Question

PB10. LO 14.4 You are a consultant for several emerging, high growth technology firms that were started locally and have been a part of a business incubator in your area. These firms start out as sole proprietorships but quickly realize the need for more capital and often incorporate. One of the common questions you get is about stockholder’s equity. Explain the key ways the companies need to view retained earnings if they want to use it as a source of capital for future expansion and growth after incorporating.

Answer 1

Business incubators help startups through their early development by providing business advice, resources, contacts and capital. They can be funded by governments, created by universities or started by entrepreneurs as non-profit or for-profit ventures, which sometimes focus on a particular industry, like technology.

Incubators are attractive for first-time founders because you can learn from experienced executives, test your business model and gain industry credibility from the program's prestige. Most programs see founders relocate to the incubator’s office space, where you work alongside other startups for the duration, or until you have the resources and capabilities to grow alone.

A)

However, for-profit incubators will look to gain equity in the company in exchange for their services or seed capital. Gaining equity in an early-stage company with strong growth prospects is the ultimate goal – and one that can provide a financial windfall for the incubator firm if the early-stage company takes off. Equity stakes in startups, however, are more commonly associated with accelerators rather than incubators.

B) key ways of companies need to view retained earnings if they want to use it as a source of capital for future explanation and growth after explanation-

KEY TAKEAWAYS

• Retained earnings (RE) is the amount of net income left over for the business after it has paid out dividends to its shareholders.
• The decision to retain the earnings or to distribute it among the shareholders is usually left to the company management.
• A growth-focused company may not pay dividends at all or pay very small amounts, as it may prefer to use the retained earnings to finance expansion activities.

Using Retained Earnings

The following options broadly cover all possibilities on how the surplus money can be utilized:

• The income money can be distributed (fully or partially) among the business owners (shareholders) in the form of dividends.
• It can be invested to expand the existing business operations, like increasing the production capacity of the existing products or hiring more sales representatives.
• It can be invested to launch a new product/variant, like a refrigerator maker foraying into producing air conditioners, or a chocolate cookie manufacturer launching orange- or pineapple-flavored variants.
• The money can be utilized for any possible merger, acquisition, or partnership that leads to improved business prospects.
• It can also be used for share buybacks.
• The earnings can be used to repay any outstanding loan (debt) the business may have.