By Kevin Johnston Updated January 25, 2019
When it's time for your small business to raise large sums of cash without borrowing from a lender, you have two choices. You can either sell stocks or you can sell bonds. Selling stocks allows investors to buy shares of your company, which means they actually own a piece of it. Selling bonds means borrowing money from investors and paying interest to them. Each method works, but there are different consequences for how you run and grow your company.
Advantage of Selling Stock: Cash to Grow Your Business
If your business doesn't have a stellar credit rating, you may not be able to borrow the money you need. If you incorporate, you can sell stock in your company instead. This is particularly attractive if you are a start-up with no track record. You can attract these investors based on your potential for profit and growth.
Advantage of Selling Stock: No Debt Repayments
Selling stock gives you the advantage of not owing any money to investors, because you are not borrowing. You don't have to make any payments for the money you raise this way. In addition, a rising stock value can increase your credit rating and make it easier to borrow money in the future. Also, the constant need to justify your actions to shareholders can give your company a sharp focus and profitability.
Disadvantage of Selling Stock: Giving Away Ownership
By selling shares of your company, you give each investor a piece of ownership. This means you have to answer for all of your actions to shareholders. You may have to reveal information to them that you would have preferred your competitors didn’t know. Because they own a piece of your company, they have a right to demand explanations and justifications for your business decisions. Depending on your company charter that lays out rights and responsibilities of shareholders, they may have the right to vote on issues affecting your company, the way you acquire and use assets, and how you keep your records.
Disadvantage of Selling Stock: Dividend Payments
You may have to offer a monthly or quarterly dividend to provide enough reward for investors to take a chance on your company. If you have agreed to pay dividends, shareholders have a right to those dividends, and if you default on a payment, you could hurt your company’s reputation and its stock price. You also have to incorporate in order to sell stock, which can bring tax consequences.
Advantage of Selling Bonds: No Dilution of Control
When your company sells bonds, you agree to pay investors interest in exchange for using their money. Bondholders don't own a piece of your business and they don't participate in your decision-making. Bonds also offer the advantage of allowing you to borrow money only for the time you will need it. For example, you can issue two-year, five-year and 10-year bonds, instead of 30-year bonds. Keeping the bond term as short as possible saves you money, because you can limit the amount of time you pay interest – although the interest is tax-deductible as an expense for your company.
Advantage of Selling Bonds: Repeat As Often As Needed
Another advantage of bonds is that you can issue them whenever you need money. This is in sharp contrast to stocks, which companies typically issue only once, because a second offering of stock tends to dilute the share price due to extra supply.
Disadvantage of Selling Bonds: Interest Payments
You must pay interest payments on time to bondholders. This differs from dividends, which you only have to pay when you declare one. You pay interest according to a strict timetable. This can create problems with your cash flow. In other words, you may have times when you wish you could use your cash for expansion or to buy assets, but you have to pay the interest on your bonds instead.
Disadvantage of Selling Bonds: Debt on Your Books
Another disadvantage of bonds is that they increase the amount of debt you show on your books. Investors often look at debt as a factor that makes a company attractive or unattractive. You will eat up a portion of your future profits paying your bond interests. Also, you will need to maintain a good credit rating if you want to issue bonds in the future. Otherwise, you could have to offer high interest rates to attract investors.
FAQs
The main advantage of a public offering is that it can raise a lot of money for your business. The downside is that it can be very costly and time-consuming, and there is no guarantee that you will be successful in selling all of the shares.
What are the advantages and disadvantages of long term debt? ›
The advantages of debt financing include lower interest rates, tax deductibility, and flexible repayment terms. The disadvantages of debt financing include the potential for personal liability, higher interest rates, and the need to collateralize the loan.
What are the major advantages and disadvantages of issuing stock as a source of long term financing? ›
Issuing stock as a source of long-term financing offers advantages such as increased capital, no repayment obligation, and limited liability. However, it also has disadvantages including loss of control, dividend expectations, and reporting requirements.
What are the advantages and disadvantages of the issue of shares? ›
The main advantage of the rights issue is that It gives existing shareholders the exclusive right to purchase additional shares at a predetermined price. However, potential disadvantages include dilution of ownership for non-participating shareholders and market distrust, which could lead to a decrease in stock value.
What are the benefits of issuing stock? ›
Issuing shares of stock grants proportional ownership in the firm to investors in exchange for money. That is another popular way for corporations to raise money. From a corporate perspective, perhaps the most attractive feature of stock issuance is that the money does not need to be repaid.
What is the advantage of issuing long-term debt? ›
Limits Company's Exposure to Interest Rate Risk – Long-term, fixed-rate financing minimizes the refinancing risk that comes with shorter-term debt maturities, due to its fixed interest rate, thus decreasing a company's interest rate and balance sheet risk.
What are the disadvantages of long-term debt? ›
Disadvantages of long-term debt financing:
It is not good for the company which raises equity also. A boost in the cost of debt causes an increase in the expense of equity also. It can be hazardous to the reputation and goodwill of the business. If a company defaults, its credit reliability is likewise get affected.
What are the advantages of long-term debt? ›
Another term of importance for long term finance debt is it usually has fixed interest rates that translate into consistent monthly payments and high predictability. This predictability makes it easy to budget the operational income that you will need to make the payments.
What are the disadvantages of issuing stocks? ›
What are some disadvantages to issuing shares? Issuing shares may result in the company being overcapitalized which can be dangerous for a company's financial health. Additionally, overly issued shares may make it difficult for companies to pay dividends.
Is it better to issue stock or long-term debt? ›
In general, equity is less risky than long-term debt. More equity tends to produce more favorable accounting ratios that other investors and potential lenders look upon favorably. However, equity comes with a host of opportunity costs, particularly because businesses can expand more rapidly with debt financing.
Equity financing may be less risky than debt financing because you don't have a loan to repay or collateral at stake. Debt also requires regular repayments, which can hurt your company's cash flow and its ability to grow.
What are two disadvantages to issuing stock for financing Quizlet? ›
Disadvantages of issuing stock include: (1) stockholders have the right to vote for the company's board of directors; (2) dividends are paid from profit after taxes and are not tax-deductible; and (3) the need to keep stockholders happy can affect managers' decisions.
What are two disadvantages of issuing bonds? ›
Bonds do have some disadvantages: they are debt and can hurt a highly leveraged company, the corporation must pay the interest and principal when they are due, and the bondholders have a preference over shareholders upon liquidation.
What are the advantages of issuing equity shares to raise long-term finance? ›
There are many advantages of equity financing for companies seeking to raise capital, including: There are no repayment obligations. There is no additional financial burden. The company may gain access to savvy investors with expertise and connections.
What are the advantages and disadvantages of issuing bonds? ›
Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
What are the cons of issuing shares? ›
The downside of issuing stock, however, is that you're giving away some ownership of your business, and those stockholders may or may not have a voice in how you run and grow your business. As a result, you have the added pressure of making your business a success not only for yourself, but also for the stockholders.
