Financing a business: raising long-term finance

The stock exchange

       The Stock Exchange (for example, London Stock Exchange) acts as an important primary and secondary capital market for businesses.

      Primary market: businesses can raise new capital by issuing new shares (for example, via Initial Public Offerings or IPOs) or new loan notes.

      Secondary market: enables investors to transfer their existing securities shares and loan notes may be bought or sold.

Distribution of UK listed businesses by equity market value

 Advantages and disadvantages of stock exchange listing

Advantages:

      Easier to raise funds

      Funds acquired at lower cost

      Raises profile

      Shares valued in an efficient manner

      Broadens investor base

      Enables other businesses to be acquired by shares rather than cash

      Can help attract and retain employees (share incentives)

Disadvantages:

      Cost (including management time)

      Increased regulatory burden

      Close monitoring of actions and decisions

      Increased vulnerability to takeover

Stock market efficiency

Weak form of efficiency:

      assumes that past market information should have no bearing on future share prices. (i.e., future share price movements are independent of past share price movements.)

      not possible to make profit by simply studying past price movements.

Semi-strong form of efficiency:

      assumes that all publicly available information, including past share prices, is fully reflected in the current share price.

      not possible for investors to make abnormal profits from security investments by studying publicly available information.

Strong form of efficiency:

      assumes that share prices fully reflect all available information, both public and private.

      all relevant information is absorbed in share prices, even those who have ‘inside’ information (such as unpublished reports or confidential management decisions) will not be able to make abnormal profits. 

      share price reflects the ‘true’ value of the share

Lessons of market efficiency and Implications for managers

      Timing doesn’t matter

      Don’t search for undervalued businesses

      Take note of market reaction

      You can’t fool the market

      The market decides the level of risk, not the business

      Champion the interests of shareholders

Common methods of share issue

 Problems of smaller businesses in raising finance

      Lack of financial management skills

      Lack of knowledge concerning the availability of finance

      Inability to provide security

      Inability to meet assessment criteria of lenders

      Bureaucratic screening processes

Long-term finance for small businesses