When it's time for your small business to raise large sums of cash without borrowing from a lender, you have two choices. You can either sell stocks or you can sell bonds. Selling stocks allows investors to buy shares of your company, which means they actually own a piece of it. Selling bonds means borrowing money from investors and paying interest to them. Each method works, but there are different consequences for how you run and grow your company.
Advantage of Selling Stock: Cash to Grow Your Business
If your business doesn't have a stellar credit rating, you may not be able to borrow the money you need. If you incorporate, you can sell stock in your company instead. This is particularly attractive if you are a start-up with no track record. You can attract these investors based on your potential for profit and growth.
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Advantage of Selling Stock: No Debt Repayments
Selling stock gives you the advantage of not owing any money to investors, because you are not borrowing. You don't have to make any payments for the money you raise this way. In addition, a rising stock value can increase your credit rating and make it easier to borrow money in the future. Also, the constant need to justify your actions to shareholders can give your company a sharp focus and profitability.
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Disadvantage of Selling Stock: Giving Away Ownership
By selling shares of your company, you give each investor a piece of ownership. This means you have to answer for all of your actions to shareholders. You may have to reveal information to them that you would have preferred your competitors didn't know. Because they own a piece of your company, they have a right to demand explanations and justifications for your business decisions. Depending on your company charter that lays out rights and responsibilities of shareholders, they may have the right to vote on issues affecting your company, the way you acquire and use assets, and how you keep your records.
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Disadvantage of Selling Stock: Dividend Payments
You may have to offer a monthly or quarterly dividend to provide enough reward for investors to take a chance on your company. If you have agreed to pay dividends, shareholders have a right to those dividends, and if you default on a payment, you could hurt your company's reputation and its stock price. You also have to incorporate in order to sell stock, which can bring tax consequences.
Advantage of Selling Bonds: No Dilution of Control
When your company sells bonds, you agree to pay investors interest in exchange for using their money. Bondholders don't own a piece of your business and they don't participate in your decision-making. Bonds also offer the advantage of allowing you to borrow money only for the time you will need it. For example, you can issue two-year, five-year and 10-year bonds, instead of 30-year bonds. Keeping the bond term as short as possible saves you money, because you can limit the amount of time you pay interest – although the interest is tax-deductible as an expense for your company.
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Advantage of Selling Bonds: Repeat As Often As Needed
Another advantage of bonds is that you can issue them whenever you need money. This is in sharp contrast to stocks, which companies typically issue only once, because a second offering of stock tends to dilute the share price due to extra supply.
Disadvantage of Selling Bonds: Interest Payments
You must pay interest payments on time to bondholders. This differs from dividends, which you only have to pay when you declare one. You pay interest according to a strict timetable. This can create problems with your cash flow. In other words, you may have times when you wish you could use your cash for expansion or to buy assets, but you have to pay the interest on your bonds instead.
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Disadvantage of Selling Bonds: Debt on Your Books
Another disadvantage of bonds is that they increase the amount of debt you show on your books. Investors often look at debt as a factor that makes a company attractive or unattractive. You will eat up a portion of your future profits paying your bond interests. Also, you will need to maintain a good credit rating if you want to issue bonds in the future. Otherwise, you could have to offer high interest rates to attract investors.
