This chapter describes the procedures used by companies for raising long-term funds in the capital market. It provides a wealth of institutional details and guidance to managers on decisions about long-term capital. It describes the venture capital financing of a young company and then takes you through to the company's initial public offering (IPO). The subsequent sections describe the general cash offer used for most public issues of debt or equity securities in the United States. Equity issues made directly to existing shareholders are called privileged subscription issues or rights issues and are covered in Appendix A. The chapter also discusses the role of the underwriter and the costs of different types of issues. An overview of private placements is also included in the chapter.

Financial managers concerned with raising finance need to decide the method of issue, the size of the issue, the pricing of the security, the use of an underwriter, and the type of underwriting arrangement. The manager should also be concerned with the effect the issue will have on the firm’s market value. All these are closely related to market efficiency. The manager will do well to remember the lessons of market efficiency learned in Chapter 13. Here are some important implications of market efficiency relevant to this chapter.

Financing Decisions and Stockholder Wealth: In general, it is very unlikely that financing decisions will enhance the market value of the firm as a whole. It is reasonable to assume that most financing decisions have a net present value of zero. This is because a positive NPV financing decision is one where the money raised exceeds the value of the liability created. In the highly competitive capital market, it is not possible for any firm to consistently fool investors in this way.

Financing Decisions and the Distribution of Wealth: Financing decisions can, however, affect the distribution of wealth between security holders and that there may be wealth transfer between one group of security holders and another. If new securities are under-priced, new holders will obtain a bargain at the expense of existing holders. This is not a problem, however, in the case of rights issues, where existing holders are given the rights to subscribe in proportion to the size of their holdings.

The Importance of Market Prices: When a company is deciding on the issue price for new securities, the best guide to what a company can hope to obtain is the price of closely comparable securities, which are already traded.