Share capital refers to the funds a company receives from selling ownership shares to the public. A company that issues 1,000 shares of stock at $50 per share receives $50,000 in share capital. Even if the value of the shares increases or decreases, the value of the share capital remains as what the company received from the initial sale, or $50,000. The two types of share capital are common stock and preferred stock.
Companies that issue ownership shares in exchange for capital are called joint stock companies. A joint stock company can be a corporation, which is a separate legal entity from any person involved with the company, or a limited liability company, which protects shareholders by limiting their risk to the amount invested in the company.
Joint stock companies raise share capital by selling ownership shares to the general public. The most common type of ownership share in a company is common stock. The company's memorandum of association defines the characteristics of its common stock, such as:
- Whether shareholders are allowed to form a board of directors and vote on company decisions.
- Whether shareholders may vote to determine a course of action in the event of a hostile takeover.
- Whether, if the company is liquidated, holders of common stock are entitled to their share of company assets if there is money left after the company pays its creditors and preferred stock holders.
Companies also procure share capital from selling preferred stock. Like common stock, this type of stock also allows members of the public to take ownership of a company. However, preferred stock confers different benefits. Owners of preferred stock typically cannot vote on company decisions or elect board members. However, they have a higher claim than common stock owners on company assets. They also receive fixed cash payments, known as dividends, at regular intervals.
A preferred stock pays a cash dividend to shareholders. Its amount, known as the dividend yield, is expressed as a percentage of share value. For example, a preferred stock with a 3% dividend yield that trades for $100 pays a shareholder $3 for every share they own. This money is paid while they own the stock, in addition to the proceeds they receive when they sell it.
If a company is forced to declare bankruptcy or liquidate its assets, preferred stock owners receive their share of company assets before common stockholders. Additionally, no dividends may be paid to common stockholders until all preferred stockholders have received their agreed-upon dividend.
Selling stock and receiving share capital in return is known as equity financing. This type of financing is a popular alternative to debt financing, in which companies obtain capital by seeking loans that must be paid back with interest. Those who provide share capital to a company do not receive repayment with interest on a fixed schedule. Instead, they share in the company's profits when they own company stock.