Companies issue shares mainly to raise capital for their operations and expansion. By purchasing these shares, investors become part-owners of the company and may also have the right to vote on company decisions. Equity financing is the term used for raising capital through the issuance of equity shares. Companies can also raise capital through debt financing by taking bank loans or issuing bonds, but this comes with interest payments that increase the cost of borrowing.
With equity financing, there is no interest to be paid back, which gives companies more flexibility in using the raised capital. Unlike debt financing, the money raised through equity financing does not need to be repaid.
But why would a company want to do that? Here are 5 reasons:
1. To Raise Capital: One of the main reasons companies issue shares is to raise money. By selling shares, companies can get cash from investors that they can use to grow their business, invest in new projects, pay off debt, or simply increase their cash reserves. This is often a cheaper and more flexible way to raise money compared to borrowing from a bank or issuing bonds.
For example, in 2020, Tesla raised $5 billion by issuing new shares to the public. The company used the funds to strengthen its balance sheet and invest in new products and factories.
2. To Attract and Retain Employees: Another reason companies issue shares is to incentivize and reward their employees. By giving employees a stake in the company's ownership, they become more aligned with the company's goals and are motivated to work harder and contribute to its success.
For instance, Google (now Alphabet) famously used stock options as part of its employee compensation package in the early days of the company. This helped to attract and retain talented employees who were willing to take a chance on the startup.
3. To Acquire Other Companies: Companies may issue shares as part of a merger or acquisition. This is often called a stock-for-stock deal, where the acquiring company uses its own shares to pay for the target company's shares. This can be a tax-efficient way to make acquisitions, and it also allows the acquiring company to preserve its cash reserves and avoid taking on too much debt.
A recent example of this is the acquisition of Slack by Salesforce in 2020. Salesforce issued $27.7 billion worth of its own shares to acquire the workplace messaging app.
4. To Increase Liquidity: When a company goes public and starts trading its shares on a stock exchange, it can issue more shares to increase the liquidity of its stock. This means that there are more shares available for trading, which can make it easier for investors to buy and sell the stock. A liquid stock is generally more attractive to investors because it allows them to easily buy and sell their shares as needed.
For instance, after going public in 2019, Uber issued additional shares in 2020 to increase the liquidity of its stock. This made it easier for investors to buy and sell Uber shares, and it also helped to boost the company's market capitalization.
5. To Maintain Control: Sometimes companies issue shares to keep control of their business. If they keep most of the shares, they can stop people from taking over or trying to change how the company is run. Sometimes they create different types of shares that give more voting power to the people who started the company.
For example, Facebook did this in 2012. The founder, Mark Zuckerberg, got shares with more voting power so he could still control the company even when it became public.
In summary, companies issue shares for a variety of reasons, including raising capital, attracting and retaining employees, making acquisitions, increasing liquidity, and maintaining control. By understanding these reasons, investors can make informed decisions about whether to buy or sell a company's stock.
