Final answer:
Very small companies opt for private investment over an IPO due to lower costs, less regulatory burden, and greater privacy. Venture capitalists are likely better informed about a firm's profit potential than potential bondholders due to their active involvement. Equity in a home purchase like Fred's is equivalent to the down payment, resulting in $20,000 of equity for Fred.
Step-by-step explanation:
Early-Stage Corporate Finance
Very small companies tend to raise money from private investors instead of through an IPO because they may not meet the regulatory requirements for an IPO, the process is expensive and time-consuming, and they may want to avoid the scrutiny and volatility of public markets. Early-stage companies might prefer an IPO to borrowing from a bank or issuing bonds to avoid the burden of regular interest payments, gain access to a larger pool of capital, and benefit from the publicity of going public.
A venture capitalist typically has better information about whether a small firm is likely to earn profits compared to a potential bondholder because venture capitalists often take a hands-on approach, engaging in due diligence, and sometimes participating in the firm's management to safeguard their investment.
From a firm's perspective, a bond is similar to a bank loan as both are forms of borrowing and require repayment with interest. They are different in that bonds can be traded on the open market and usually have a fixed interest rate, whereas bank loans are typically held by the lending institution and can have either a fixed or variable interest rate.
Equity calculation for a home purchase: Fred's equity in the home would be the down payment amount, which is 10% of the purchase price, hence $20,000.