A company will often issue equity stock to investors and owners in order to raise capital to expand and fund operations. There are several ways to raise capital, including debt and preferred shares; however, ordinary shares of common stock are most well-known by average investors. Ordinary shares, also known as common shares, have many benefits for both the investor and the issuing company.
- Three characteristic benefits are typically granted to owners of ordinary shares: voting rights, gains, and limited liability.
- Common stock, through capital gains and ordinary dividends, has proven to be a great source of returns for investors, on average and over time.
- Companies also benefit from issuing shares in that they do not incur debt obligations, although they do forfeit some of the ownership's stake.
The first is voting rights. Common shareholders can participate in internal corporate governance through voting. Ordinary shares provide a small degree of ownership in the issuing company. Stockholders have a certain amount of say in how the company is run and are allowed to vote on important decisions, such as the appointment of a board of directors. For each share of common stock owned, the stockholder gets one vote, so the stockholder's opinion becomes weightier when they own more shares.
While this may be an important advantage for an individual or institutional investor who controls a large percentage of a company's stock, for the average retail investor, the main benefits of common shares are found in their potential for capital gains and dividends, which represent the two ways common shareholders profit from their ownership.
Capital Gains and Dividends
For individuals, investing in the stock market is a relatively straightforward way to generate income. While there are no guaranteed profits, almost anyone can open an online trading account to buy and sell shares of publicly traded stock.
In addition to its transactional simplicity, investment in ordinary shares has the potential for unlimited gains, while the potential loss is limited to the original amount invested. Selling shares at a higher price than the original purchase price results in the investor realizing a capital gain. However, the opposite can also happen; shareholders may realize a capital loss if they sell shares for less than they paid for them.
When a company turns a profit, it often rewards its investors by paying a small portion of that profit to each shareholder according to the number of shares owned. While this dividend is not guaranteed, as with preferred stock, many companies pride themselves on consistently paying higher dividends each year, encouraging long-term investment. Shareholders may elect to reinvest dividends or receive them as income.
Other stockholders' rights include limited liability, which means that common shareholders are protected against the financial obligations of the corporation and are only liable for their shares' value. They also gain preemptive rights. Shareholders with preemptive rights gain access to new share issues before the rest of the investing public, often at a discount.
Benefits for Issuing Companies
For businesses, issuing common shares is an important way to raise capital to fund expansion without incurring too much debt. While this dilutes the ownership of the company, unlike debt funding, shareholder investment need not be repaid at a later date.
Of course, shareholders do expect returns on their investments, either through stock growth or dividend payments. But the company always has the option to repurchase some or all of its outstanding shares if and when it no longer has need of equity capital, thereby consolidating ownership and increasing the value of shares still available by reducing the supply.