Why companies issue shares

In simple terms

Every business needs money to grow: to build a factory, open new branches, hire people or develop a product. When the owners' own savings and the company's profits are not enough, it has two main choices.

1. Borrow the money. This is called debt. The company takes a loan from a bank or issues bonds, promises to pay interest, and must repay the full amount on fixed dates.
2. Sell part of the company. This is called equity. The company creates new shares and sells them to investors. The investors become part-owners. The money never has to be repaid, but the new owners are entitled to a share of all future profits.

Listing on a stock exchange and selling shares to the public is a way to do the second at a very large scale, by selling small pieces to many investors at once.

What the company gains and gives up

Debt is cheaper when things go well, because lenders only ever receive their agreed interest. Equity is safer for the company when things go badly, because there is no fixed payment that could push it into default. Most companies use a mix of both.

Dilution: why the founders own a smaller slice

When a company sells new shares, the total number of shares goes up. Existing owners still hold the same number of shares, but each share is now a smaller fraction of the company. This is called dilution.

The founders and their families who control a listed company are called promoters in India. Many listed companies are still run by their promoters, who continue to own a large part of the shares.

Why going public is a big step

Selling shares to the public through a stock exchange brings advantages beyond the money itself. The company's shares get a market price, early investors and employees can sell some of their holding, and a listed company often finds it easier to raise more money later.

It also brings obligations. A listed company must publish its financial results regularly, disclose important events promptly, hold shareholder meetings and follow the regulator's governance rules. Ownership becomes public, and the company's decisions are scrutinised by thousands of shareholders and analysts.

Why it matters

Knowing why companies issue shares tells you what you are actually buying and where you stand.

As a shareholder you are an owner, not a lender. Nobody promises you interest or your money back. You gain if the business grows and its profits rise; you lose if it struggles. And in a bankruptcy, lenders, employees and the tax authorities are paid before shareholders. That is why shares are riskier than fixed deposits or bonds, and also why, over long periods, they have the potential to earn more.

It also helps you read company news. When a company announces it will raise money by issuing new shares, existing shareholders will be diluted. Whether that is good or bad depends on what the money is used for and the price at which the new shares are sold.

Limitations

The table above is a simplification. There are many forms of financing in between pure debt and pure equity, such as convertible bonds and preference shares, and the right mix depends on the business. Companies also issue shares for reasons other than raising cash, for example to reward employees through stock options or to pay for acquisitions.

This lesson also does not cover how a share sale is priced or run. You will meet that in IPO basics.

Common mistakes

• "Equity is free money for the company." It never has to be repaid, but it is the most expensive form of money if the business does well, because the new owners share in all future profits.
• "Dilution is always bad." Owning a smaller slice of a much bigger company can be better than owning a large slice of a small one. What matters is what the new money achieves.
• "Shareholders are repaid first if a company fails." It is the opposite. Shareholders have the last claim on what is left.
• "A company issues shares only once." Companies can raise money through new share issues many times, for example through follow-on offers or rights issues.

Try it yourself

A made-up company, Meera's Bakery Pvt Ltd, has 50,000 shares owned entirely by Meera. To fund new ovens, she sells 10,000 new shares to an investor.

1. How many shares exist after the sale?
2. What percentage of the company does Meera own afterwards?
3. If the company was worth ₹50 lakh before and the investor paid ₹10 lakh, what is the company worth after the money arrives, assuming nothing else changes?

Answers: 60,000 shares; 50,000 ÷ 60,000 = about 83.3%; ₹60 lakh. Meera's 83.3% of ₹60 lakh is still worth ₹50 lakh, the same as before. Her stake only grows in value if the ovens make the business more profitable.