A share purchase plan is a way for companies to raise capital. This capital can then be used for to pay down debt, invest in the business, fund a new acquisition, etc. It is an offer to existing shareholders to purchase further shares usually at a discounted price to what the stock is trading on the market. Companies can also raise funds through debt financing. However, there are some reasons why companies prefer to use equity financing.
Benefits of equity financing
• Companies may decide to issue a share purchase plan instead of using debt as they will not incur ongoing interest expenses. With a share purchase plan, more stock is issued to existing shareholders so there is no debt associated when raising capital. That is, they do not have to pay the shareholder back.
• As no debt is used to raise funds, then the debt ratios of the company will look financially healthier.
• A share purchase plan may be a faster strategy to raise funds.
• A company may already have a lot of debt on their balance sheet and do not want to take on more. Further debt may increase interest payments and this may reduce net earnings.
• Companies with poor credit ratings may find it difficult to borrow more money.
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• In a high interest rate environment, some companies may find it hard to repay debt so choose equity financing instead.
Features of share purchase plans
• No Brokerage: Share purchase plans are offers directly from the company so no third-party intermediary is involved.
• Discount: Share purchase plans are usually offered at a discount of the market price of the share to entice investors to participate.
• Can’t Sell on the Market if Non-Renounceable: If the share purchase plan is non-renounceable then shareholders can’t sell their entitled shares on the market. As investors are not obligated to take part, if they do not take up the offer then it will just lapse.
• Scale-backs: If the share purchase plan is very popular then it may be scaled back. This means that shareholders will only receive a fraction of their initial offer.
Lauren Hua is a private client adviser at Fairmont Equities.
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