Raising funds through initial public offerings means that the company will have to sell some common stock to the public. Stocks represent a share of the company, and this gives the stockholders rights within the organization. The company has to consider the opinions of the stakeholders when making decisions (Ray & Day, 2006). Floatation expenditure or the costs of selling the stock can be high. However, the company will not have to reimburse the money it has received from the investors. In addition, organization can choose to use the retained earnings as additional sources of funds for its business. Companies do not have to pay dividends to the shareholders if they are not realizing any profits (Pride, Hughes, & Kapoor, 2011). Firms seeking to raise money in this way have the advantage of being able to raise significant amounts. They increase liquidity for their shares and enhance their market prestige by becoming a public company. In addition, the founders increase their wealth, and the company acquires increased opportunities for forming mergers and acquisitions that provide additional financing and offer increased growth opportunities (Sherman, 2005).
The firm could approach venture capitalists. These individuals fund risky businesses. They especially look for small organizations that have the potential to become successful. Venture capitalists would consider investing in the firm as they see the possibility of its profitability because of the increased demand for the business in overseas markets. It is challenging to find venture capitalists to invest in the business, and the process of getting funds can be challenging to some companies. The firm will have to share the profits with the venture capitalists because they receive an equal position in the business (Cumming, 2009).
Another alternative for the firm would be to take loans from commercial banks or other financial institutions. The company will have to convince the bank to lend it the money by having a convincing purpose. It will have to show that it is capable of paying back the loan received. Most financial institutions require the business or individual to have collateral and a solid credit history. The company will have to pay an agreed amount at the end of a specified period, such as one month. In addition, the company will have to pay the interest charged by the financial institution when paying back the loan (Sherman, 2005).
The organization can consider looking for business angels or angel investors to raise its funds. The company has to be willing to relinquish some control of the business with the investors. However, it can be extremely challenging to find these individuals, willing to risk their money in foreign business ventures. Moreover, most angel investors prefer keeping a low profile. Companies choosing to use this approach have to determine the type of investors they want. Some investors are interested in making quick and easy returns while others are interested in investing in the organization for a longer term. Although some business angels may want a level of involvement in the organization, they are minority shareholders, and they will not interfere with its operations. Some business angels accept lower returns compared to the venture capitalists in place of some involvement in the company (Barrow, 2004)
Journal entry if all payments were made during the application date.
|18/04/2013||Ordinary shares applications||30,000,000||60,000,000|
|Over allotted shares||400,000||800,000|
Journal entry for application
|April 18, 2013||Cash||$|
|Application payment at $0.80||24,000,000|
|Excess shares at $0.80||320,000|
Journal entry after Allocation
|May 13, 2013||Cash||$|
|Payment of $0.50/ share||15,000,000|
|Excess shares at $0.50||200,000|
Journal entry of final payment event
|June 30, 2013||Cash||$|
|Final payment of $0.70||21,000,000|
|Excess final payment at $0.70||280,000|
Other than returning the excess shares, directors of Johnson P/L can decide to use the green shoe option to stabilize the price. In the green shoe option, a company issuing an initial Public Offer can allow the underwriter to increase the number of shares by up to 15% of the agreed number. This happens when the shares are on demand. It is not only viewed as a means of raising capital above the expected level but also for stabilizing the price of shares after issuing. In this case, Johnson P/L directors do not have to return the excess shares to the unlucky customers. Instead, it can use them for price stabilization in the future, generating additional capital and maintaining the credibility of the company (Latter 2012).
The green shoe option has several benefits to the company aside from allowing over-allotment during the IPO that raises additional capital. Stabilizing share prices is the main benefit of GSO especially after the IPO. It stabilizes share prices by having the underwriting company purchase the excess shares after the initial offer when the price goes down below the initial price. This way, it takes the shares off the market, thus reducing supply to ensure the price does not go below the offering price. This ensures that Johnson P/L will have an exit route within the first month of issuance. This period is called the GSO window (Ray, 2012). The underwriters buy the shares at a price equal to the initial one. On the other hand, when the share price increases after the IPO, the underwriting company has to deliver the oversold shares. Since the oversold shares are equal to the over-allotted option, the underwriting company will only exercise the green shoe option where it receives shares from the issuing company to cover for the overselling (Walther 2013). Johnson P/L directors can engage in a Green Shoe Option instead of having to return the excess shares (Latter 2012). A GSO option will also help in stabilizing the prices in case of fluctuations immediately after the IPO.
Barrow, P. (2004). Raising finance: A practical guide to starting, expanding & selling your business. United Kingdom: Kogan Page Publishers
Cumming, D. (2009). Private equity: Fund types, risks and returns, and regulation. Hoboken, NJ: John Wiley and Sons
Latter, A. (2012). Understanding the Over-Allotment Option, or Green Shoe, in an IPO. Retrieved from http://www.allenlatta.com/1/post/2012/05/understanding-the-over-allotment-option-or-green-shoe-in-an-ipo.html
Pride, M. W., Hughes, J. R., & Kapoor, R. J. (2011). Foundations of business, 3rd ed. New York, NY: Cengage Learning
Ray, R. H., & Day, H. (2006). What economics is about: Understanding the basics of our economic system. Council for Economic Education
Ray, S. (2012). Effectiveness of Green Shoe as a Technique of Price Stabilization in India. Advances in Applied Economics and Finance, 2(1): 281-268.
Sherman, J. A. (2005). Raising capital: Get the money you need to grow your business. AMACOM Div American Mgmt Assn
Walther, L. (2013). Chapter Fourteen: Corporate Equity Accounting. Retrieved from http://www.principlesofaccounting.com/chapter14/chapter14.html
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