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Equity Financing

Equity Financing

Author: James Howard

Identify how companies can use equity for financing.

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Hello, and welcome to this tutorial on equity financing. Now as always with these tutorials, please feel free to fast forward, pause, or rewind, as many times as you need, in order to get the most out of the time you'll spend here.

So let me ask a question. Let's say you own a business and you don't really want to take out a loan, but I need money for a long term project. What are my options? What's available to me? Well during this tutorial, what we're going to be looking at are reasons for issuing stock. We're also going to be taking a look at retained earnings and earnings per share. The key terms for this lesson are going to be equity financing, retained earnings, dividend, and earnings per share.

So let's take a look at some reasons why we may want to issue stock. Well stock finances costs and growth for a business. What stock is an equity stake of ownership within the company. Equity financing-- one of our key terms-- is a method of financing through the selling of a portion of ownership interest. So when I issue stock, it's a form of equity financing, and I'm issuing part of ownership in my company through the sale or issue of stock.

Now when a stock first enters the market, it enters through something called an initial public offering. And it's the first time stock is offered to the public. And IPOs can be a great way to raise money. However, they're generally pretty expensive and really time consuming because, as you can imagine, there's a lot of regulations involved in putting these together.

Now shareholders are the persons or the organizations that buy the stock and own that share of stock. Stockholders invest because they think they're going to see a potential gain-- either through raising of the stock price, so they can sell it for more later down the road; or possibly through dividend income.

Now with stocks, a dividend is the monies paid on a routine basis to shareholders from the profits of a company-- for example, something like $0.25 per share. And capital gain of a stock is an earning based on the change of the price from when you bought the stock to the time that you sell it. For example, if I buy a stock in a certain company at $5, and I sold it later on for $13, then I have a capital gain in that stock of $8.00. Market value is the price or the current price of the stock on the open market. So market prices is the price of the stock that it's going it's worth right now. That will help define what my capital gain is.

Now we've talked a little bit about common versus preferred stock before. Just as a refresher, common stock is the most basic type of stock, and it's there for ownership within the company. Now these owners are the last paid out, and they also have voting rights only on major issues within a company. So they're not going to dictate every little thing that goes on within the company.

And common stock-- those shareholders will be the last people to receive dividends, any dividends that the company will pay out. And preferred stock is a much safer form of ownership, because the stock that these owners have has priority in the dividend payment. So any time there's a dividend, the preferred stock stockholders get that dividend before the common stock stockholders.

Now preferred stock stockholders can also sometimes be forced to sell their stock back to the company, and also, they don't have voting rights. So they have no say it all in how the company will run.

Let's talk about retained earnings. Now retained earnings is the monies held from the net income, to be used by the corporation, as opposed to dispersed to the shareholders. And this is the part of the net income that the company or the corporation is going to hold back instead of distributing out to the different shareholders in the form of dividends.

Now a higher retained earning will mean a lower dividend to the shareholders, and this may cause a decrease in the demand for the stock and also the price. Now a company that's reinvesting retained earnings is generally considered very attractive to investors. So instead of simply holding that money back and keeping it in the bank account, if they're reinvesting that those retained earnings into the business to grow the business, then this is generally considered to be a pretty good deal for the shareholders.

Earnings per share is the financial value of each individual share of a common stock. And the way you get this number, is you take the net income and you divide that by the number of outstanding shares of stock. So let's say for instance, I had 1,000 shares of stock out there, and my net income was $1,000. In that case, the earnings that I have per share of stock in my company would be $1 per share.

Now the ratio is evidence of earning power of the company, and it could also indicate the potential for profit. So typically, what we're going to see here, is companies with a high earnings per share, or companies that have a growing earnings per share.

Go back to that 1,000 shares and $1,000. If the next year I have $1,200 in earnings, then the next year I have $1,500 in earnings, and the next year I have $1,600 in earnings-- this indicates that the company's growing, and it has more earning power each year over year. And every time that earnings per share grows, that indicates the possibility of a profit. And when I have a profit, I can then pay a dividend to my shareholders. So the higher earnings per share, the bigger potential you have for a profit within the company.

So what did we talk about today? Well, we looked for the reasons for issuing stock. We also looked at retained earnings. And lastly, we looked at earnings per share. What's the net income I have per share of stock?

Now as always, I want to thank you for spending some time with me today. And you folks have a great day.

Terms to Know

The monies paid on a routine basis to shareholders from the profits of a company.

Earnings Per Share

The financial value of each individual share of a common stock.

Equity Financing

A method of financing through the selling a portion of ownership interest.

Retained Earnings

The monies held from net income to be used by the corporation as opposed to dispersed to shareholders.