Most people are familiar with the basics of the stock market: When you buy stock, you are actually buying a small piece of a company. If you purchase common stock, you then get the ability to vote on a company’s decision at annual stockholder meetings. You can hold onto the stock and watch it appreciate. If a stock offered dividends, you could collect those on a quarterly basis.
What is less clearly understood is this important question: Why do companies issue stock? There are many answers to that question – here’s an overview of some of the reasons.
Finance Growth
Financing growth is unquestionably the biggest reason that companies will issue stock.
Indeed, most of the reasons listed below are tied to the need to finance growth in some way. Issuing stock can be a great way to bring in money. When a company holds an Initial Public Offering (IPO), it raises capital in the open market.
The company then collects the proceeds from the sale of that initial stock. This provides a massive infusion of cash and likely one that will be on more attractive terms than it could receive via loans or other financial methods.
To be clear, there are tradeoffs of issuing stock. Records become public, and the company is no longer completely owned by its initial owners or investors. It raises the possibility of a hostile takeover, and stockholders can have more control over company decisions. However, in many cases, it is well worth it for the company that is offering shares of its company to outside stakeholders.
Hire Employees
A huge part of any growth effort is to hire new staff, and companies will often use the proceeds of the stock sale to hire staff. This staff will enable the company to grow further.
The staff hired are often part of Sales teams aimed at continuing a company’s expansion or for Research & Development intended to improve product quality or build new products.
By hiring broadly for research and development, marketing, and product development roles, a company builds a more robust company and establishes a talent moat that competitors may struggle to match. If a company works in a particularly competitive industry, or one that is short on talent, then it may use the stock sale to increase wages or provide retention bonuses.
Pay Off Debt
The proceeds of a stock sale may be used in order to pay off debt.
This is a less common reason for selling stock, as debt load should be manageable in order for the company to sustain its existing operations. Furthermore, once a company “goes public,” all of its financial records – including its debt – become visible to the public.
If a company is found to have extensive debt, it will likely hurt its valuation and the amount of money that it can make with a share issuance.
However, in some cases, stock sales can be a good way of paying off debt. Management will have to show its new shareholders why it is using proceeds from stock sales in this way. It will also have to demonstrate how paying off debt will be useful to cash flow, and what it will do with its new cash.
Launch New Products
Launching new products is another growth-oriented reason that a company may sell stock.
If the sale of stock goes well, it can provide a critical infusion of capital. That money can then be invested into the launch of a new product.
Building new products requires hiring staff and often expensive research and development tools and infrastructure – costs that may rise extensively, depending on the industry that a company is in.
It will likely also involve additional staff-related costs, as a company will have to hire more staff and marketers to get the word out about a product. There may also hard costs associated with product launches, and these costs are usually exhibited in terms of buying raw materials for a product’s creation and manufacturing.
As you can imagine, all of the above adds up. Depending on the circumstance, a company may simply be able to take out loans to fund the offering of a new product. However, offering new stock can be preferable.
Expand Into New Markets
The expansion of a product into new regions can be among the most costly initiatives a management team can pursue. When launching products abroad, new barriers must be overcome, whether language, regulatory, or new hiring. However, it can be extremely lucrative for the company in question.
Geographical expansion may involve working with a government to ensure appropriate permitting and adherence to that government’s regulatory scheme. This may mean product modifications and/or expensive legal costs. It will almost certainly mean hiring more staff to manage the expansion.
If there are language barriers, the company in question will need to use at least some of its funds to hire translators and culturally-competent staff to tweak the marketing and make sure that it is optimized for the new region.
Enlarge Facilities or Build New Ones
This is another growth-oriented reason that a company may sell stock. If a company is looking to rapidly expand and is engaged in a business that requires new facilities or equipment, selling stock may be an ideal way to fund this expansion.
The sale of stock can be used to purchase new property, plants and/or equipment. These new assets can then be plowed directly back into the company’s existing operations, as they can be used to create new products that can be sold to the market at large.
Money from stock sales may also be needed to upgrade existing equipment. The company in question may have purchased older or less-efficient equipment when it was first starting out. With additional resources, it may be able to afford a major upgrade to its equipment. This, in turn, can allow it to be more successful and profitable.
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