Capital Raising | Corporate Finance | Part 2 | Section B | Episode 27 | CMA USA

Welcome back to CMA USA exam coach. In this episode, we are going to dive into one of the most critical areas of corporate finance, capital raising. This topic plays a key role in understanding how companies secure funds for growth and operations. And just a quick note, this is the final section of part two, section B of your CMA USA exam syllabus. So, make sure to focus well and complete your notes, as this will wrap up a major portion of your study journey. So, what exactly is capital raising? Capital raising is the process through which a business secures funds to support its operations, fuel expansion, invest in new projects, or even restructure existing finances. Why do companies raise capital? Well, no matter how profitable a company is, growth often demands more money than it currently has. Whether it's opening a new factory, launching a product line, or simply meeting day-to-day working capital needs, external financing becomes necessary. That's where capital raising comes into the picture. And why is this topic important for you as a CMA USA student? Because as a management accountant or finance professional, you'll need to understand the strategic sources of funds, the costs associated with each, and how these decisions directly impact the company's financial structure and shareholder value. When we talk about raising capital, we mean the process of obtaining funds to start, operate, or grow a business. These funds can come from internal sources like retained earnings, or from external sources like investors or financial institutions. But when it comes to startups, the journey of raising capital is quite unique and dynamic. In the beginning, a startup may just be an idea, an innovative solution, or a disruptive product. But to turn that idea into reality, the founders need money. And usually, their personal savings aren't enough. So they approach outside investors. One major source of early-stage funding is a venture capitalist, often called a VC. So who is a venture capitalist? A venture capitalist is typically a private equity investor or firm that provides funding to startups and small businesses that are believed to have long-term growth potential. In exchange for their investment, venture capitalists receive equity ownership in the business, meaning they become part owners or promoters. Venture capitalists don't just bring in money. They often provide valuable guidance, networking opportunities, and strategic support to help the startup scale. As the business grows and goes through multiple rounds of funding, more venture capitalists might come on board, increasing the capital base and the company's valuation. Eventually, when the company becomes stable and ready to expand on a much larger scale, it may decide to go public. This means offering shares to the general public through the stock market, a process known as an IPO, or initial public offering. An IPO marks a significant milestone in the company's life. It helps the business raise substantial funds, provides an exit route to early investors, and brings more visibility and credibility to the brand. So from idea to IPO, capital raising plays a vital role at every stage of a company's growth. To make this more real, let's take a quick example of a famous company that grew through venture capital support. Airbnb, one of the world's largest online marketplaces for lodging and travel experiences, began as a simple idea. In its early days, Airbnb struggled to raise money and even sold custom cereal boxes to survive. But eventually, they caught the attention of Sequoia Capital, one of the top venture capital firms in the U.S. Sequoia saw potential in Airbnb's model and invested millions of dollars during its early funding rounds. With that support, not just money but also strategic guidance, Airbnb scaled rapidly, improved its platform, expanded globally, and eventually went public through an IPO in 2020. This shows how venture capital can turn a small startup into a globally recognized brand. Now that we understand the role of venture capital in helping startups grow, let's talk about some of the major venture capital firms in the United States that are leading this space. One of the most well-known names is Sequoia Capital. This firm has backed some of the biggest success stories in the tech world, including companies like Apple, Google, Instagram, WhatsApp, and Airbnb. Sequoia is known for identifying promising startups early and supporting them through multiple stages of growth. Another top player is Andreessen Horowitz, also known as A16Z. Based in Silicon Valley, this firm has invested in a wide range of companies, especially in software, crypto, and fintech sectors. They've been involved with businesses like Facebook, Coinbase, and Slack. Then there's Accel, a global VC firm that played a major role in the early growth of companies like Facebook, Dropbox, and Flipkart. Accel is known for its strong global network and long-term partnership approach. Kleiner Perkins is another major name, especially in the biotech and clean energy space, in addition to tech. They funded companies like Amazon and Google in their early stages. Benchmark Capital also deserves a mention. They have a focused portfolio and are known for high-impact investments. They backed companies like Uber, Twitter, and eBay in their early days. Other prominent VC firms in the U.S. include Bessemer, Venture Partners, Lightspeed Venture Partners, Greylock Partners, General Catalyst, and Founders Fund, all of which have helped shape the landscape of modern entrepreneurship by supporting disruptive and innovative startups. So, behind almost every big tech success story, you'll usually find a venture capital firm that believed in the idea and fueled its growth in the early stages. Now let's understand one of the most important events in a company's capital-raising journey, the initial public offering, or IPO. So what is an IPO? An IPO is when a company offers its shares to the general public for the very first time. Until this point, the company may have been funded privately by venture capitalists, founders, or private equity firms. But with an IPO, the company enters the public capital market and opens up ownership to outside investors. This process happens in what we call the primary market, where new shares are created and sold directly to investors. It's different from the secondary market, like stock exchanges, where already issued shares are bought and sold between investors. Now, during an IPO, the company can raise money in two ways. First, by issuing new shares. This is called a fresh issue, and the money raised goes directly to the company for expansion, debt repayment, or other needs. Second, through a secondary offering, where existing shareholders, like founders or early investors, sell some of their shares to the public. In this case, the money goes to those shareholders, not the company. But how is the price of these shares decided? Well, before the IPO, the company works with large institutional investors, like mutual funds, pension funds, and hedge funds, to understand how much they are willing to pay per share. Based on this investor demand, the offer price is set. The entire IPO process is managed by a specialized financial institution called an investment bank. The investment bank helps the company prepare the necessary documents, markets the IPO to potential investors, and most importantly, underwrites the issue. Underwriting means the investment bank agrees to buy all the shares from the company and then sell them to the public. This ensures the company gets the required funds, even if some shares remain unsold. And what if the company wants to raise more money from the public after its IPO? In that case, it goes for a follow-on public offering, also known as an FPO. Here, the company issues additional shares. And usually, the price for these new shares is based on the current market price, not investor negotiation. So in summary, the IPO marks the company's transition from a privately held business to a publicly traded one, allowing wider ownership and access to large-scale funding. Now that we've introduced the role of underwriters in the IPO process, let's take a closer look at how underwriters earn their revenue. Underwriters, usually investment banks, don't work for free. They take on significant responsibility in helping a company go public, and in return, they earn revenue through two main sources. First, they charge fees and commissions directly to the company, known as the issuer. These charges cover the cost of legal work, marketing, due diligence, regulatory filings, and advisory services. The second and more significant source of revenue is called the underwriting spread. So what is the underwriting spread? It's the difference between the price at which the underwriter buys the shares from the company and the price at which those shares are sold to the public. The underwriter pockets that difference as profit. For example, if the underwriter purchases shares from the company at $90 per share and sells them to the public at $100 per share, the $10 difference is the spread, and that's part of the underwriter's revenue. Now, let's look at two common types of underwriting arrangements. First is the firm commitment. In this model, the underwriter agrees to buy all the shares from the company, regardless of whether they can sell them to the public or not. This gives the company full assurance that they will receive the funds. If some shares don't sell, the underwriter bears the loss. The second type is called best efforts. Here, the underwriter does not guarantee to sell all the shares. They only agree to make their best effort to sell as many as possible. Any unsold shares are returned to the company. So in a firm commitment, the underwriter takes the full risk, but in a best efforts arrangement, the risk stays with the issuing company. Understanding these revenue models and risk-sharing arrangements is very important for a finance professional, especially when evaluating the cost and benefits of raising capital through a public issue. Once a company is listed on the stock market, its share price keeps changing every day. Sometimes it goes up, and sometimes it goes down. But why does this happen? The main reason is information. When new information comes into the market, investors react to it by buying or selling shares, and this affects the price. There are three types of information that can influence a company's share price in the secondary market. Let's understand them one by one. The first type is called historic information. This means information from the past, like old stock prices, past annual reports, previous profits, or charts showing how the price moved over time. This information is available to everyone in the market. Many investors study this past data to try and guess what might happen in the future. The second type is published information. This includes all the latest news and updates that a company shares publicly, like results on their website, news and newspapers, press releases, announcements about new products, or major business deals. Everyone can see this information at the same time, so it gives a fair chance to all investors. The third type is private information. This is secret information that only a few people inside the company know. For example, maybe the company is planning a big merger or has made a huge profit, but it hasn't been announced yet. If someone uses this secret information to buy or sell shares and make money before the public knows, that's called insider trading, and it is illegal. So, in short, share prices move up or down based on what people know or think about the company. If the news is good, more people buy the shares and the price goes up. If the news is bad, more people sell and the price goes down. Now let's talk about a very important concept in the stock market called market efficiency. Market efficiency simply means how quickly and accurately stock prices react to new information. There are three forms of market efficiency based on how much information is already included or priced in by the market. Let's look at each one in simple words. One, weak form efficiency. In a weak form market, stock prices already reflect all past or historical information, like old prices and past financial results. But the market does not fully reflect current news or inside information. So, people who have access to published news or private information may still be able to make profits. Two, semi-strong form efficiency. In this form, the stock price reflects both past information and all public news, like press releases, company announcements and earnings reports. So, if you only use public information, you can't easily beat the market. But people who have secret or private inside information might still be able to earn profits. Three, strong form efficiency. This is the highest level. In a strong form market, all information is already included in the stock price, past data, public news and even private insider information. That means no one, not even company insiders, can earn extra profit using any information because the market has already adjusted for everything. So, to sum up, in weak form, only past data is reflected. In semi-strong form, past data and public news are reflected. In strong form, everything, even private info, is reflected. Now, let's talk about something that is strictly illegal in the stock market and that is called insider trading. Insider trading means to buy or sell shares and make a personal profit. For example, imagine a company insider knows that their company is about to announce very high profits. If that person buys shares before the news becomes public and then sells them after the price goes up, that's insider trading. This is unfair to other investors who do not have access to this secret information. Insider trading is considered illegal because it violates the trust or fiduciary duty that insiders have toward the shareholders and the public. People who are caught doing insider trading can face heavy fines, jail time and a ban from the stock market. In a fair market, everyone should have equal access to information so no one gets an unfair advantage. Let's now understand an important topic for dividends. So, what is a dividend? A dividend is a portion of a company's profit that is given to its shareholders. It's like a reward for investing in the company. Dividends can be paid in different forms. The most common is cash where the company deposits money directly into the shareholder's account. Sometimes, companies may also give additional shares called stock dividends or even property, though that's less common. Now, not all companies pay the same way. It depends on their dividend policy. Let's look at two common types. One, residual dividend policy. In this case, the company first uses its profit for all important things like investing in new projects, buying equipment or expanding the business. Only if there's any money left, after all that, dividends are paid to shareholders. So, dividend payments under this policy are not regular and may change from year to year. Two, active dividend policy. Here, the company makes a clear decision to pay dividends regularly, like every quarter or every year. Even if the company has future plans to invest, it still sets aside money to reward its shareholders on time. Different companies follow different policies based on their growth plans, cash needs and shareholder expectations. So, in short, dividends are the way companies share their success with investors and the dividend policy tells us how and when that sharing happens. Now that we know what dividends are, let's understand the important dates in the dividend distribution process. When a company decides to pay dividends, it follows a proper timeline so that everything is clear and fair to all shareholders. There are four key dates you should know. One, announcement date. This is the date when the company officially declares the dividend. The board of directors makes the announcement, mentioning how much dividend will be paid and when. From this day, the news becomes public. Two, record date. The record date is used to decide who will receive the dividend. Anyone who is listed as a shareholder on this date will be eligible to receive the dividend. Three, ex-dividend date. This is a very important date. It is the last date to buy the company's shares if you want to receive the dividend. Due to the stock exchange settlement rules, you must buy the shares before the ex-dividend date to be listed as a shareholder by the record date. If you buy the share on or after the ex-dividend date, you will not get the dividend. The previous owner will get it. Four, payment date. This is the day when the company actually pays the dividend, either by crediting cash to your account or issuing bonus shares, depending on the type of dividend. So, to announcement date tells everyone a dividend is coming. The record date decides who qualifies to receive it. The ex-dividend date is the cutoff to buy the share and still qualify. And the payment date is when you actually get the money or shares. Now let's understand a useful concept in the capital raising process. It's called shelf registration, also known as a shelf prospectus. So what does this mean? Sometimes, a company wants to issue new shares to the public, but not immediately. It may want to wait for a better time in the market when prices are higher or investor demand is strong. In such cases, the company can prepare all the legal paperwork and approvals in advance. This includes filing the prospectus and completing other formalities required by regulators. Once everything is ready and approved, the company can keep the offer on the shelf and issue the shares quickly whenever market conditions become favorable. That's why it's called shelf registration, because the company keeps the approved documents on the shelf, ready to use when the right time comes. This process is very useful because it saves time and allows the company to act fast when the stock market is in a good phase. So, in simple words, shelf registration helps companies prepare early so they don't miss the chance to raise money when market conditions are perfect. Next, let's understand an important concept in the world of finance, credit rating. So what is a credit rating? A credit rating is a score or grade given to a company or its bonds by a specialized agency. This rating shows how safe or risky it is to lend money to that company or to invest in its bonds. In simple terms, it tells investors, is this company likely to repay its debt on time or not? Credit ratings are very important because they help investors decide whether to invest in a company's bonds or avoid them. A high credit rating means the company is financially strong and less risky. A low rating means the company may struggle to pay back its loans and the risk is higher. These ratings are given by credit rating agencies, which are independent organizations. They study the company's financial statements, debt levels, past repayment behavior, industry risks, and many other factors. Some of the most well-known credit rating agencies in the world are Standard & Poor's S&P, Moody's Investor Service, Fitch Ratings. For example, a company like Apple might receive a high rating such as AA Plus or AAA, showing that it is a very safe investment. But a struggling company may get a rating like BB or B, which means it carries more risk. When investors look at bonds or companies, one of the key things they consider is the credit rating. This rating is an independent evaluation of how likely a company is to repay its debts. For example, a company with a AAA credit rating is considered to have the lowest risk. It's financially strong and very likely to meet its obligations. If a company is rated AA, it's still strong but slightly riskier than AAA. As the rating goes lower, the risk increases. For instance, a rating like C Plus means the company is much more risky and there's a higher chance it might struggle to pay back its debts. So, credit ratings help investors make smart decisions based on the level of risk they are comfortable with. So, in short, credit ratings help investors make smarter decisions and also help companies know how they are viewed in the financial market. Before we wind up, let's quickly review what we covered in this episode on capital raising. We started by understanding what capital raising means and why companies need to raise funds to grow their business. We then explored the role of venture capitalists and how startups go through different stages of funding, eventually leading to an initial public offering, or IPO. We discussed how companies go public, the IPO process, the role of underwriters, and how they earn their revenue through fees and spreads. Next, we looked at the secondary market and how stock prices are influenced by different types of information, historic, published, and private. We also explained the forms of market efficiency, weak, semi-strong, and strong, and what they mean for investors. Then we talked about insider trading, why it's illegal, and how it gives an unfair advantage in the market. We covered dividends, the dividend distribution process, and important dates like the announcement date, record date, ex-dividend date, and payment date. We also learned about shelf registration, which helps companies prepare their documents in advance and issue shares quickly when the market is favorable. And finally, we discussed credit ratings, the role of rating agencies like S&P, Moody's, and Fitch, and how investors use these ratings to make smart investment decisions. This wraps up our detailed session on capital raising. Make sure to revise these topics and practice questions to strengthen your understanding. Thank you so much for watching. Don't forget to practice the questions and keep reading your textbook to deepen your understanding. All the best and goodbye.