You have been successful in putting up your start up company and business is doing well. A lot of doors have opened and clients have been lining up in order to do business with you. There is so much room for growth and expansion, but the current cash flow coming in is not enough to support these plans. Where do you turn to for needed funding? We take a look and explore ways on how to raise the needed finances in order to move your company forward. After going through the advantages and disadvantages we hope that a decision can be made as to which way is best.
Companies face a situation where they need to avail of financing in order to grow their business. There are two ways to go about this. For companies that are more stable and have sufficient cash flow, debt financing is the usual solution. When there is limited cash flow expected, common stock financing can provide the funding needed.
Common stock financing is a way for companies to raise funds by selling ownership of stakes within a corporation in exchange for cash or capital funding.
Advantages Of Common Stock Financing
When you are the company issuing the common stocks in exchange for capital funding, the biggest advantage is you don’t need to make any mandatory payments. Compared to debt financing, which requires a company to make payments including interest for the loan acquired on a regular basis. The only possible payout the company makes is when dividends are given to common stockholders. This is not mandatory and is only given when a company makes a profit.
Common stock can also increase the credit profile or rating of the company which they can use as leverage to get into debt financing at a lower cost in the future. It is also easier to sell common stock than to get approved for debt financing especially for startups.
Common stock investors are always on the lookout for companies who would want to raise funds through common stock financing. They do their homework and due diligence in knowing who the founders and the management team of the company are and the potential for growth. If they see that the company has a great strategy in place and are passionate about their business, there is a big chance that they would purchase their offer of common stock. These investors know too well the potential for growth and large returns compared to other investment instruments that are available out there. There are a lot of companies who have had tremendous growth in just a short span of time. This may be risky and common stock investors know this, but if it plays out right then it’s just like hitting the jackpot
Disadvantages Of Common Stock Financing
When common stocks are issued, voting rights are given to the new stockholders. This can become a problem in the future if these new stockholders assert their rights contrary to the company’s plans and directions. Control of the company can be given over to a bloc of common stockholders who have a majority of the shares.
It also gives new stockholders a right to a percentage of the profit compared to a fixed rate and payment in the case of debt financing.
When the company gives out dividends to common stockholders, these are not tax deductible compared to interest payments paid to creditors in debt financing.
When you choose stock financing through common stock, company ownership is reduced due to the sale of common stock to persons or entities in exchange for cash.
Common stock investors also share the risks that are applicable to owners and management. They are in a position to lose their entire investment if the company closes down or files for bankruptcy.
Stock financing can be a great way to raise funds without having to go through debt financing. Having a strong or high value common stock can be used as “currency” and be sold at high prices in order to fund company expansion and capital expenditures. We have looked at both the advantages and the disadvantages when a company chooses to raise capital through equity financing. In the end, owners and management have to make a decision on whether to push for equity financing or debt financing.