Chapter 8 • Sources of long-term finance
The primary capital market
We shall in fact be considering the capital market in its primary function, as a market
for newcapital. The primary capital marketdoes not reside in a single location. It is a
somewhat nebulous market; in fact, any point of contact between a supplier and a user
of capital is part of the primary capital market. In the UK this includes the London
Stock Exchange (LSE) which, as well as being probably the most important part of
the secondary market (that is, the market for ‘second-hand’ shares and loan notes),
which is its more familiar role, is also a very important sector of the primary market.
However, the primary market also includes a large number of other institutions and
organisations. We shall be looking at the secondary capital marketin Chapter 9.
An important financial source in the modern UK is grants given by the government
and the European Union. We shall therefore be considering these in broad terms.The factors that influence decisions on raising new finance
From the point of view of the business and its existing shareholders there are several
important factors relating to any particular source of new finance. These include:
l the administrative and legal costs of raising the finance;
l the cost of servicingthe finance, for example interest payments;
l the level of obligation to make interest or similar payments;
l the level of obligation to repay the finance;
l the tax deductibility of costs related to the finance; and
l the effect of the new finance on the level of control of the business by its existing
shareholders and on their freedom of action.
To the supplier of new finance to the business, the following are likely to be import-
ant factors:
l the level of return that is expected by investors;
l the level of risk attaching to the expected returns;
l the potential for liquidating the investment either through direct repayment by the
business or by using the secondary market;
l the personal tax position of investors in relation to returns from their investment; and
l the degree of control or influence over the business’s affairs that the investor is
likely to acquire as a consequence of investing.
In this chapter we shall assess each of the financial sources reviewed, in the context
of these factors. We should note that those relating to suppliers of finance are of more
than passing interest to the business’s financial managers and existing shareholders.
Those factors have a considerable bearing on the attractiveness of any particular type
of finance (as an investment) and therefore on the likely success of an attempt to raise
new finance in that particular way.Risk and return
Both intuition and the results of several research studies suggest that investors expect,
and actually get, on average, higher returns where higher risk is involved. The rela-
tionship appears to be something like that depicted in Figure 8.1.‘
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