10

I'm just curious, what are the ways that a publicly traded company can ask for more money? Do they just sell shares of their company stock they own themselves, or do they issue more bonds? Are there any other methods? I'm curious from following Tesla and their bid for SolarCity, but I'm very interested in it in general.

  • 3
    Can you clarify how this is related to personal finance? – ChrisInEdmonton Jun 29 '16 at 13:05
  • 1
    Sorry, if this should go in another forum, do you know which one? I couldn't find out for investing. However this question does pertain to personal stock investing and future planning. Thanks! – Sean C. Li Jun 29 '16 at 13:15
  • 9
    @ChrisInEdmonton If you are an investor in a company that needs more capital, it would be good to know the different ways that the company might do that. – Ben Miller Jun 29 '16 at 13:16
  • 6
    @SeanC.Li This is the right site for investing questions, and this is a good question, in my opinion. – Ben Miller Jun 29 '16 at 13:18
  • 8
    @BenMiller Agreed; the fundamentals of what a corporation is and how it operates is critical learning for a new investor. – Grade 'Eh' Bacon Jun 29 '16 at 14:52
15

There are many different methods for a corporation to get money, but they mostly fall into three categories: earnings, debt and equity.

Earnings would be just the corporation's accumulation of cash due to the operation of its business. Perhaps if cash was needed for a particular reason immediately, a business may consider selling a division or group of assets to another party, and using the proceeds for a different part of the business.

Debt is money that (to put it simply) the corporation legally must repay to the lender, likely with periodic interest payments. Apart from the interest payments (if any) and the principal (original amount leant), the lender has no additional rights to the value of the company. There are, basically, 2 types of corporate debt: bank debt, and bonds.

Bank debt is just the corporation taking on a loan from a bank. Bonds are offered to the public - ie: you could potentially buy a "Tesla Bond", where you give Tesla $1k, and they give you a stated interest rate over time, and principal repayments according to a schedule. Which type of debt a corporation uses will depend mostly on the high cost of offering a public bond, the relationships with current banks, and the interest rates the corporation thinks it can get from either method.

Equity [or, shares] is money that the corporation (to put it simply) likely does not have a legal obligation to repay, until the corporation is liquidated (sold at the end of its life) and all debt has already been repaid. But when the corporation is liquidated, the shareholders have a legal right to the entire value of the company, after those debts have been paid. So equity holders have higher risk than debt holders, but they also can share in higher reward. That is why stock prices are so volatile - the value of each share fluctuates based on the perceived value of the entire company.

Some equity may be offered with specific rules about dividend payments - maybe they are required [a 'preferred' share likely has a stated dividend rate almost like a bond, but also likely has a limited value it can ever receive back from the corporation], maybe they are at the discretion of the board of directors, maybe they will never happen. There are 2 broad ways for a corporation to get money from equity: a private offering, or a public offering.

A private offering could be a small mom and pop store asking their neighbors to invest 5k so they can repair their business's roof, or it could be an 'Angel Investor' [think Shark Tank] contributing significant value and maybe even taking control of the company. Perhaps shares would be offered to all current shareholders first. A public offering would be one where shares would be offered up to the public on the stock exchange, so that anyone could subscribe to them. Why a corporation would use any of these different methods depends on the price it feels it could get from them, and also perhaps whether there are benefits to having different shareholders involved in the business [ie: an Angel investor would likely be involved in the business to protect his/her investment, and that leadership may be what the corporation actually needs, as much or more than money].

Whether a corporation chooses to gain cash from earnings, debt, or equity depends on many factors, including but not limited to: (1) what assets / earnings potential it currently has; (2) the cost of acquiring the cash [ie: the high cost of undergoing a public offering vs the lower cost of increasing a bank loan]; and (3) the ongoing costs of that cash to both the corporation and ultimately the other shareholders - ie: a 3% interest rate on debt vs a 6% dividend rate on preferred shares vs a 5% dividend rate on common shares [which would also share in the net value of the company with the other current shareholders].

In summary: Earnings would be generally preferred, but if the company needs cash immediately, that may not be suitable. Debt is generally cheap to acquire and interest rates are generally lower than required dividend rates. Equity is often expensive to acquire and maintain [either through dividend payments or by reduction of net value attributable to other current shareholders], but may be required if a new venture is risky. ie: a bank/bondholder may not want to lend money for a new tech idea because it is too risky to just get interest from - they want access to the potential earnings as well, through equity.

  • 9
    You omitted asking for donations from gullible folks expecting to get something in return, aka kickstarter. :-) – R.. Jun 29 '16 at 18:11
  • 1
    @Michael To issue public bonds requires information to be made available to the public, similar to if the company had shares listed on a public exchange. For a public company, the cost to issue new bonds may be small (although small public companies may not necessarily have the in-house staff and know-how to issue bonds, requiring outside firms to be used to prepare the prospectus), but for private companies, the cost to issue bonds may be substantial. – Grade 'Eh' Bacon Jun 29 '16 at 18:13
  • 4
    It's a bit simplistic to say that public bond is "more expensive" than bank loans. The fixed cost associated with public offering indeed would be undesirable for a small company that just wants to borrow a small amount. But bank loans usually come with unfavorable restrictive covenants designed to protect creditor interest. On the other hand, bank loans and private placements take place in the dark which could be advantageous if say you want to secretly build another factory without raising attention of the competitors. – xiaomy Jun 29 '16 at 19:57
  • 2
    Also private placement can take place in the form of corporate debt, too. – xiaomy Jun 29 '16 at 19:59
  • 2
    There is also convertible securities that are a mix of bond and debt not mentioned here that may also be worth noting. – JB King Jun 29 '16 at 22:32

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .