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Corporations, How Corporations Raise Funds for Investment

bondholder, corporate profits, new investments, legal obligations, stockholders

By investing in new issues of a company’s stock, shareholders provide the funds for a company to begin new or expanded operations. However, most stock sales do not involve new issues of stock. Instead, when someone who owns stock decides to sell some or all of their shares, that stock is typically traded on one of the national stock exchanges, which are specialized markets for buying and selling stocks. In those transactions, the person who sells the stock—not the corporation whose stock is traded—receives the funds from that sale.

An existing corporation that wants to secure funds to expand its operations has three options. It can issue new shares of stock, using the process described earlier. That option will reduce the share of the business that current stockholders own, so a majority of the current stockholders have to approve the issue of new shares of stock. New issues are often approved because if the expansion proves to be profitable, the current stockholders are likely to benefit from higher stock prices and increased dividends. Dividends are corporate profits that some companies periodically pay out to shareholders.

The second way for a corporation to secure funds is by borrowing money from banks, from other financial institutions, or from individuals. To do this the corporation often issues bonds, which are legal obligations to repay the amount of money borrowed, plus interest, at a designated time. If a corporation goes out of business, it is legally required to pay off any bonds it has issued before any money is returned to stockholders. That means that stocks are riskier investments than bonds. On the other hand, all a bondholder will ever receive is the amount of money specified in the bond. Stockholders can enjoy much larger returns, if the corporation is profitable.

The final way for a corporation to pay for new investments is by reinvesting some of the profits it has earned. After paying taxes, profits are either paid out to stockholders as dividends or held as retained earnings to use in running and expanding the business. Those retained earnings come from the profits that belong to the stockholders, so reinvesting some of those profits increases the value of what the stockholders own and have risked in the business, which is known as stockholders’ equity. On the other hand, if the corporation incurs losses, the value of what the stockholders own in the business goes down, so stockholders’ equity decreases.

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