Cost of Capital
When it comes to the cost of capital, common stock is one of a few options on the table for raising funding. From various debt instruments to preferred stock to common stock, larger organizations tend to diversify funding input to optimize their potential financial leverage. In order to understand the weighted average cost of capital (WACC) of all of these inputs, the cost of each source of debt and/or equity must be determined.
The Cost of Common Stock
When it comes to issuing common stock, there are both direct and indirect costs to consider.
Direct Costs
In terms of literal capital spent, the issuance of new common stock incurs a variety of capital costs both at the initial offering and throughout the process of managing this funding source over time:
- Legal fees for the distribution of business shares to the general public
- Increased accounting costs (if initial IPO) for management of a publicly traded firm
- Marketing costs for recruiting investors
- The time and effort of management
- Taxation (which differ region to region) pertaining the the distribution of equity
From a general perspective, the process of offering shares is skill intensive, from management to legal to accounting, firms must hire and maintain a wide pool of talent to maintain this form of equity.
Indirect Costs
In addition to the tangible capital costs involved, there are also a variety of indirect trade-offs that organizations must understand prior to pursuing this source of funding. Indirect costs include:
- Requirement to release financial information, including information that competitors may find valuable
- Compared to debt, it is less reliable as there may not be buyers interested at the desired price point
- Some loss of control, as the sale of shares is essentially the sale of organizational ownership
- Depending on the scale of shares available, the organization must consider takeover risks
As the issuance of publicly traded common stock is essentially the sale of the public auction of organizational equity, any and all considerations pertaining to control, ownership and legal implications should be considered as opportunity costs compared to other forms of funding.
Common Stock
Stock image of common stock.