There are two types of capital, debt and equity.
Rebecca Cline
When looking to raise more capital, it is important to look at all the options that are available, as well as the current financial state of the company in order to make an informed decision. There are two types of capital, debt and equity. It is important to have a balance between the two. Debt is typically less expensive for the company than equity. Debt is typically in the form of a loan where interested had to be paid back. Equity is typically when a company receives cash in exchange for ownership in the company, typically in the form of stock. Assets should impact the decision due to the fact hat there should be a balance between debt and equity. There are pros and cons for both equity and debt. Debt requires the repayment of interest. When a company issues common shares, they are allowing the share holders voting rights. When a company issues preferred shares, they owners of the shares become limited owners, but do not have voting rights. The preferred shares holders are also guaranteed a specific dividend (Boyte-White, 2021).
In the current economic environment, I would recommend issuing bonds. A bond allows the company to pay a fixed rate of interest. The bond is also worth the face value at maturity. The current interest rates are low, so issuing bonds would allow for the company lock into the lower interest rate through the term of the bonds. The locked in rate will allow the company to know what they will be responsible for paying. The company also knows what the payment at on the maturity date will be. This would allow the company to plan. This maturity date can also be a significant length of time, sometimes up to thirty years. One con of issuing bonds is the obligation of repayment at maturity as well as having to pay interest on the bonds regardless of the financial standing of the company. The pros of issuing bonds are that the company is not selling any portion of the company. No one is given voting rights that could influence decisions made at the company (Plaehn, 2018).
Foregoing the immediate opportunity of raising more capital may be a good idea at this time due to the opportunity to buy back some of the outstanding common stock. Buying back outstanding common stock would reduce the cost of capital. A company should buy back the outstanding common stock at a time where they are doing well and do not need as much equity financing. If the company feels as though the company’s stock is undervalued, the company can choose to repurchase all or some of the outstanding stock at the deflated price. The company can then wait for the market to correct the price and at the time, the company can reissue the same number of shares and the new higher rate (Boyte-White, 2021). The result of repurchasing shares at the deflated rate and reissuing at a higher rate allows for the “total equity capital increases while the number of outstanding shares remain stable” (Boyte-White, 2021).
The company is not obligated to pay shareholders a dividend. When a company pays dividends to its shareholders, the message the company is presenting is that the company is stable. When a company chooses to reinvest cash, it typically leads to higher stock prices, which provides capital gain for investors (Fontinelle, 2021). The option to pay shareholder a dividend is a company choice. I would forego the payment of dividends and allow the stock to increase in price so that the shareholder has a greater investment. This would allow the company to grow at a more rapid rate while still providing for the shareholders.
Resources:
Boyte-White, C. (2021, April 21). When does it benefit a company to buy back outstanding shares? Investopedia. https://www.investopedia.com/ask/answers/040815/what-situations-does-it-benefit-company-buy-back-outstanding-shares.asp#:~:text=A%20company%20may%20choose%20to,profits%20to%20pay%20executive%20bonuses.
Boyte-White, C. (2021, June 11). How should a company be raising capital? Investopedia. https://www.investopedia.com/ask/answers/032515/what-are-different-ways-corporations-can-raise-capital.asp.
Fontinelle, A. (2021, July 29). Why do some companies pay a dividend, while others don’t? Investopedia. https://www.investopedia.com/ask/answers/12/why-do-some-companies-pay-a-dividend.asp.
Plaehn, T. (2018, October 19). Common Stock Vs. Preferred Stock Vs. Bonds. Pocketsense. https://pocketsense.com/debt-vs-equity-securities-2779.html
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