In this article, we’ll look into the purpose of a company issuing stock and discuss why share issue is the most effective equity financing approach that can be used for raising capital.
Corporations, even though they are considered individual entities such as a human being, have more availability of capital than individuals do. This is basically one of the premier tenants of why a business would become a corporation.
It is easier to raise capital as a corporation rather than a sole proprietorship or partnership. Corporations have three available avenues upon which to raise capital.
In order to find out the reason why companies prefer issuing stock, you must first understand these three avenues: bank loans,
We'll go into detail each one of them in turn.
Raising Funds from Bank Loans
The first option that a corporation can utilize to raise capital is the same as individual utilizing a bank loan.
Of course, in order for a corporation to borrow money from a bank it has to meet certain preset standards by the bank. This includes income, assets, term of the loan, and other items.
Additionally, just as when you have to get a loan a corporation has to work with the bank in meeting all regulatory requirements and thus there is a very large amount of paperwork, which must be completed.
Finally, some corporate loans would have to be in such large amounts that a bank would have to develop a syndication of several banks in order to meet the amount of capital the business needs to be successful.
In short, bank loans are both time-consuming and require a large amount of capital resources to develop the loan.
Raising Funds by Issuing Bonds
The second option that a corporation could use to finance its operations is sell bonds.
Bonds are exactly like loans but instead of being issued by a bank the loan is being issued by bondholders who are lending the money directly to the
The process of issuing bonds does take
On the whole, though, corporate finance theory dictates that when a corporation is financing itself it has to choose between bonds in stock.
Raising Funds by Issuing Stock
Stock is the third and most successful mechanism for corporation to develop capital.
Bond and loan are based upon fixed return set for a specific time period. Stock on the other hand just grants to the owner the potential right to receive profits from the company in the form of dividends or stock appreciation.
In this situation, it is much cheaper for a business to issue stock rather than bonds or seek out a loan because there is no set repayment schedule of the money raised. Therefore, stocks save the corporation money because they do not have to pay back a specific amount of debt over a period of time.
The advantage to the corporation is obvious, they can raise a large amount of capital at a very cheap price, and the only real expense is that the company may have to pay a dividend of the earnings in the future, but there is no guarantee that they must.