Christy Norfleet answered:
A company can issue common stock through an initial public offering (IPO) or by issuing additional shares into the capital markets. Either way, the money that is provided by investors that purchase the shares are used to fund capital initiatives. In return for providing capital, investors demand a return on their investment (ROI) which is a cost of equity to a business. The return on investment can usually be provided to stock investors by paying dividends or by effectively managing the company’s resources so as to increase the value of the shares held by these investors. One drawback for this source of capital funding is that issuing additional funds in the markets dilutes the holdings of existing shareholders as their proportional ownership and voting influence within the company will be reduced.
Capital funding can also be gotten by issuing corporate bonds to retail and institutional investors. When companies issue bonds, they are in effect, borrowing from investors who are compensated with semi-annual coupon payments until the bond matures. The coupon rate on a bond represents the cost of debt to the issuing company. In addition, bond investors may be able to purchase a bond at a discount, and the face value of the bond will be repaid when it matures. For example, an investor who purchases a bond for $910, will receive a payment of $1,000 when the bond matures.
Capital funding through debt can also be raised by taking out loans from banks or other commercial lending institutions. These loans are recorded as long-term liabilities on a company’s balance sheet, and decrease as the loan is gradually paid off. The cost of borrowing the loan is the interest rate that the bank charges the company. The interest payments that the company makes to its lenders is considered an expense in the income statement, which means pre-tax profits will be lower.
While a company is not obligated to make payments to its shareholders, it must fulfill its interest and coupon payment obligations to its bondholders and lenders, making capital funding through debt a more expensive alternative than through equity. However, in the event that a company goes bankrupt and has its assets liquidated, its creditors will be paid off first before shareholders are considered.
There are companies that exist for the sole purpose of providing capital funding to businesses. Such a company might specialize in funding a specific category of companies, such as healthcare companies, or a specific type of company, such as assisted living facilities. The capital funding company might also operate to only provide short-term financing and/or long-term financing to a business. These companies, such as venture capitalists, could also choose to focus on funding a certain stage of the business, such as a business that is just starting up.
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