Three investors started a company called “A – B Computers”. Because their funds were limited, their company was small, but they were dedicated and produced only superior computer software.
They had two options:
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Borrow money from a bank.
- Bring in new investors willing to invest $600 for a share of the company in the form of new stock issued by the company.
Where can new investors be found?
Family, friends, and any other person with means could be potential investors in the company. Assume that each founder convinced a cousin to invest $200 for 200 shares, or one share for every dollar invested.
There are now six investors in the company: Three original founders and three new investors. Allen previously owned one-third of the company – 200 of the 600 shares. He now owns one sixth – 200 of the 1,200 shares – but the company is twice as large. Has his situation worsened?
Owning one sixth of a $1,200 company is just as good as owning one third of a $600 company, just as one sixth of a 200-gram chocolate bar is as good as one third of a 100-gram chocolate bar.
The original investors may even profit from this move.
If the company can demonstrate that demand for its products exists, it can charge more money per share than the original investors paid when it was founded and its future had been unclear. Assume that the entrepreneurs ask their three cousins for $2 per share.
In that case, the cousins will receive only 100 shares for every $200 that they invest.
There will now be 900 shares in the company: 600 owned by the founders and 300 owned by the new investors. Each founder will own two-ninths of the company, and each new investor will own one-ninth.
A Public Stock Offering
Another way to find new investors is to invite the public to invest in the company.
When expansion requires a great deal of money, it is difficult to raise the total amount from friends and relatives. The easiest and most common method is to invite the public to buy stocks in the company. This is called an initial public offering (IPO).
A firm seeking to issue stock to the public prepares a booklet, called a prospectus. The prospectus is a complete detailed description of all aspects of the company. It includes the names of the founders,
the education and skill of the company’s senior officers, the products made by the company, a description of all of the company’s capital, the range of its sales, its net income, and hundreds of other details.
In addition, the company describes how it plans to use the funds that it is trying to raise. The prospectus allows potential investors to see a full picture of the company before making their investment decisions.
An accountant and a lawyer sign the prospectus and verify that all of the information declared in it is accurate. A company that misleads the public in any way is subject to prosecution.
