Why Do Companies Convert to Common Stock?

by Jordan Meyers

Companies have a number of choices when it comes to obtaining money from investors. Often, companies sell bonds and common and preferred stocks as part of their plans for raising money. Bonds and preferred stocks offer investors more stability and ensure the receipt of earnings, while common stocks involve accepting more risk in exchange for the chance to have these investments increase significantly in value.

Raise Money

Often, businesses convert to common stocks as a way to raise money. When an investor buys common stock, he purchases ownership in the company. If the company's performance improves, the value of his stock goes up, and he may eventually sell the stock for far more than he purchased it. Likewise, an investor can receive dividend payments and vote on matters concerning the company. This makes common stock an attractive investment for many and means a business may have an easier time getting people to invest in it. The investment money received from the sale of common stock can then go toward running or expanding the business.

Prepare for Economic Challenges

A company might also convert to common stock when its business is thriving, but it believes sales may decrease considerably in the future. In such a case, a company often seeks to head off this change by securing more cash through the sale of stocks. The money it raises this way may help it survive temporarily decreased sales. When businesses issue common stocks for this reason, the selling of common stocks is usually just one part of a plan to stay in business.

Common Stocks Versus Bonds

Many companies issue bonds, which provide the investor with guaranteed interest. Bonds can represent a risk for a business, however, as they require payment of interest no matter what the company's financial health. Investors who hold a company's bonds have more rights than the holders of common stock. Bondholders can seize control of a company that fails to pay interest, but this is not a risk when a company cannot pay dividends to common stock holders.

Opportunity

Sometimes companies convert to common stock because they have a plan for taking control of another company. For example, a business may use the sale of common stock, in combination with other cash available to it, to buy another company. This kind of strategy may prove particularly viable when the company wants to purchase a struggling business. Often, such companies are in a weak financial position and willing to offer low selling prices.

Improve Lending Prospects

When a company has a significant amount of debt, it may decide to convert to common stock to get the money it needs to pay off some of its debt. This reduced debt can prove attractive not only to investors but also to lenders. For example, the sale of common stock and the wiping out of debt can make a company seem a better risk to business-rating organizations. With an improved rating, a company may not only enjoy increased access to loans but also better rates.

About the Author

I am happy to write for any of Demand's sites.

Photo Credits

  • stock exchange image by Christopher Walker from Fotolia.com