Issuing shares in a company, also known as equity financing, is the practice of raising capital for a business by selling shares of ownership in the company. It is one of the major alternatives to debt financing, which is the practice of raising capital through bank loans, bonds and other forms of borrowing.
There are several reasons why raising finance by issuing shares poses an attractive option, especially for SMEs. However, it should be noted that there are some drawbacks and pitfalls to avoid, and those considering raising funds through issuing share capital should consider both sides of the coin carefully before making a decision. Below is a quick rundown of the pros and cons to aid you in that decision:
Advantages of raising funds by issuing share capital
- Shareholder expertise. When bringing shareholders on board, they will have a vested interest in seeing the business succeed. Therefore, they may be able to contribute any skills, knowledge or experience they may have to help it prosper.
- Dictating terms. When selling off shares, a company has complete flexibility in deciding how many shares it wishes to sell, at what value and what rights the shares will afford to the shareholder.
- Timing. A company can decide when to launch its initial public offering (IPO) of shares and can even sell more shares to raise further capital at a later date. It can also repurchase shares that have already been sold if it wishes.
- Use of funds. Often when a creditor (be that a bank or private lender) loans capital to a company, they will place stipulations or limits on how that money can be used. With share capital, there are no such restrictions on the funds.
- Repayments. Unlike debt capital, share capital does not have fixed repayment requirements which need to be made at specific intervals and for specific amounts. Instead, shareholders are rewarded for their investments through dividends, normally paid annually, and with the control that their shares give them. Therefore, repayments by way of share capital can be more flexible.
- Security. If a company is failing to make agreed-upon payments (with interest) to a creditor like a bank, that creditor can force the business into declaring bankruptcy. There is no such risk with share capital.
Disadvantages of share capital
- Reduced control. Selling shares in a company is effectively akin to selling off tiny pieces of its ownership and control. Shareholders are entitled to a say in how the business is run and even who is running it.
- Hostile takeover. Similarly, if a majority of shares are acquired by a single person or syndicate, they can take complete control of the business.
- Pricing. Unlike debt capital, which has a fixed rate of repayment and interest, share capital involves higher risk for its investors. Therefore, it is commonplace for shares to be sold at a lower price and consequentially for less capital to be raised to offset that risk.
- Overheads. Organising an IPO involves administrative and advertising costs and it is likely that professional guidance from a solicitor will also be required, all of which are additional expenses not present with debt capital.
- Distraction. As well as investing money into organising the sale of shares, it will also take valuable time and effort that is bound to distract from the day-to-day running of the company.
- Taxation. While any interest paid to creditors for loans is tax deductible, dividends paid to shareholders or fees used to repurchase sold shares are not.
- Privacy. When raising capital through public investors, companies are legally required to disclose certain aspects of their business. This requirement is not present with debt capital.
If you’re considering taking your business to the next level through the funds raised by share capital but aren’t quite sure if it’s the right move for you, it could be time to obtain professional advice. At Profile, we’re experienced business accountants with a proven track record of giving insightful financial advice that can offer practical benefits to your company.
To learn more about how we can help you progress, give us a call on 020 8432 2289 or drop us an email at [email protected] and we’ll get back to you as soon as we can. What are you waiting for? Get in touch today!