As part of your research to find the best penny stocks, you may want to find out how the company plans on raising funds.
Every growing business at some point will consider raising funds for its expansion.
The method the company plans on pursuing could have a direct effect on the value of your shares.
A company issuing shares for funds will be diluting the value of the existing or outstanding shares.
The new shares will diminish the ownership percentage of the shares you may own.
If the shares that the company issues are restricted, the dilution will not have an effect on the outstanding shares until they become free trading.
Once they are free trading the holders of those shares will be able to sell them in the open market.
So by introducing new shares into the market the supply is increased.
The price will decrease if the demand for the shares is constant with the supply.
One way companies may opt to raise funds is by borrowing.
They issue a bond or note to a lender in exchange for the funds.
Typically the interest rate for a penny stock will be high due to the high risk generally associated with these types of loans.
Debt is less expensive than raising funds through equity since the interest paid on loans is tax deductible versus dividends that are not tax deductible.
Penny stocks generally do not issue dividends but they are still better off borrowing money versus issuing shares.
The structure of the loan or note becomes most important in the case of default of the loan.
In a default, the loan can typically be converted to equity.
At this point there will be major dilution of stock since the debtor receives the money owed to him in stock.
This would only happen in the worst-case scenario where the debtor and company cannot work out an amicable payment plan.
In this case, the stock would be worth less due to the higher amount of shares.
In the reverse scenario when the company does perform well and does make its interest payments, the company is in a better position overall because it does not have to dilute its ownership.
It's important to find out what method of fundraising a penny stock may undertake to raise funds.
Depending on how the company executes on its obligations, could play a major role on the value and risk of your investment.
Every growing business at some point will consider raising funds for its expansion.
The method the company plans on pursuing could have a direct effect on the value of your shares.
A company issuing shares for funds will be diluting the value of the existing or outstanding shares.
The new shares will diminish the ownership percentage of the shares you may own.
If the shares that the company issues are restricted, the dilution will not have an effect on the outstanding shares until they become free trading.
Once they are free trading the holders of those shares will be able to sell them in the open market.
So by introducing new shares into the market the supply is increased.
The price will decrease if the demand for the shares is constant with the supply.
One way companies may opt to raise funds is by borrowing.
They issue a bond or note to a lender in exchange for the funds.
Typically the interest rate for a penny stock will be high due to the high risk generally associated with these types of loans.
Debt is less expensive than raising funds through equity since the interest paid on loans is tax deductible versus dividends that are not tax deductible.
Penny stocks generally do not issue dividends but they are still better off borrowing money versus issuing shares.
The structure of the loan or note becomes most important in the case of default of the loan.
In a default, the loan can typically be converted to equity.
At this point there will be major dilution of stock since the debtor receives the money owed to him in stock.
This would only happen in the worst-case scenario where the debtor and company cannot work out an amicable payment plan.
In this case, the stock would be worth less due to the higher amount of shares.
In the reverse scenario when the company does perform well and does make its interest payments, the company is in a better position overall because it does not have to dilute its ownership.
It's important to find out what method of fundraising a penny stock may undertake to raise funds.
Depending on how the company executes on its obligations, could play a major role on the value and risk of your investment.
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