2.1 How Shares Come Into Being
To start a business there are many requirements such as product/service idea, operational facility, people to work etc. All these activities imply that the company needs money or ‘capital’. Companies raise this money mainly in two ways:
1) The founders of the business, also called promoters,contribute money. This is called initial capital.
2) The amount can be borrowed from a bank or a financial institution.
Again, at some point during the growth of the company it needs to raise money, whether to open up regional sales offices, build a new production facility, or hire a batch of engineers etc. This is the additional funding requirement.
Here also the company has two choices:
• Borrow the money
• Raise it from investors by selling them a stake (issuing shares of stock) in the company.
That’s how the stocks come to existence. All public limited companies are started privately by a promoter or a group of promoters. But the promoters’ capital and the borrowings from banks and financial institutions are not sufficient for financing a project or setting up a business. So, these companies invite the public to contribute towards equity and issue shares to these individual investors through an initial public offer (IPO).
Shares received through an initial public offer are again traded by investors in what is called a secondary market. The secondary markets are generally called stock markets. Don’t worry about all this right now. You will learn more about it in the coming chapters.
Since each owner has his own share of contribution towards the owners’ capital (also called equity), each of them is given his/her legal entitlement to share the ownership of the company in the form of document. These documents are called shares and the owners are shareholders.
The company, by choosing to raise capital in this manner, creates certain expectations and obligations. This is an important point and so please read this carefully: People who buy equity shares (also referred to as subscribers to equity shares) have expectations. They expect that the capital or money they have invested will give them returns. The return from shares is typically two-fold:
1) Appreciation of the value of the share. This is referred to as capital gain as the capital invested leads to gains with the increase in the selling price of the share.
2) A fixed payout in the form of dividends.
So, in simple language, a share of stock is the smallest unit of ownership in a company. If you own a share of a company’s stock, you are a part owner of the company. You have the right to vote on members of the board of directors and other important matters before the company. If the company distributes profits to shareholders, you are likely receive a proportionate share.
Now, typical stock buyers rarely think like owners, and it’s not as if they actually have a say in how things are done. Owning 100 shares of Microsoft makes you, technically speaking, Bill Gates’ boss, but that doesn’t mean you can call him up and give him a tongue-lashing. Nevertheless, it’s that ownership structure that gives a stock its value. If stock owners didn’t have a claim on earnings, then stock certificates would be worth no more than the paper they are printed on. As a company’s earnings improve, investors are willing to pay more for the stock. In simple terms, subsequently the share prices also go up.
A fixed payout in the form of dividends
You have the right to vote on important matters before the company, like election of members to the board of directors. If the company distributes profits to shareholders, you are likely to receive a proportionate share.