Corporate Stock Information

Debt Financing and Equity Financing

When a company needs to raise money for some activity, such as overseas expansion or factory improvements, management decides whether it should borrow the funds, or raise them by selling a portion of the company. When a company borrows, it takes loans from a financial institution or issues bonds, in a process known as debt financing. In equity financing, on the other hand, the company sells ownership claim in the form of stocks. The number of shares a company can issue, known as authorized shares, is fixed at the time of incorporation and stated in its charter.

A company may prefer equity financing over debt financing for a number of reasons. When a company raises money by debt financing, it has to repay it within a defined period, and also has to make periodic interest payments on the loan. In equity financing, the company does not have to pay the money back because the additional funds are not loans; rather, the money comes as proceeds from the sale of ownership claim. A disadvantage of issuing stock is that it may lead to a dilution of management control; if stockholders acquire significant numbers of shares, they may take over management of the company.

From the investor's point of view, a person may buy shares of a corporation's stock to increase personal wealth. When a company performs well over a period of time, the price of its shares tends to reflect the performance. If a shareholder purchased 1000 shares for $2 a share and sold the 1000 shares for $3 a share, he would make a profit of $1 per share, giving him $1000. Another source of earnings for investors is dividends, which are distributions of company profits. When a business performs well and makes a substantial enough profit, the business may distribute the earnings proportionally among stockholders.

Corporations may issue either common stock or preferred stock. A preferred stockholder has certain privileges, such as priority over common stockholders in dividends distribution and liquidation. If a company is unable to generate significant income for a period, it may decide not to pay any dividends to its common stockholders, but it must eventually pay preferred stockholders. In addition, preferred stockholders also have redemption and anti-dilution rights, and the ability to convert to common stock.

For investors, risks associated with owning a corporation's stocks include the risk of not receiving dividends and the risk of losing the entire sum of investment in the event that the corporation goes bankrupt. Companies are not obligated to pay dividends, and may instead decide to retain earnings for future growth; in such cases, the stockholder may only make a return on the investment if the stock prices appreciate.