What are the advantages and disadvantages of selling shares to raise funds for a small business?

Written by nicholas malino
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What are the advantages and disadvantages of selling shares to raise funds for a small business?
Selling shares can be an efficient means of raising capital under certain conditions. (Christine Balderas/Photodisc/Getty Images)

Many companies get their start with capital contributed by friends, family, and people close to the company who may provide capital in exchange for ownership in the company in the form of shares. As a business matures and begins operations, some of its capital requirements may still be met by additional sales of stock. There are several important advantages and disadvantages of using stock sales as a source of capital.

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Advantages

Selling shares has the advantage of raising capital without incurring a corresponding debt that will have to be repaid. The investor is receiving ownership interest in the company as consideration for the investment. The purchasing shareholders are counting on the value of their ownership increasing so that when the investors need their money back, the shares can be sold at higher price.

Variable

In order for a company to sell its shares, the shareholding should be entered in the company register, which should then be submitted to Companies House. A public company that wants to sell shares on the stock exchange should apply for this status at Companies House. The company must have a share capital of at least £50,000. It will then receive a trading certificate from companies house, which will classify the company as a public limited company, or "PLC."

Disadvantages

Every company in the UK has to have a share register. this creates administrative tasks that sole traders do not have to perform. It also requires that the name and address of each shareholder be registered with Comanies House, to which all members of the public have free access, thus removing the anonymity of the company's owners.

Dilution

Another disadvantage is the potential for dilution of the existing shares. Whenever additional shares are issued, the percentage of the prior shareholders' ownership is diminished. This is referred to as dilution. If additional shares are issued and the overall value of the company remains the same, then the value of the stock owned by the original shareholders lessens. Needless to say, this is not in the best interest of the shareholders.

Bottom line

Selling the company's common stock to raise capital can be an effective method of capital formation. The result of the sale should be the increase in the overall value of the company resulting from the application of that capital that exceeds the loss in value to the original shareholders resulting from the dilution.

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