Small and medium-sized enterprises (SMEs) have the option to borrow money from a bank or a microfinance institution (MFI), which collaborates with entrepreneurs. Alternatively, they can utilize crowdfunding or factoring. However, in some cases, it might be more advantageous to issue shares or bonds.
By issuing shares, you offer investors a stake in your company. They can expect dividends – usually a portion of the profits. You don’t guarantee investors a specific return, but they become co-owners of your business and gain the right to influence its development. This is a relatively high-risk option for both you and potential buyers. Additionally, in this scenario, your company needs to be registered as a corporation.
Bonds essentially function as your debt notes. When you issue bonds, you borrow money from investors and commit to paying them interest – the coupon yield. The advantage is that, unlike a loan, you determine how much you’re willing to pay bondholders and how often. This method of raising funds is more predictable than shares. Hence, it’s a more feasible choice for business owners and investors alike. Companies of any organizational structure can issue bonds.
As practice shows, representatives from various business sectors successfully enter the stock market: stores, cafes, restaurants, manufacturing enterprises, financial and IT companies. However, issuing securities is suitable primarily for mature businesses that have been in operation for more than three years and have clear growth plans.
It’s crucial for both investors and the company itself to understand the financing objectives and the revenue sources that will be used to pay shareholders or bondholders.
Securities, stock exchange – sounds very complicated. Isn’t it easier to get a loan?
It all depends on the circumstances, but if you decide to raise funds through the stock exchange, it might turn out to be more cost-effective than loans and crowdfunding. Moreover, it will provide you with greater financial freedom and growth prospects.
You have the autonomy to determine the reward for investors. With bonds, you need to pay coupon income, and with shares, it’s dividends, but their amount is your prerogative.
No collateral is needed. Business loans usually require collateral like real estate, vehicles, or equipment, whereas for issuing securities, expensive assets are not necessary, and there’s no need to transfer rights to a bank or an MFI.
The raised funds can be utilized at your discretion. Loans and borrowings are often targeted, such as for production development. However, funds obtained through the stock exchange can be used more flexibly.
The pool of investors is much broader compared to creditors. Anyone, including private individuals, can purchase shares and bonds. Their number surpasses that of banks and MFIs.
Publicity and PR. Listing your company on the stock exchange is an opportunity to attract attention to your business. The more well-known your company and its products become, the easier and more cost-effective it will be to secure financing through the stock exchange in the future.
However, there are downsides to financing through the stock exchange.
Lengthy procedure. Issuing securities, especially for the first time, takes more time than obtaining a loan. On average, going public takes about three months. It’s also uncertain how long it will take for investors to buy all your shares or bonds.
Full transparency. You’ll need to disclose your company’s structure, strategy, business plan, financial statements to investors, and then consistently keep them informed about your affairs: reporting company news, writing about significant deals and other changes that could affect your securities’ quotes.
Reputation risks. If you encounter financial difficulties leading to a drop in the price of your securities or an inability to repay bondholders on time, all potential investors will become aware of this immediately. In the future, it could be challenging to raise funds through the stock exchange. In the case of loans and borrowings, your temporary challenges won’t attract such attention. You have the chance to negotiate debt restructuring, and this won’t be immediately known to all your business partners, buyers, or clients.
In some cases, entering the stock market might prove to be more expensive than loans and borrowings. Rates from preferential credit programs can be more favorable than the interest you’d need to pay to your bond or share buyers. Therefore, it’s essential to carefully calculate the cost of each type of financing in advance.
Issuing and maintaining securities will also incur expenses. The issuance of stocks or bonds is organized by intermediaries known as underwriters. These are professional participants in the securities market, including brokerage firms and banks with brokerage licenses.
The custody of your stocks or bonds must be handled by depositories and registrars. And transactions involving securities take place on the stock exchange. All these organizations will charge you for their services. On average, you can expect to spend around 2-3% of the amount you manage to raise on various fees.
However, in some cases, there are opportunities for savings. For small and medium-sized enterprises, there’s a special platform known as the Growth Sector of the Moscow Exchange. Here, issuing securities might be more cost-effective than usual.
Moreover, small and medium businesses have the chance to offset a portion of their expenses for issuance and investor payments through government subsidies.
What happens if the company fails to pay coupon income on bonds or dividends on shares?
Issuers of bonds and stocks have varying responsibilities towards investors.
In the case of issuing bonds, a company is obligated to pay a scheduled coupon income and, upon maturity, the principal debt, which is the face value of the security. If the issuer lacks sufficient funds for the planned payment, two scenarios can unfold.
When financial difficulties are temporary and the company anticipates improving its situation in the near future, there’s a chance to negotiate debt restructuring with bondholders. This involves adjusting the payment schedule, such as deferring, temporarily reducing, or extending payments. In such a scenario, the company continues its operations.
However, if a way out of the financial crisis isn’t foreseeable or an agreement with investors cannot be reached, the issuer must declare default. Trading of its securities is immediately halted on the exchange. Subsequently, bankruptcy proceedings usually ensue, which can be initiated by bondholders.
If you have guarantees or endorsements from the Small Business Corporation, it will repay a significant portion of the debt to investors on your behalf. In such a situation, the likelihood of bankruptcy can likely be avoided.
In the case of issuing stocks, the issuer is not obliged to make payments to investors. They receive money only if the shareholders’ assembly decides to allocate a portion of the company’s profit for dividends. Typically, the controlling stake of shares is held by company owners, and they agree to payouts only when it doesn’t hinder business development.
This approach is more advantageous for you, but significantly riskier for investors. That’s precisely why attracting buyers for stocks is much more challenging. Generally, this is achieved by successful and publicly traded companies that already have experience in entering the stock market with bonds.
What happens after the issue?
Once a company’s securities are listed on the exchange, investors can purchase them. The rules of issuance must specify the placement period, the timeframe for the initial sale. Typically, this period ranges from three months to a year. It can be extended, but not beyond three years.
During this time, the issuer is not obligated to sell all the issued securities. However, placement organizers usually assist the company in promoting its securities and attracting investors.
Following the issuance, the issuing company must regularly disclose information about itself, pay coupon income, and report to investors and the exchange.
After the issuance takes place, it’s possible to apply for obtaining government subsidies.
What if it is not possible to sell securities and the cost of issuance does not pay off?
In theory, this is possible, but in practice, it almost never happens. After all, even during the stage of preparing the issuance concept, the company, with the help of placement organizers and consultants, such as the New York Stock Exchange or the Small Business Corporation, assesses its prospects.
Then, the placement organizer verifies the issuance parameters – the volume, face value of securities, coupons (in the case of bonds). A professional intermediary will not undertake the task if they perceive that the company lacks the potential to attract investors.