There are projects that may require a company to seek for external funding in order to boost its capital base. You can easily study the company form of funding from it’s from the capital structure, which may include; common stock, financing from reserves or debt financing.
Public companies have the option of raising capital through issuing common stock or bonds. Each form of financing has its own merits and demerits.
When issuing common stock you is in essence relinquishing a portion of the company’s owner ship to a third party. This form of funding gives stakeholders the right to vote during the Annual General Meetings and receive dividends in tandem with company performance. The company can issue common stock through initial public offering (IPO) or secondary public offering. The organization will be obligated to give a group of investment banks and stock brokers, when issuing common stock to the public. The amount spend on issuing stock will be regarded as a risk premium which is an expected return.
Liquidity makes reference to the capacity to change your investment into cash. Common Stocks can easily be converted to cash as compared to Bonds. The company is compelled to make periodic interest and principal investment repayments, which may drain the company of the much needed capital for operations. However ordinary shareholders (Common Stock) are not entitled to dividends if the performance of the company is poor. The Company directors may decide to convert part of the dividends into company reserves, which will cushion from future losses or be instrumental for investing in other projects. This makes common stocks more appropriate for cash conservations.
However if the company omits to pay interests on bonds, it may be declared bankrupts and lead to insolvency.
Restrictions And Obligations
There are strict conditions that a company has to adhere to when engaging in Bond Contracts. These Contracts may restrict a company of what projects to invest in that lenders deem less risky. The issuance of stock restrictions may also include; payments of dividends, maintaining specific financial ratios like a fixed percentage of debt to equity ratio and issuing additional debts. Apart from giving stakeholder a right to vote during Annual General Meeting, Common Stock may not expose the company to such restrictions. However common stock holders can be engaged in important decision making like picking the board of directors.
Company’s Credit Rating
The credit rating of the company is at a higher risk when issue more debts, since it will increase the probability of defaulting. However issuing stock will be favorable because payment of dividends is optional. This will enhance your credit rating and make it easier for the company to raise funds through debts in future. This is usually instrumental for companies that may want to be involved in takeover offers in future. Without Bonds, the company will be able to get higher credit rating and hence ask for a better buyout price. In some cases the federal government may require companies to have better credit rating before they engage in any business with the government. This implies that poor credit ratings may deny the company juicy business opportunities.
Merits of Common Stock
Common issuance of stock is less risky and doesn’t obligate the company to finance debts on regular basis. The Company’s balance sheet will be cushioned from more debts and reduce the expenses incurred in servicing debts. This makes issuance of common stocks to be less expensive compared to bonds. It also gives the company stock a better rating in the stock market.
When issuing shares to the public the company is relinquishing ownership of the company to more individuals. This is because when issuing common stock the company increases the amount of outstanding shares. Therefore raising funds through common stock may jeopardize decision making in a company especially during Annual General Meeting voting.
Risks of Bankruptcy
When a Company faces financial crisis and undergoes bankruptcy, it will not be compelled to compensate the common stock for dividends. This is because when undergoing insolvency Bonds and Company’s debts are given first priority. After this, preference shareholders are given a priority of the common stock (Ordinary Shareholders). According to the US Securities and Exchange Commissions, Common Stock investors are paid after all creditors and other shareholders have been paid in case of company insolvency.
Issuance of stock is a less risky way to raise capital in terms of the company’s financial obligations in case of poor performance in future. However issuing common stock will relinquish ownership from existing shareholders and give them lesser powers in decision making.