A financing can improve reported earnings per share while weakening the company. Your job is to connect the issuer's cash needs with investors' objectives, legal eligibility, and risks.
Before recommending securities, identify who controls the issuer, who owes its taxes, and what ownership restrictions apply. Organizational structures determine which financing alternatives are practical.
C corporations are separate legal entities whose shareholders generally have limited liability. They can issue different equity classes and accommodate institutional owners. Federal corporate taxable income generally faces a 21% rate. Dividends can create another tax layer for shareholders, so compare investor returns after relevant taxes.
S corporations elect federal pass-through treatment: shareholders generally report allocated income even without cash distributions. They generally permit no more than 100 shareholders, who must be individuals or certain estates, trusts, and exempt organizations. A nonresident alien cannot be a shareholder. Only one economic class of stock is permitted, although voting rights can differ. An institutional equity investment can therefore require a structural change.
Common mistakes
- Treating $5 million of individual investments as QIB qualification confuses qualified-purchaser eligibility with an institutional resale test.
- Calling a 2-million-share secondary sale company financing misdirects the proceeds; selling shareholders receive them.
- Treating a $30 rights subscription as an automatic $10 gain ignores the theoretical adjustment from $40 to $38.
Bottom line
- S corporations generally allow no more than 100 shareholders and one economic class of stock.
- QIB status generally requires an eligible institution with $100 million in unaffiliated securities ($10 million for registered dealers; banks also need $25 million net worth).
- Qualified-purchaser tests include $5 million in individual investments and $25 million invested discretionarily.
- Primary proceeds go to issuers; secondary proceeds go to selling holders.
Exam shortcut
Trace the cash first: identify who pays, who receives proceeds, and whether share count changes. Check the investor's legal form first; QIB status is institution-only. For rights questions, add subscription cash to existing equity value, then divide by all post-offering shares. For repurchases, adjust both earnings and shares. Stress the earnings assumption before accepting an apparently favorable percentage.
The full lesson (about 4,185 words, 28 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- A10
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