Pros & Cons of Financing Through Stocks
Businesses have two major avenues of financing major activities, debt and equity. Debt financing is common and can take many different forms, including large loans from banks, private loans from investors and bonds that businesses issue in a series. These debts are all money that the business must eventually pay back, along with interest. Financing through equity is the process of selling shares of stock in the company to investors, who buy the shares at a specific price per share and allow the company to use the funds for advancement. There are both advantages and disadvantages to this type of equity financing.
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Dealing with Debt
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First, financing through stocks is always related to debt financing, even though the two are opposed. Companies seek a balance between the two for the benefit of both investors and company liabilities. If a company is using too much debt to finance basic operations, financing through equity can relieve the pressure and even help the business pay off key debts to assert a better balance. But a company can also depend too heavily on equity financing and not use funding that may be available through debt to grow the business.
Company Ownership
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Company ownership is another vital component to equity financing. If a company only sells part of its shares but keeps the controlling interest within the business, stocks can be a great way to raise capital--which is why so many businesses do it. But shares are literally ownership in a company, and company ownership can become diluted by selling too many shares, spreading the ownership among many investors. Among other problems, this opens the company up to a possible takeover if a rival were to buy up these outstanding shares until it had a controlling interest.
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IPOs
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IPO stands for initial public offering, the step a business takes as it becomes a corporation and issues stock for sale on public stock markets. Companies can choose to sell stock to interested investors before an IPO, but this typically restricts stock sales to a few investors and owners. An IPO opens up company stock to many different trading opportunities and is a reliable way to raise a large amount of money through equity. On the con side, an IPO can be a complex and expensive process for a business and often takes years of work to successfully accomplish.
Long Term Strategies
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A clear advantage of stock financing is the avoidance of debt payments--companies typically pay investors dividends on their stock, but this represents a much lower obligation than paying back liabilities. But investors buy stock with clear expectations. They want a company to use the funds for long -term growth strategies that will increase profits and improve stock value. This creates a different sort of obligation, a relationship between the business and its shareholders that requires more strategic thinking and less paying off short-term debts.
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