive side the interest paid amount on bonds, goes out from before tax earning, hence it reduces overall tax liability. So the cost of capital comes down. In case the company goes out of business before the bonds mature and final par value is paid back, in that case, the company might have to liquidate assets to pay off the debts/bonds.

So, if we ignore the cost of issuing the corporate bonds, there will be few changes in the balance sheet, the current asset will increase as the cash will stand at $ 4,136,400. And long-term debt will increase to $3,970,300.

There will not be any change in shareholder equity. But the current ratio will change to 1.5 (rounding up 1.47). And Debt ratio will change to .67 (rounding up .666).

From next year there will be a cash outflow towards paying the coupon or interest on the bonds to the bondholder.

Common stock –

The company can go public to raise $200,000. Currently, the common stocks are valued at $300,000. They will have to hire an investment bank to underwrite and prepare for the IPO.

Before going public the company needs to make sure it has experienced management team since equity sale is essentially selling stakes in the company, the management will have to be accountable to investors/shareholders. And the company would need accounting and legal team to meet SEC requirement to stay listed.

To comply with regulations the company has to review and publish last 5 years financial statements (Investopedia, 2018). This process starts with 6-12 before going public.

The company has to engage investment bank for underwriting, who has prior experience with the same market sector. The underwriting, account and any legal work will be done by the investment bank to comply with SEC regulations.

The underwriters come up with S-1 which is required by SEC for IPO filing, S-1 is the main disclosure document and it contains the business model, organization structure, financial statements, competition information, employee information and the risks company foresees. And then the company has to submit the S-1 to SEC for review and approval until review and approval is done the company cannot come out in public with their IPO plan.

Once SEC approves S-1, the CEO or executives and investor relations can start road shows to increase awareness and generate buzz. This step starts 20 days before listing.

Based on the response received from potential investors during the roadshow, the underwriting team and company decide on offer price and amend the prospectus to update the offer price and date. 10 days before going public, underwriters start advertising the IPO. Once everything is finalized, the company decides to list on NYSE or NASDAQ and start trading.

The underwriting team will finalize the price of the stock, and based on that it will be decided how much stake needs to be sold to raise $200,000, as long as the current stakeholders manage to keep controlling shares, they will have the power to make decisions.

But, each common stockholder will have voting rights, and any major decision can be taken as long as majority shareholder is in agreement.

Once the share price is finalized, the common stock price will have to be revised and the shareholder equity will also have to revise based on common stock price.

 

 

 

 

 

 

References –

Simpson, S. ( December, 2017). How To Sell stock in your company. Retrieved from https://www.investopedia.com/articles/stocks/12/how-to-sell-company-stock.asp

Reichter, M.( n.d.). Private Debt. Retrieved from http://www.goldingcapital.com/en/investors/private-debt.html

Retrieved on 5/27/2018. Retrieved from https://www.investopedia.com/terms/s/shareholdersequity.asp

2 Comments

  1. Sadofduh December 13, 2018 Reply
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