Page 451 - Business Principles and Management

Unit 5

mance record find it hard to sell stocks or bonds to potential investors. A newly
formed company has similar difficulties in securing a loan. Many banks avoid
doing business with these types of organizations because of the added risk. When
they do agree to provide financing, interest rates and other requirements are much
higher than for successful, established firms.

INVESTMENT BANKS

Many commercial banks do not generally become involved in helping large corpo-
rations raise capital by selling stocks and bonds. For these services, a corporation
may turn to an investment bank—an organization that helps a business raise large
sums of capital through the sales of stocks and bonds. Investment banks are also
known as underwriters. Investment banks can assist a rapidly growing, privately
held company through an initial public offering (IPO). An IPO is the first time that
a company sells stock to the public. Investment banks provide a variety of financial
and investment services for their clients regarding large capital projects.
The process of selling securities is simple but expensive. Assume a corporation
wishes to raise $50 million by selling bonds. It first finds a willing investment bank.
The bank offers advice, buys the bonds at a price below the expected market value,
then sells the bonds to the investing public through its marketing channels. The
bank’s profit would be the difference between what it paid the corporation for the
bonds and the selling price it receives from the bond purchasers.

STOCK OPTIONS

Some corporations may wish to sell only a small number of additional shares of
stock. In that case, a corporation can handle the sale itself. It can make the sale
of additional shares attractive to current stockholders by offering stock options.
A stock option is a right granted by a corporation that allows current stockhold-
ers to buy additional shares when issued at a fixed price for a specific period of
time. These options give current stockholders the opportunity to buy enough
stock to maintain the same percentage of ownership in the company as they had
before the new stock was issued. Often the stock option is offered at a lower
price to attract more funds to the corporation without the additional expense of

PHOTO: © GETTY IMAGES/PHOTODISC.

Venture capitalists provide
large sums of money to
people who want to start
new companies. What do
you think would most
influence a venture
capitalist’s loan decision?

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