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The advantages of using stock financing are:
- Common stock does not obligate the firm to make fixed payments to stockholders
- Carries no fixed maturity date
- Increases the creditworthiness of the firm thus increasing the future availability of debt at a lower cost
- Can often be sold more easily than debt if the firm’s prospects look potentially good but risky and
- Financing with common stock serves as a reserve of borrowing capacity
The disadvantages of common stock financing to the corporation:
- Issuing common stock extends voting rights and perhaps even control, to new stockholders
- Gives new stockholders the right to a percentage of profits rather than to a fixed payment in the case of creditors
- The cost of underwriting and distributing common stock is high
- If common stock is sold to the point where the equity ratio exceeds that in the optimal capital structure, a firm’s average cost of capital will increase and its stock price will not be maximized and
- Dividends paid to stockholders are not tax deductible as is interest paid to creditors.
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