How Do Corporations Raise Funds Through Stock Sales?

by Alia Nikolakopulos

When corporations sell stock, investors purchase shares and are entitled to a portion of future profits the corporation generates. Although corporations share profits with shareholders, the company’s ability to raise cash through stock sales assists with present operational needs that allow the corporation to become profitable or sustain its current profitable status. There are several options a corporation may pursue to raise capital through stock sales.

Initial Public Offering (IPO)

An initial public offering is the first offer a corporation makes to the public to purchase stock shares. If the company’s stock is in high demand for investors, an IPO has the potential to yield more capital than shares offered to the public in secondary markets. Secondary market sales occur after the IPO period expires. During the IPO period, it is common for a lockup period to be in effect, which prevents company insiders from selling shares.

Private Stock Offering

Private stock offerings are used by non-public corporations to raise capital. All corporations must authorize a number of shares for issuance upon formation, but not all corporations must trade publicly on the stock market. A private corporation may offer a certain percentage of stock to a private investor in exchange for a cash investment into the business. The investor does not take control of the company but is entitled to a percentage of the business profits equal to the percentage of stock he purchases through the investment.

Preferred Stock

Preferred stock is a special class of stock a corporation may offer. Preferred stock is attractive to investors because preferred shares take precedence over common stock shares if the corporation experiences financial hardship. Preferred stockholders receive dividends before common stockholders, which means if economic conditions do not allow both preferred and common stockholders to receive dividends, those who hold preferred shares still get paid. Only C corporations may offer both preferred and common stock. S corporations are limited to common stock offerings only.

Employee Stock Ownership Plans (ESOP)

Employee stock ownership plans allow corporations to raise capital by offering stock to employees at a rate that is less than the market price per share. Employees typically purchase the stock through payroll deduction on a pre-tax basis, similar to 401k contributions. This method of fundraising is available to both C corporations and S corporations; however, an S corporation must have less than 100 shareholders. If you own an S corporation, ESOPs are best if you employ fewer than 100 employees.

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