From the shareholders’ perspective, they make a one-time purchase that can potentially make them massive profit with minimal effort on their part, but for the company, isn’t that like taking out a high-interest loan that they can never pay off? Wouldn’t an actual loan be better if they just need money?
In: Economics
Whether it’s “high-interest” depends on how successful the company ends up being.
Let’s say you’re opening a restaurant and need $1,000,000 to buy cooking equipment before you’ll be able to serve any food to customers, and there are two available options for funding:
* Option 1 (loan): An investor offers you $1,000,000 now, in exchange for you promising to pay them $200,000/yr for ten years. Five years later there’s a global pandemic and you don’t sell any food that year, so you end up having to sell off the cooking equipment in order to pay your investor their $200,000. Your restaurant goes out of business.
* Option 2 (stock): An investor offers you $1,000,000 now, in exchange for you promising to pay them 50% of your future profits. Five years later there’s a global pandemic and you don’t sell any food that year, so you don’t owe the investor anything that year. Your restaurant survives.
Sure, if your restaurant ends up wildly successful, you may regret having promised to give the investor 50% of your profits. But the restaurant is more likely to *become* successful in the first place if you choose Option 2 than if you choose Option 1.
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