The large corporation has grown to its present size in partbecause it has found innovative ways to raise new capital forfurther expansion. Five primary methods used by corporations toraise new capital are:
Issuing bonds
A bond is a written promise to pay a specific amount of moneyat a certain date in the future or periodically over the courseof a loan, during which time interest is paid at a fixed rate onspecified dates. Should the holder of the bond wish to get backhis money before the note is due, the bond may be sold to someoneelse. When the bond reaches "maturity," the company promises topay back the principal at its face value.
Bonds are desirable for the company because the interest rate islower than in most other types of borrowing. Also, interest paidon bonds is a tax deductible business expense for thecorporation. The disadvantage is that interest paymentsordinarily are made on bonds even when no profits are earned. Forthis reason, a smaller corporation can seldom raise much capitalby issuing bonds.
Sales of common stock
Holders of bonds have lent money to the company, but theyhave no voice in its affairs, nor do they share in profits orlosses. Quite the reverse is true for what are known as "equity"investors who buy common stock. They own shares in thecorporation and have certain legal rights including, in mostcases, the right to vote for the board of directors who actuallymanage the company. But they receive no dividends until interestpayments are made on outstanding bonds.
If a company's financial health is good and its assetssufficient, it can create capital by voting to issue additionalshares of common stock. For a large company, an investment bankeragrees to guarantee the purchase of a new stock issue at a setprice. If the market refuses to buy the issue at a minimum price,the banker will take them and absorb the loss. Like printingpaper money, issuing too much stock diminishes the basic value ofeach share.
Issuing preferred stock
This stock pays a "preferred" dividend. That is, if profitsare limited, the owners of preferred stock will be paid dividendsbefore those with common stock. Legally, the owners of this stockstand next in line to the bondholders in getting paid. A companymay choose to issue new preferred stock when additional capitalis desired.
Borrowing
Companies can also raise short-term capital -- usuallyworking capital to finance inventories -- in a variety of ways,such as by borrowing from lending institutions, primarily banks,insurance companies and savings-and-loan establishments. Theborrower must pay the lender interest on the loan at a ratedetermined by competitive market forces. The rate of interestcharged by a lender can be influenced by the amount of funds inthe overall money supply available for loans. If money is scarce,interest rates will tend to rise because those seeking loans willbe competing for funds. If plenty of money is available forloans, the rate will tend to move downward.
If the corporate borrower finds that it needs to raise additionalmoney, it can refinance an existing loan. In this transaction thelender is essentially lending more money to its debtor. But ifinterest rates have gone up during the period since the originalloan was secured, borrowers pay a higher rate in order to holdadditional funds. Even if the rate has gone down, the lenderbenefits by having increased the size of its original loan at alower rate of interest.
Using profits
Some corporations pay out most of their profits in the formof dividends to their stockholders. Investors buy into thesecompanies because they want a high income on a regular basis. Butsome other corporations, usually called "growth companies,"prefer to take most of their profits and reinvest them inresearch and expansion. Persons who own such stocks are contentto accept a smaller dividend or none at all, if by rapid growththe shares increase in price. These persons prefer to take therisk of obtaining a "capital gain," or rise in value of thestock, rather than be assured a steady dividend.
The typical corporation likes to keep a balance among thesemethods of raising money for expansion, frequently plowing backabout half of the earnings into the business and paying out theother half as dividends. Unless some dividends are paid,investors may lose interest in the company.
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