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IPOs - How They Affect Small Businesses
A Capital Table is basically a table giving an assessment of the percentages of ownership, equity Dilution, net value of equity, and net worth of an initial round of financing by owners, founders, and partners. This percentage of ownership or equity Dilution is often used to determine if an acquisition is a good investment for the company. It can also be used to calculate the cost of capital as opposed to financing for a business startup. The numbers that are listed on a Capital Table are usually the percentage of equity dilution and net worth per ownership percentage. A Capital Table can be given by many different sources but the most widely used are typically from banks that do the underwriting for commercial mortgage loans.

A Capital Budgeting System is another popular method of capital table calculation. In this method, financial metrics are used to determine the value of equity, the amount of capital funds available to be invested, the potential growth of capital funds, and potential future value of equity compensation. The capital budgeting process is not without its critics however. Some economists argue that calculating the cap table using the conventional methods of capital budgeting can underestimate the true economic value of long-term capital appreciation.

Many companies use capital budgets to hedge their exposure to risk. Cap tables can also be used to hedge exposure to variable interest rate debt instruments such as corporate debt and notes. In these cases, a company can calculate its potential losses if the interest rates fall enough to cause the total amount of debt to rise. The company can then use the capital budget to offset this risk by borrowing more money or selling more equity into the capital pool. However, companies must realize that the purpose of the cap table is to provide the company with protection against outside shocks. If the company is not able to raise enough money or if the amount of equity in the company dwindles, a cap table can actually lead to a worse situation where the company is forced to cut costs or sell assets to survive.

A second point that makes cap tables really confusing is that many people believe that they are meant to give shareholders a limited or non-exhaustive way to control the management of the company. This is simply not the case. Capital funds are a highly inefficient way for a shareholder to determine the value of his or her investment. Even if a company does well, a shareholder will generally only receive a dividend once a year or less frequently at the most. Owners of companies that do well enough to be able to make a dividend payment regularly will generally pay far less than a person would pay for the same shares of stock.

The last confusion that I will touch on is with regards to the difference between a transaction advisory and a capital structure. One would think that a capital structure would allow a person to obtain unlimited shares of ownership at one point in time, with no restrictions. This is simply not the case. Transaction advisory shares are restricted, which means that the person purchasing them has to remain within the restrictions imposed by the Securities Exchange Commission (SEC).

Also, because the SEC sets the holding rate for these types of shares, new investors must work to qualify to purchase shares. All investors must first be accredited members before they can begin to acquire capital stock. New investors are also subject to a performance risk premium, which is added to the price of each share based upon the performance of the company. The founder's shares are excluded from this rate.

Lastly, when startups deal with outside investors they may be dealing with a capital funnel that funneles cash into the company as it grows and as it is being operated. This funnel is often referred to as a "cash hose." This is not really a bad thing, but it can create a number of operational issues for startups . Most startup employees are unaware of how the capital flow works, and there can be a significant unintended consequence if this capital becomes uncontrollable. Because startups typically have a small staff, the problem is magnified greatly, as there are not enough employee shareholders to effect the overall capital structure.

As you can see, there are two major risks associated with an IPO and one significant advantage: founder owners may not have enough money to properly operate the business, which may result in them voluntarily turning over control of the business to an associate or employee. However, the IPO may also spark an initial flurry of growth for the company, resulting in an IPO that underperforms the S&P 500. Also, there is always the risk that the new venture will not perform as well as anticipated, thus the founder may decide not to sell, but instead reinvesting their profits into the company. In the latter case, IPOs often fail to generate enough proceeds to cover the costs of the IPO, causing the stock price to fall. So, depending on your goals and financial situation, an IPO may be a highly desirable investment, but it is not for everyone.
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