I’ve made some decent money with stocks and I was curious why do companies issue shares? Also, how does a company make money from shares, why issue dividends, and much more.
Companies issue shares to raise money, so they can grow and get bigger.
Keep reading and I’ll share the pros and cons for a company going public. I’ll share why a company issue dividends and why they care about the price of their stock after they issue shares.
What is a Company?
A company is a group of people that sell products and services for money. Most companies start small and from humble beginnings.
The company Apple and Amazon.com both started in a garage, now they are both HUGE.
Soon any startup will require more money to grow. This money can be used to hire talented team members. They can use this money for marketing, product creation, or anything else such as a bigger building.
This company could go to a bank to get a loan or they can give up equity (ownership) of their business to get money.
They can issue equity of their company either privately or publicly. Privately means the company sales equity (part ownership) of their business to Angel investors or sharks from the show “Shark Tank.
This is a funny video.
A benefit to privately selling equity is the company still gets some privacy, but the downside is investors will have a harder time turning their shares into cash.
A large benefit to privately selling equity is the company doesn’t have to share with the public every detail about their business.
Another option is the company can go public and be listed on a stock exchange. The benefit of going public is that it’s free. All the company has to do is give up some of the equity of the business in exchange for money.
If the company doesn’t work out then the company doesn’t owe anything.
If the company borrows money from a bank then there is more risk.
If the company doesn’t work out the founders still have to pay back the bank.
For a company to go public they first go to the SEC (Security and Exchange Commission). Then an investment bank gets involved to decide how many shares to issue and at what price.
Next shares are sold at the primary market for cash by the bank.
Another name for the primary market is an IPO (Initial Public Offering). Usually, hedge funds, financial institutions, pension funds, and big players can gain access to the primary market.
Investors like you and me don’t usually get access to the primary market. The ONLY exception was when the trading app Robinhood went public and it reserved 20-30% of IPO’s to small investors.
You can read more about Robinhood’s unique approach to an IPO from the link HERE.
Then shares get sold on the secondary market also called the stock market where everyday investors buy and sell shares.
Why Can’t Everyday Investors Get Access to an IPO?
The investment bank that sells the first shares does sell some to retail brokerages, but it’s only around 10%.
Every day investors can buy IPO shares from these retail brokerages, but the requirements are larger. With Fidelity for example an investor has to have $100,000 or $500,000 in retail assets for an IPO.
Usually, you have to have lots of cash to participate in an IPO.
Also, IPO’s are usually riskier. The reason why IPO investments are riskier is that usually, the company has not been around for a long time.
According to Investopedia, 65% of startups fail in the first 15 years, you can read more by clicking the link HERE. The longer a company has been in business the less risky the investment.
Why Do Companies Issue Dividends?
A dividend is a portion of a companies earnings paid to shareholders. Just by owning a stock, you can earn money with dividends.
It’s similar to owning real estate and getting paid on rent. Not all companies pay dividends, but some do and it’s usually 4 times a year this is called quarterly.
The main reason a company pays a dividend is to attract investors. This way they can drive up the price of the stock.
Once a company issues a dividend it’s very hard to remove the dividend. Removing a dividend usually causes the stock to drop and this is not what a company wants to do.
The main question is if the dividend would be more helpful in growing the company or paying out investors.
It’s similar to the question of is it better to re-invest dividends you receive from stock to buying more stock or getting the cash.
I always re-invest the cash to get more shares.
This leads to a great question and that is why does a company even care about the price of a stock after the IPO?
Why Does a Company Care About their Share Price?
The main reason why a company cares about its share price after an IPO is due to perception. If the value of a stock rises then people associate that company with having more value.
Plus, everyone has an ego, right? It’s branding.
Another reason a company cares about its stock price is for buying other companies. Stock is almost like its own form of currency.
Companies can also use the price of their shares to raise more money if needed.
Another reason a company cares about its share price is for management’s compensation.
A lot of companies pay management in stock, so as the stock price rises the management is happy. If the stock price falls and investors are not happy then it negatively affects the jobs of the leaders of the company.
Perhaps the board decides to replace managers or reduce the compensation they receive. Also If a company’s stock is performing well the company will receive more favorable press.
This favorable press can help the company attract business deals, more investors and make life easier.
Reminds me of a saying I like “The pen is mightier than the sword.” I remember the saying from the movie “Indiana Jones.”
Negatives of Going Public
At this point you might be wondering if going public was such a great thing, then why doesn’t every company do it?
Why do some companies remain private?
When a company goes public they have to reveal everything about their company. There is a lack of privacy with everything.
Going public is also more challenging. Before a company goes public it has to form a board of directors that make decisions for the company.
The CEO of a company can be fired by the board. There is an interesting story about Steve Jobs being fired from the board of Apple, which is the company he started. You can view this story by clicking on the link HERE.
Since there is a board of directors that runs the business there could be a delay in making decisions. When a company is private the owner has more freedom. This reminds me of a joke.
What is the one thing that is fixed, but never works?
A jury.
I was involved in a jury with an interesting case of someone shooting a gun at the police. Towards the end, we as a jury had a very hard time making a decision.
It’s the same with how congress can have a difficult time making a decision. This reminds me of another funny joke.
What is the opposite of progress?
Congress
The largest advantage of staying private is complete ownership of the business. You don’t have to give up the equity of the business to get cash.
This is why you see investors on the show Sharktank ask for equity of a startup in exchange for giving up money.
Conclusion
The great thing about buying shares of a company is you can become an owner of something. You are also supporting what the business stands for and what it sells.
It’s a great way to make some extra money, have fun and give value to the world through a company.
I hope this post on why do companies issue shares was helpful to you, bye for now.