New readers, and why a company goes to the market

Prairie Sky goes to market

Prairie Sky Software Inc. is a Saskatoon firm that builds scheduling software for hospitals. For twelve years it was owned by its two founders and a handful of employees, reported under ASPE, and borrowed from one bank. This year it lists on the Toronto Stock Exchange. Nothing about the software changes, but the set of people reading its financial statements does.

Internal stakeholders work inside the company and already had access to its numbers: employees, management and the board. External stakeholders stand outside and depend on what the company publishes: the new public shareholders, the market analysts who write research about the company, lenders, customers, suppliers, regulators (the Ontario Securities Commission and the TSX itself) and the community of Saskatoon. Two of these readers are new the day the company lists — public shareholders and analysts — and neither can walk into the office and ask. That is why a public company faces the reporting and governance rules the rest of this half of the course describes.

Why a capital market exists

Prairie Sky wants $9 million to build a US sales team. No single investor in Saskatoon has $9 million to spare on one software firm. A stock exchange solves three problems at once:

1. Pooling. Thousands of investors each buy a few hundred shares; the company receives the total.
2. Liquidity. An investor who needs cash next year can sell the shares to someone else on the exchange in seconds, at a quoted price. Without that exit, few would buy in the first place.
3. Price discovery. Every trade sets a price that reflects what the market collectively believes the company is worth — a signal the company itself uses when it raises more money or when the board judges management.

The primary market is the issue itself: Prairie Sky sells new shares and receives the cash. Everything after that — an investor selling to another investor on the TSX — is the secondary market, and the company receives nothing from those trades. It is the existence of the secondary market that makes the primary market possible.

The claims hierarchy and limited liability

If Prairie Sky were wound up, its assets would be paid out in a fixed order: creditors first (the bank, suppliers, employees for wages), then preferred shareholders, and common shareholders last, taking whatever is left. In exchange for standing last, common shareholders own the votes and the upside. And a shareholder's loss is capped at what they paid for the shares — limited liability — which is what lets a stranger buy a piece of a company they will never visit.

Equity or debt?

The founders could have borrowed the $9 million instead. The trade-off the midterm asks you to write out:

Equity is the more expensive money per dollar over the long run — investors demand more for standing last — but it never has to be paid back and it strengthens every leverage ratio a lender looks at. A growing company with uneven cash flows usually wants some of each.