Corporations are the only business structure allowed to sell stocks. When a new corporation issues stock for the first time, it is called an initial public offering because the stock can be purchased by any investor on the open market. The proceeds from an initial public offering flow directly to the corporation. After a corporation’s initial public offering, shares of the company can be bought and sold freely on NASDAQ and the New York Stock Exchange. Selling stock has many advantages for a company.
Raising capital is one of the biggest benefits a new company gains by selling stock. A company that goes public by selling its stock on the open market has the ability to raise huge sums of money. The company can use proceeds from the sale of stock to pay off some of the its existing liabilities or the company may use the funds to finance an expansion project. The funds can be used to further research and development, or the company can use the proceeds from a stock sale to acquire assets.
Raising capital by selling stock allows a company to avoid adding debt to the company’s financial situation. When a company borrows money to finance the company’s activities, it puts an obligation on the company’s assets because the debt must be repaid. When a company sells stock to investors, the company does not have to repay investors. However, investors expect to share in the company’s profits according to the amount of their investment. Using equity to finance the company’s operating activities as opposed to debt makes it easier for the company to acquire a loan in the future should the need arise.
A company that sells shares of its stock has the advantage of not paying interest on a loan. The company does not have to pay investors interest for the capital invested in the business. When a company takes out a loan, the company must pay the lender interest payments on a monthly, quarterly, semi-annual or annual basis, depending on the loan terms. Selling shares as opposed to taking out a loan will save the company thousands of dollars in terms of interest payments. This allows the company to keep more of its cash to acquire additional assets.
For a new company, selling shares of stock places a value on the business. Selling shares helps the company establish a value in the marketplace because the company gains an understanding of how much investors are willing to pay per share for stock in the business. It may be harder for a new company to locate investors when the company’s price per share is not established in the marketplace. Also, selling shares capitalizes the company so that managers can focus on the company’s long-term financial health as opposed to worrying if the company has enough cash to meet its short-term obligations.
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