Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VI. Cost of Capital and

Long−Term Financial

Policy

16. Raising Capital © The McGraw−Hill^553
    Companies, 2002

CHAPTER

16

Raising Capital

On July 21, 1999,MP3.com was born as a publicly traded company. On that day,

the firm completed its initial public offering, or IPO, by selling stock to the public

for the first time. The investment turned out to be a smart one for the lucky

buyers. MP3.com’s stock price closed at $63.3125 per share that first day, which

amounted to a one-day gain of 126 percent! The offering gave MP3.com the

financing it needed to grow its business, and, as you might imagine, MP3.com

was not alone. In fact, 1999 was a big year for IPOs. Even after excluding issues

with low offering prices and those with unusual features, MP3.com’s IPO was just

1 of almost 500 offerings for the year. In addition, for the year, 117 of the IPOs

doubled in value (or did better) during their first day of trading. By comparison,

in the 25 years from 1974 to 1998, only 39 IPOs doubled in value on their first

day of trading. What is more, 1999 sported the biggest one-day price gain ever,

698 percent for VA Linux shares and the then-biggest IPO ever, by United Parcel

Service (UPS). In this chapter, we will examine the process by which companies

like MP3.com, VA Linux, and UPS sell stock to the public, the costs of doing so,

and the role of investment banks in the process.

ll firms must, at varying times, obtain capital. To do so, a firm must either bor-

row the money (debt financing), sell a portion of the firm (equity financing), or

both. How a firm raises capital depends a great deal on the size of the firm, its

life cycle stage, and its growth prospects.

In this chapter, we examine some of the ways in which firms actually raise capital.

We begin by looking at companies in the early stages of their lives and the importance

of venture capital for such firms. We then look at the process of going public and the

role of investment banks. Along the way, we discuss many of the issues associated with

selling securities to the public and their implications for all types of firms. We close the

chapter with a discussion of sources of debt capital.^1

A

(^1) We are indebted to Jay R. Ritter of the University of Florida for helpful comments and suggestions on this
chapter.
525