Financial Management:
Company Financing
My T. Nguyen
Fulbright University Vietnam
January 2025
My T. Nguyen Financial Management January 2025 1 / 38
This lecture we ask
What are the sources of funding for companies?
What types of funding can companies raise?
What are the differences between these types of funding?
My T. Nguyen Financial Management January 2025 2 / 38
Sources and Uses of Funds
Sources Uses
Banks Land
Financial markets Buildings
Venture capital Equipment
Private equity Labour
My T. Nguyen Financial Management January 2025 3 / 38
Venture Capital
Start ups typically find it challenging to raise funding in the public
markets:
They have
They havelimited
limitedoperating
operating history
history
The issuance of securities is a complex
The issuance of securities is a complex process that founders
process need to
that founders
comprehend
need to comprehend.
Venture capital is a source of getting funding for early-stage,
high-potential, growth startup companies
Venture capitalists pool funds from a variety of investors
Venture capitalists typically ask for ownership and control over
company decisions in return for the funding
Success of a new firm is highly dependent on the effort of the
managers, venture capitalists structure a deal that provides
management with strong incentives to work hard
My T. Nguyen Financial Management January 2025 4 / 38
Venture Capital
Funds are usually dispersed in stages, after a certain level of success is
achieved.
Venture capitalists may cash in on their investment by:
sell the firm to a larger firm
the firm goes public through IPO, and venture capitalists sell their
shares and pocket the money
Examples of companies raising funding from venture capital:
Facebook, Spotify, Tiki, Momo, Fika
My T. Nguyen Financial Management January 2025 5 / 38
Venture Capital
Venture capitalists expect that most of their portfolio companies will
fail, but that if one company becomes the next Facebook (or
unicorn), they can still earn great returns.
My T. Nguyen Financial Management January 2025 6 / 38
Venture Capital
Recently, people have had to invent the term decacorn and hectocorn
Examples of hectocorn: SpaceX, ByteDance (parent company of
Tiktok)
Examples of decacorn: Revolut, Canva, Grammarly
My T. Nguyen Financial Management January 2025 7 / 38
Private equity
Private equity is a source of getting funding for not publicly listed
companies on a stock exchange at a more mature stage of growth
The companies may be deteriorating or failing to make the profits due
to inefficiency
Private equity firms mostly buy 100% ownership of the companies in
which they invest with the aim of making them more profitable
Private equity firms generally aim to sell the company they turn
around and on average, it takes between 5 and 10 years
Risk is typically lower than venture capital so return is lower
My T. Nguyen Financial Management January 2025 8 / 38
Private equity
You can think of private equity as being somewhat similar to car
dealer. They buy old car from you, and do a makeover of the car to
make it shinier with the goal of selling it with a profit in the future
My T. Nguyen Financial Management January 2025 9 / 38
Financial Markets
Financial markets provides companies with access to funding through:
Primary market is where firm raises fresh capital by issuing securities,
such as:
Initial Public Offering (IPO)
Private placing
Right issues
Secondary market is where existing securities are traded; no new capital
raised
My T. Nguyen Financial Management January 2025 10 / 38
Initial Public Offering (IPO)
IPO: First offering of stock to the general public
It is a lengthy process for the firm with many steps, such as preparing
a prospectus, conducting a roadshow to talk to potential investors,
deciding on the offer price
Benefits of going public:
Ability to raise new capital
better branding
more access to resources
Downsides of going public:
Costly and lengthy process
Dilution of ownership of existing shareholders
reveal sensitive information as responsbility
My T. Nguyen Financial Management January 2025 11 / 38
Initial Public Offering (IPO)
The most anticipated IPO in the near future?
My T. Nguyen Financial Management January 2025 12 / 38
Private placing
Firm offers shares to a group of investors (outside of existing
shareholders)
Benefits of private placing:
Less costly than going public
Require less disclosure of sensitive information about the company
Downsides of private placing:
Limited investor base
Dilution of ownership of existing shareholders
My T. Nguyen Financial Management January 2025 13 / 38
Right issues
Firm offers existing shareholders opportunity to buy new shares pro
rata to number of shares they already own
One share is one right
Shareholders have short period to decide whether or not to take up
offer (up until the expiry date)
instead of exercising option to buy new shares, shareholders can sell
their rights for cash
Issue price of new shares is set below current market price
to incentivise shareholders to take part in
Issue of new shares increases the total number of shares and the value
of company
Firm may work with underwriter, who agrees to buy any new shares
that are not taken up by existing shareholders in return for a fee
My T. Nguyen Financial Management January 2025 14 / 38
Right issues
Benefits of rights issues
Cost effective
Gives shareholders opportunities to maintain their ownership
Drawbacks of rights issues
Still results in dilution of ownership if shareholders do not participate in
it
My T. Nguyen Financial Management January 2025 15 / 38
Rights issues
A company has 2 million shares currently trading at $1 each and
wishes to raise additional 1 million via rights issue. What is the value
of one right just before expiry date?
1 for 1 means that existing shareholders can buy 1 new share at the
issue price for every 1 share they already own
2 for 3 means that existing shareholders can buy 2 new share at the
issue price for every 3 shares they already own
“1-for-1” “2-for-3”
Prior to issue:
No. of existing shares 2 million 2 million
Share price $1 $1
Value of company $2 million $2 million
Expiry of issue:
New money raised $1 million $1 million
My T. Nguyen Financial Management January 2025 16 / 38
Rights issues
A company has 2 million shares currently trading at $1 each and
wishes to raise additional $1 million via rights issue.
“1-for-1” “2-for-3”
Prior to issue:
No. of existing shares 2 million 2 million
Share price $1 $1
Value of company $2 million $2 million
Expiry of issue:
New money raised $1 million $1 million
No. of new shares 2million
Issue price $0.5 --> 1m/2m
No. of shares in total 4m
Share price 3m (money)/4m (share)
# rights needed to buy 1 share 2m/2m
Value of right to buy 1 new share at expiry (0.75-0.5)/1
My T. Nguyen Financial Management January 2025 17 / 38
Types of funding
Firms can receive funding in different types of financial claims:
Debt
Equity
Many other financial claims, most of which are hybrids between debt
and equity
My T. Nguyen Financial Management January 2025 18 / 38
Debt
Debt owners lend the money to the company:
Reward: company promises to receive regular interest payments and
one final principal payment (face value)
Risk: the company may default
Debt has important features:
In the event of liquidation, bond holders receive what they have been
promised first, before more junior claimaint such as equity can receive
anything
Among all the debt, the senior debt has higher seniority than junior debt
Debt holders typically do not have the right to participate in the
decisions of the firm or the appointment of its management team
My T. Nguyen Financial Management January 2025 19 / 38
Equity (= ordinary shares)
Shareholders use money to buy shares issued by the company:
Reward: residual profits after bond holders have been paid
Risk: firm may make losses rather than profits or may default
Equity has important features:
Shareholders are entitled to whatever is leftover after the company has
paid all of its debt payments and tax
Shareholders have the right to elect the corporate board, which in turn
appoints the management team
My T. Nguyen Financial Management January 2025 20 / 38
Firm value
Debt and equity are called state contingent claims
Their future value depends on the future state of the firm
A firm is financed by bond, equity, and no other claims. Bond has a
face value of $200 (i.e., the promised payoff to debt holders at
maturity is $200). How much cash flows can the bond holders get if
the firm value is $0, $50, $100, $150, $200, $250, $300, $350, ...?
How about for equity holders?
My T. Nguyen Financial Management January 2025 21 / 38
Firm value Example 1
A firm is financed by bond, equity, and no other claims. Bond has a
face value of $200 (i.e., the promised payoff to debt holders at
maturity is $200). How much cash flows can the bond holders get if
the firm value is $0, $50, $100, $150, $200, $250, $300, $350, ...?
How about for equity holders?
Firm value Bond value Stock value
$0 $0 $0
$50 $50 $0
$100 $100 $0
$150 $150 $0
$200 $200 $0
$250 $200 $50
$100
$300 $200
$150
$350 $200
My T. Nguyen Financial Management January 2025 22 / 38
Firm value Example 1
Payoff for equity and bond holders
400 300
Claim value, in $
Debt
200
Equity
Debt
100
0
0 100 200 300 400 500 600
Firm value, in $
My T. Nguyen Financial Management January 2025 23 / 38
Firm value Example 2
A firm is financed with a senior bond that promises to pay $100, a
junior bond that promises to pay $200 (of lower seniority but of equal
maturity to the senior bond), and equity. Write down the payoff table
and then draw the payoff diagrams when the two bonds are due
Firm value Senior Bond value Junior Bond value Stock value
$0 $0 $0 $0
$50
$100
$150
$200
$250
$300
$350
$400
$450
My T. Nguyen Financial Management January 2025 24 / 38
Firm value Example 2
Payoff for equity and bond holders
400
Equity
300
Claim Value, in $
Junior Debt
200 100
Senior Debt
0
0 100 200 300 400 500 600 700
Firm value, in $
My T. Nguyen Financial Management January 2025 25 / 38
Preference Shares
Hybrid security in-between debt and equity
Unlike ordinary shares, do not confer voting rights
Promise to pay pre-determined (usually fixed) return (preference
dividend) to preference shareholders
preference dividends typically greater than coupon payments on debt
but paid only after all lenders have been paid
Unlike coupon payments on debt, preference dividends can be
deferred
but no dividend can be paid to ordinary shareholders until cumulative
preference dividend has been paid to preference shareholders
Unlike coupon payments on debt, preference dividends are not
corporate-tax deductible
My T. Nguyen Financial Management January 2025 26 / 38
Quiz
You want to set up a company with limited liability. Your initial
investment is $900. You have $300 of your own and you get $300
each from your grandma and your uncle that you promise to pay back
in one year if things go well. Your relatives do not want any interest.
In one year you will leave Fulbright for your semester abroad. At that
time you are liquidating the firm. There are four potential outcomes
at that time: $1350, $750, $450, $150.
My T. Nguyen Financial Management January 2025 27 / 38
Quiz
a) Who is an equityholder and who is a debtholder in your company? How much
will equity and debtholders get in each outcome next year?
b) Your uncle is paid fully before your grandma gets a cent. How do you call the
two types of debt contracts? Which kind of debt is more risky? How much will
equity and debtholders get in each outcome in this case next year?
c) Your girl/boy-friend is upset due to your heavy workload for studying and
running business. To soothe her/him you plan to invite her/him for an upscale
dinner. As you are short of money, you sell preferred shares of your company for
$100 giving the following cash flow rights: The first $50 of equity are entirely for
the preferred shares. From every $1 for total equity that exceeds $50, preferred
shareholders will get $0.25. How much will equity- and debtholders get in each
outcome in one year?
The first $50 of equity are entirely for the preferred shares: Before any distribution
or allocation of equity is made to common shareholders, the preferred shareholders
will receive up to $50 first.
My T. Nguyen Financial Management January 2025 28 / 38
Convertibles
Convertibles
debt security with an embedded option to exchange that debt for a
fixed number of new shares in issuing firm for a fixed period of time
since embedded option is valuable, firm can issue that debt with a
lower coupon rate
My T. Nguyen Financial Management January 2025 29 / 38
Convertibles Example 1
The firm with 40 outstanding shares of equity has 20 outstanding
convertible bonds that promise $10 each in a future date. Each of
these bonds can be converted at the discretion of bondholders, into 3
new shares of stock in that future time. Show how the payoff diagram
for both bondholders and shareholders look like if the firm value is $0,
$100, $150, $200, ...?
My T. Nguyen Financial Management January 2025 30 / 38
Convertibles Example 1
Total value of convertible bonds in the firm: 20 ×$10 = $200
If all bondholders convert, the number of new shares created is 20
×3 = 60
It means that if all bondholders convert, they will hold 60: (60+40)
= 60% of the firm
If firm value is less than $200,bondholders get the entire firm value
and equity holders get nothing, so bondholders will not convert if the
firm value is less than $200
Bondholders will only convert if they can get more than $200, which
happens if 60% of the firm value is worth more than $200:
60% × F irmvalue > $200
Bondholders will convert if F irmvalue > $333
My T. Nguyen Financial Management January 2025 31 / 38
Convertibles Example 1
If firm value is less than $200
Bondholders will not convert
Bondholders get the entire firm value, equity holders get nothing
If firm value is greater than $200 but less than $333
Bondholders
Bondholders
If firm value is equal $333
Bondholders are
Bondholders get
If firm value is greater than $333
Bondholders will
Bondholders
My T. Nguyen Financial Management January 2025 32 / 38
Convertibles Example 1
Payoff table
Claim value Convertible Equity
0 0 0
100 100 0
150 150 0
200 200 0
250 200 50
300 200 100
333 200 133
350 210 140
400 240 160
450 270 180
500 300 200
My T. Nguyen Financial Management January 2025 33 / 38
Convertibles Example 1
Payoff diagram
400
Conv Debt
300
Claim Value, in $
Conv Debt
200
$133 Equity
100
Conv Debt
$333
Equity
0
0 100 200 300 400 500 600 700
Firm Value, in $
My T. Nguyen Financial Management January 2025 34 / 38
Convertibles Example 2
A convertible zero bond that promises $10,000 can be converted into
50 shares of equity at its maturity date. If there are 2,000 such bonds
and 300,000 shares outstanding, write down the payoff table. Show
how the payoff diagram for both bondholders and shareholders look
like
My T. Nguyen Financial Management January 2025 35 / 38
Pecking Order theory
Companies seeking funds for new investment typically observe pecking
order (Myers 1984)
first internal funds i.e. retained earnings, accumulated cash reserves
then external funds: debt followed by new equity
My T. Nguyen Financial Management January 2025 36 / 38
Pecking Order theory
Transaction costs
Relying on internal financing avoids the transaction costs associated
with issuing new debt or equity
Issuing debt is less costly than equity
Control and ownership dilution
Relying on internal financing avoids dilution of control and ownership
Issuing debt also does not impact control and ownership but issuing
equity can lead to a dilution of control of existing shareholders and may
result in management having to answer to a broader group of
shareholders
My T. Nguyen Financial Management January 2025 37 / 38
Pecking Order theory
Information asymmetry
If a company is financing itself internally, the public can assume that
the company is doing well because earnings are high enough to fund
current operations and growth.
If a company is financing itself through debt, this is a signal that
management is confident the companyâs earnings are enough to cover
the costs of loan repayment.
If a company seeks financing through equity by issuing new shares of
its company, this is a sign that the company considers its own stock to
be overvalued. The internal hope may be that the company can raise
funds through selling shares, something it may not be able to do once
its share price falls.
My T. Nguyen Financial Management January 2025 38 / 38
