One of the first and hardest challenges many business owners and founders encounter is raising funds to start or grow their business. Aside from the rare instances in which wealthy people start businesses, chances are that outside funding will be needed to scale the business past a certain size. When a business decides it wants to take on outside funding, it has two primary options: issue stocks or take on long-term debt.
As with most things business-related, there are advantages and disadvantages to each option, and which one a company chooses depends largely on how they prefer to run their company.
Stocks represent ownership in a company. When someone owns shares of a company, they have part ownership of that company. Owning stock in a company gives investors the right to vote on specific business matters, as well as the right to some of the company's profits.
Among the advantages and disadvantages of issuing preferred stock you can list the complications inherent in the form.
If a company chooses to raise capital by issuing common stock, they must know that they are giving away part ownership.
One of the main advantages of issuing common stock is that it allows a business to keep the cash it has while seeking out additional money. This avoids scenarios in which a company may owe lenders.
Issuing common stock also allows business to bring other qualified businesspeople into the mix. Because investors own part of the company, they have a vested interest in its success and will likely offer services and resources to help.
The primary disadvantage of issuing stock to raise capital is that founders and owners begin to lose ownership of the company as more shares are sold.
If a company has 10 million shares and sells 2.5 million shares to raise money, they are giving up 25 percent ownership in the company. If a person or entity owns 51% of a company's stocks, they hold majority ownership and can make all business decisions.
As companies grow and raise more money by issuing stocks, there may come a time when owners and founders no longer have majority control.
Taking on long-term debt is done by selling bonds or taking out loans. Bonds do not represent ownership, they represent debt. Among the long term debt advantages and disadvantages is that when someone purchases a bond, they are loaning the issuing company money. They expect to receive their money back with interest.
Companies choose to take on long-term debt to raise capital because it allows them to keep ownership in the company. A company may need money but would rather not give up parts of the company to acquire it. Such situations make long-term debt the optimal option.
Another advantage of taking on long-term debt is that the process can be repeated whenever a company needs money. With issuing stocks, the amount of times that can be done is limited because eventually there will be no more ownership in the company to offer to investors.
A company can take out a loan however often they see fit, as long as they are willing and able to pay the money back.
The disadvantages of issuing bonds and taking on long-term debt are the costs associated with it.
Nobody loans out funds for free; the money a company receives from issuing debt must be paid back with interest. These payments – whether in the form of bond coupon payments or monthly installments – can tie up a company's future earnings and hinder their growth opportunities.
There may come a time when a company wants to invest in its business or purchase certain assets. Depending on the amount of their debt, they may be unable to because they have to pay out coupon payments or loan installments.