Overview
Corporate financing is crucial for businesses as very few companies generate enough cash internally to meet their operational needs. In Canada, corporate financing usually happens through a negotiated offering—where a corporation’s management and a dealer determine pertinent factors such as the type of security, price, interest or valuation multiple, and any special features needed for a successful issue.
Corporations can raise capital primarily through two methods: selling shares (equity financing) or issuing debt/fixed-income securities (debt financing).
Equity Financing
Equity financing involves raising capital by selling common shares to investors. Often, corporations’ charters also authorize preferred or special shares, which might be non-voting yet hold preferential treatments regarding dividends, liquidation asset distribution, etc. Both common and preferred shares constitute a company’s share capital.
Share Capital
- Authorized Shares: The maximum number of shares (common or preferred) a corporation can issue as per its charter. Companies often authorize more shares than they need to have flexibility for future capital raising.
- Issued Shares: These are authorized shares issued to investors, insiders, or institutional investors. Shares owned by all shareholders collectively are called outstanding shares.
This balance essentially showcases the company’s market capitalization, computed by multiplying the current market price against the number of outstanding shares.
Examples
Example 1:
ABC Inc. has authorized to issue 10,000,000 shares. Out of these, it has issued 6,000,000 shares and recently bought back 150,000 shares. Thus, its outstanding shares tally up to 5,850,000. If the current share price is $10, the market capitalization would be calculated as:
$$\text{Market Capitalization} = 5,850,000 \times 10 = 58,500,000 \\
\text{\textbf{Market Capitalization}} = \$58,500,000 \\
\text{\textbf{Authorized Shares}} = 10,000,000$$
Example 2:
DEF Inc. authorized to issue 1,500,000 shares and it has issued 1,000,000 of these. If the current share price stands at $10, the market capitalization would be:
$$
\text{Market Capitalization} = 1,000,000 \times 10 = \$10,000,000 \\
\text{\textbf{Issued Shares}} = 1,500,000
$$
Insider and Institutional Holding Impact on Public Float
Not all of a company’s outstanding shares are available for trading. Shares might be held by insiders or mutual funds long-term, reducing availability in the market, referred to as the public float.
Debt Financing and Other Alternatives
When corporations need large capital amounts, they often resort to debt financing where issued funds hint at loans from investors needing eventual repayment. Two chief securities here are:
- Mortgage Bonds: Secured by a specific asset pledge like land/property guaranteeing the lender’s investment.
- Debentures: Supported broadly by the firm’s creditworthiness and ability to settle obligations without a specific asset pledge.
Beyond these, corporations consider other financial paths such as bank loans, money market borrowing, commercial paper, bankers’ acceptances, leasing, government grants, and export financing help.
- Corporate Capital Raising: Companies raise money primarily via equity (issuing shares) or debt (issuing securities) financing.
- Share Capital: Determines maximum authorized number by charter and the actually issued shares affecting market capitalization.
- Market Capitalization: Depicts company value based on outstanding shares and market price.
- Insider Holdings Influence on Public Float: Shares issued to insiders/institutions reduce shares available to public—affecting stock volatility.
- Debt Financing Revenue Security: Also ensures large capital needs through mortgaged assets or the company’s deemed trustworthiness.
Glossary
Authorized Shares: Maximum shares a corporation bars for issuing, decided by its charter.
Issued Shares: Part of authorized shares that are distributed to investors.
Outstanding Shares: Total issued shares collectively held by shareholders.
Public Float: Portion of outstanding shares available to general trading post excluding insiders.
Debt Financing: Raising funds necessitating repayment term; includes mortgage bonds and debentures structuring forms.
Market Capitalization: Total company valuation based on issuing share prices and numbers.
Key considerations should navigate areas ensuring sustainable growth while balancing lender obligations, mitigating unforeseen market fluctuate repercussions.
📚✨ Quiz Time! ✨📚
## What is corporate financing primarily needed for?
- [ ] To fund personal expenditures of the company’s management
- [ ] To pay dividends to shareholders
- [x] To satisfy the operational needs of the company
- [ ] To purchase government bonds
> **Explanation:** Very few companies generate enough internal cash flow to cover their operational needs, necessitating corporate financing to fill the gap.
## How do corporations typically raise capital through equity financing?
- [ ] By issuing bonds
- [x] By selling shares
- [ ] By obtaining bank loans
- [ ] By accepting government grants
> **Explanation:** Equity financing involves raising capital by selling common or preferred shares to investors.
## What do "authorized shares" refer to in corporate financing?
- [ ] The number of shares currently sold to investors
- [x] The maximum number of shares a corporation may issue according to its charter
- [ ] The number of shares bought back by the corporation
- [ ] Shares that are held in the company's treasury
> **Explanation:** Authorized shares are the total number of shares a company is permitted to issue as per its charter.
## In an example where a company has 10,000,000 shares authorized and has issued 6,000,000 shares but bought back 150,000 shares, what is the number of outstanding shares?
- [ ] 6,000,000
- [ ] 10,000,000
- [x] 5,850,000
- [ ] 9,850,000
> **Explanation:** Issued shares minus the shares repurchased gives the outstanding shares: 6,000,000 - 150,000 = 5,850,000.
## What determines a company's market capitalization?
- [ ] The number of authorized shares
- [ ] The total assets of the company
- [x] The product of outstanding shares and the current market price per share
- [ ] The amount of debt the company holds
> **Explanation:** Market capitalization is calculated by multiplying the number of outstanding shares by the share price.
## What portion of a company’s outstanding shares does the public float refer to?
- [x] Shares available for trading by the investing public
- [ ] Shares held by company officers and directors
- [ ] Shares held by institutional investors
- [ ] Total outstanding shares
> **Explanation:** Public float represents the shares that are not held by insiders or large investors and are available for public trading.
## Which of the following is a primary difference between mortgage bonds and debentures?
- [ ] Mortgage bonds are not secured, debentures are
- [x] Mortgage bonds are backed by specific assets, debentures are not
- [ ] Mortgage bonds offer no interest payments, unlike debentures
- [ ] Mortgage bonds are issued only by banks, debentures only by governments
> **Explanation:** Mortgage bonds are backed by specific assets (like property), while debentures are unsecured and depend on the creditworthiness of the company.
## What happens to a company's outstanding shares when it repurchases shares from the market?
- [ ] Increases outstanding shares
- [ ] Decreases authorized shares
- [x] Decreases outstanding shares
- [ ] Has no effect on outstanding shares
> **Explanation:** Share repurchasing reduces the number of outstanding shares held by the public.
## What impact does a smaller public float have on a stock’s price?
- [ ] Increases stability of the stock's price
- [ ] Reduces volatility of the stock's price
- [x] Increases volatility of the stock's price
- [ ] Makes the stock untradeable
> **Explanation:** A smaller public float means fewer shares are available for trading, increasing price volatility with large trades.
## Which of the following is NOT a form of debt financing?
- [ ] Issuing debentures
- [x] Selling common shares
- [ ] Mortgage bonds
- [ ] Bank loans
> **Explanation:** Selling common shares is a form of equity financing, while the other options are forms of debt financing.