Capital Markets: Advantages and Disadvantages of Investing In Capital Markets As the advantages and disadvantages of financing through capital markets, described below, suggest, financing decisions will differ from company to company and from owner to owner, depending on their expectations, preferences, and the actual situation the company is in. It is therefore very important to explain the basic advantages and disadvantages of the various ways of financing through ownership instruments (shares). The advantages of financing through ownership financing instruments include: They are not a fixed cost for the enterprise - as already pointed out, dividends do not have to be paid on a specific date, any more than the principal matures at a specified moment. The cost only appears if the company makes a profit, in the form of profit distribution. Consequently, this model of financing is considerably more stable and less risky for the company. There is no maturity term - as a rule, investments in shares are investments in permanent capital that cannot be withdrawn and whose return from the company cannot be requested. In this sense, there is an advantage for the company, which has no obligation to return or pay, if it has business problems or negative financial results. It is fresh capital that improves the credit rating - by issuing shares, a company acquires new, fresh, permanent capital that strengthens its business position, making it stable. As new capital enters the company, its leverage improves and debt indicators decrease, improving its credit rating and opening up new possibilities for financing through debt instruments. Easier sale - a good and stable company can sell shares far more easily than bonds, since the market is wider. A well-developed secondary market opens up possibilities for investors to acquire both dividends and capital gain and to liquidate their capital fast through the financial market. Higher yield - due to the greater risk of investing in shares, investors obtain a higher yield, which is, however, less favorable from the issuer's viewpoint, as they have higher financing costs. As noted above, as well as dividends, the investor can see capital gain in the form of higher share prices. Ownership rights - from the investor's viewpoint, investment in ownership instruments allows active participation in managing the company, as well as voting rights at AGM. This is a disadvantage from the issuer's point of view, since it means "dilution" for them. Quotation on the stock market has many advantages for the issuer. If the issuer's business is transparent and successful and investors trust the management, the issuer can finance projects by issuing new shares. This way of acquiring fresh capital is used far more heavily in the West, even though the difference in cost between capital acquired by share issue and that from a loan with commercial banks is far smaller there than here. If we look at bank interest rates, the question arises as to why joint-stock companies here are not financed in this way. The first step would certainly be acceptance to stock-exchange quotation. A further advantage for a listed issuer is less scope for manipulating the share price. If a security is included in the quotation, contracts cannot be formed at prices that deviate more than 10% from the last concluded price. Certain basic disadvantages of financing through ownership instruments can also be defined, namely: Dilution - it has already been noted that there is no "dilution" with bonds, but there is with shares. If a company opts for financing by share issue, their number will increase, increasing the amount of capital and decreasing existing owners' percentage ownership. A more expensive source of financing - the considerably higher risks faced by investors in ownership instruments entail an obligation to pay higher compensation. In other words, the company distributes the net profit among capital owners. Unfavorable tax treatment - this way of financing lacks tax incentives. The dividend is paid out of net profit after taxes, and is thus not a tax shelter from profit tax. Investors also have to pay tax when profits are transferred to their accounts, so that there is no tax incentive there either. Under new legal regulations in BiH, however, capital gains from increased share price are not subject to tax, so that this income segment is sheltered from tax. Unknown obligation - the dividend is paid based on business performance, and the investor does not know when and how much they will profit from a given share, while the issuer also does not necessarily have full control over payment of profit to shareholders. The decision on the amount of the dividend is made at the AGM. Risk of loss - although there are many advantages for investors, as well as the possibility of higher profit, investing in ownership instruments carries a risk of loss. If dividends are not paid because the company's performance is negative and the share price falls at the same time, the investor can incur significant financial losses in the form of capital losses. Moreover, in company liquidation, the shareholder is ranked last in the order of payments out of the liquidation assets.
