1 The capital is tied up in the business throughout its life. A sole trader can overcome this problem by taking a partner; partnerships may expand in size by taking additional partners. Both sole traders and partnerships can decide to convert to companies. The owners of shares in a company can convert their holding in the company into cash only by selling their shares to somebody prepared to buy them. This is relatively easy if the company is listed on the Stock Exchange. The body that runs the Stock Exchange (the Stock Exchange Council) will accept a company for listing - and therefore for its shares to be bought and sold by members - only if it meets stringent financial requirements. People holding shares in unlisted companies find it more difficult to sell them. Aware of this problem, the Stock Exchange opened another market for shares.This is known as the Unlisted Securities Market (USM). The financial requirements needed to enter this market are less stringent than those required for listed securities but they still provide safeguards for people buying and selling shares on the Stock Exchange.
2 A high proportion of owners' capital increases the owners' risk. They may be shareholders in a listed company but if they wish to dispose of their shares at any time they may have to sell for a lower price than they paid, particularly if the dividends of the company have been low compared with the prevailing rate of interest or the dividends paid by other companies.
3 Raising money by issuing more shares is expensive in administrative costs. A rights issue, where shares are offered to existing shareholders, is the cheapest method. It is also difficult for a company to estimate the market price of its shares and, if underpriced, there is an additional cost to the company. Issuing shares by tender attempts to overcome this problem by stating the minimum price the company will accept for its shares and inviting the public to state how much they are prepared to pay for them.
Apart from the administrative costs of floating a share issue, owner capital appears the cheapest method of acquiring funds. The opportunity cost of using owner capital, that is the earning potential of alternative investment, should not be forgotten.
Preference shares
Between owners' capital and loans there is a less well-defined area of preference shares. The holder of a preference share:
– is not an owner of the company.
– receives a fixed rate of return but has no legal right to it.
– has priority over ordinary shareholders when a dividendis declared.
– has priority over ordinary shareholders when the company goes into liquidation.
Apart from these four points the rights of preference shareholders will vary from company to company. Companies design their preference shares to attract investors who do not want to take the risk of holding ordinary shares and who either do not have sufficient capital to lend to the company or wish to spread the risks of lending money. Cumulative preference shares have the right to claim arrears of dividends if the company does not pay a dividend in one year. Redeemable preference shares can be bought back by the company after a stated number of years. Some preference shares carry voting rights, others do not. The rights of the preference shareholders are laid down in the company's articles of association.
2.Comprehension check.
Read the text again more carefully. Here are some answers about the main sources of finance for any business. Write the questions.
a) __________________________________________________________________
Owners’ capital, borrowing from other people or organizations and obtaining goods on credit.
b) __________________________________________________________________
Using some of the private wealth, increasing the number of partners, floating a business as a company, issuing more shares by existing companies, etc.
c) __________________________________________________________________
The capital is tied up in a business throughout its life, a high proportion of owners’ capital increases the owners’ risk, raising money by issuing more shares is expensive in administrative costs.
Companies design their preference shares to attract investors who do not want to take the risk of holding ordinary shares and do not have sufficient capital to lend to the company.
