Overview of Shares and Stock

A stock (also known as Equity) is a financial security that represents the ownership of a fraction of a corporation, business or firm. This ownership entitles the owner to a proportion of the company’s assets and profits equal to how much stock they own. Stock, when broken down into smaller units are referred to as “Shares.”

UNDERSTANDING THE CONCEPT

Companies issue/sells stock to raise funds for their business operations. The holder of the stock (a shareholder) by implication, has bought a piece of the company and depending on the type of stock held, may have a claim to a part of its assets and earnings. The degree of ownership is determined by the number of shares a shareholder owns relative to the number of shares outstanding in the company. For example, if a company has 2,000 shares of stock outstanding and a shareholder owns 200 shares, then he owns and have a claim to 10% of the company’s assets and earnings.

Shareholders do not own companies, they own the shares issued by the companies however, a company (private or public) is a special form of business organisation in that the Law treats it as separate legal entity, distinct from its initial founder(s). In other words, companies file taxes, can borrow, can own properties, can sue and be sued, etc all in its own name, hence the idea that the company is a ‘person’ means that it can own its own assets. Therefore, in a typical corporate office full of equipment, they all belong to the company itself and not the shareholders.

SHAREHOLDERS AND OWNERSHIP

As highlighted above, what shareholders actually own are the shares issued by the company and the company owns its assets. So if a shareholder owns 20% of the shares of a company, it is somewhat incorrect to say that he owns one-fifth of that company, instead he owns 100% of one-fifth of the company’s shares. A shareholder cannot do as he pleases with a company’s assets by the virtue of the Law of ‘separation of ownership and control.’

TYPES OF STOCK

There are 2 main types of stock, common stock and preferred stock:

1. Common stock: Common stock/ordinary shares is a form of equity ownership which gives the stockholder the right to share in the profits of the company and vote on matters of corporate policy and the composition of the members of the company’s board of directors. The term “common stock” indicates that the stockholders do not own any particular assets, but that all of the company’s assets are shared or common property of all stockholders. In the event of a company’s liquidation, common stockholders are paid last after the bondholders, creditors and preferred stockholders have been paid, hence as recompense for the exposed risks, common stockholders are always given certain exclusive rights such as voting rights and preemptive rights (right to retain proportional ownership in a company upon issuance of additional stock). Also, common stock offers holders the potential for capital appreciation.

2. Preferred stock: Preferred stock/preference shares are the type of stock that represents ownership in a corporation and have priority claims over common stock on the company’s assets and earnings. The shares are senior to common stock but are junior relative to bonds in terms of claims on assets. They are also prioritized over common stockholders in dividend payments. Preferred stock have certain features that differentiates them from debt and common equity, they include: preference in payment of dividends and assets upon liquidation, non-voting rights, convertibility to common stock amongst others. Also, it is a very flexible type of security, having different variants which are convertible preferred stock, cumulative preferred stock, exchangeable preferred stock and perpetual preferred stock.

Companies looking to expand their businesses may decide to finance the endeavor by taking the company public and issuing stock. Most times, private market may not offer the kind of financing or amount of financing a company needs for growth and expansion, hence registering as a publicly traded company and undertaking an I.P.O (Initial public offering) can simplify the process and raise capital quickly via issuing stock. Although issuing stock is a popular way a company can raise funds, there are significant downsides to doing so.

By Chiemerie Oguejiofor, for The Finance Hub.