Similarly, the sources of debt capital to small firms are also limited. Because of the limited access to the capital markets for new equity, small firms tend to retain a much larger portion of their earnings to fund future growth than larger firms.

Issuance costs for common stock sales of small firms may exceed 20 percent of the issue size.Īs a consequence, the cost of equity capital tends to be significantly higher for small firms than it is for larger firms. If stock can be sold, investors will often pay much less for these shares than they would for similar firms that are larger and have their stock traded regularly on an organized exchange or over the counter. Many firms are so small that it is nearly impossible to raise funds by selling common stock. In this way, capital can be raised without losing voting control. In contrast, Class B stock, often held by the company’s founders, has greater voting power than Class A stock. Class A stock usually receives a higher dividend than Class B. Owners of small firms are reluctant to sell common stock because they do not want to lose voting control in the company.When shares are sold, many small firms create two classes of stock, such as Class A and Class B.The Class A stock is the one that is traded most extensively in the capital markets. Small firms have a difficult time attracting capital to support their investment programs. This is accomplished by first plotting the returns expected from the proposed capital expenditure projects against the cumulative The optimal capital budget can be determined by comparing the expected project returns to the company’s marginal cost of capital schedule.

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