Saturday, September 07, 2013

Why Do Companies Issue Stock?

Public Companies throughout the world issue new stock or shares every day. But what is stock, and why does a company issue it?

What is Capital ?
Let’s imagine that you decide to start up your own ice cream shop business. You will need to invest in equipment, food supplies and property. All the money that you invest to start your business is called capital. Essentially, the capital of a business consists of all of its assets (or items to assist in the creation of wealth). What if it dawns on you that you don’t have enough cash to buy all the needed assets? Let’s see how new businesses and companies deal with this problem.

Equity vs. Debt

To start a new business (or fund a new project) a company can raise money in two ways – by selling shares of equity or by incurring debt. If the owner of our ice cream parlor invested all their own savings to buy the materials necessary to start the business, they made an equity investment in the company. Equity is simply ownership of a corporation. Typically, ownership units in a corporation are referred to as stock. However, if our owner did not have necessary funds to start their own business they could finance their operation in one of two ways:
  1. Issue stock (or certificates of partial ownership in his company) to people who may be interested in helping their venture out in return for a proportional share of the profits that the company might generate.
  2. Borrow money that will need to be paid back with interest. So, what are the advantages of selling stock?

Why Do Corporations Issue Stock?

Businesses issue stock to raise capital. It’s as simple as that.

Advantages of issuing stock:

  1. A Company can raise more capital than it could borrow.
  2. A Company does not have to make periodic interest payments to creditors.
  3. A Company does not have to make principal payments.

Disadvantages of Issuing Stock:

  1. The principal owners have to share their ownership with other shareholders.
  2. Shareholders have a voice in policies that affect the company operations.

Advantages for Stockholders

As part owner of a corporation, you may be entitled to share in the profits of the company. There is also a chance that the company will grow and the price of the stock may rise. If the company achieves economic success, the stock value will go up and stockholders will benefit. For example, if you invested $1,000 to buy 100 shares of a company at $10 each and the shares rose to $13 each you would gain $300. This is equivalent to a 30% return. In cases like this, both the stockholders and the business would be pleased.

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