Corporations and startups have many different options when they’re looking to mine additional funding to supplement or expand a project. Selling stock to shareholders can be a great option, but it’s critical to know what you are trading in exchange for those much needed dollars.

Businesses generally issue one or more types of securities which usually includes common stock, preferred stock, and debentures or bonds. Those who buy shares of common or preferred stock are simply buying an ownership interest in a company. Purchasing a debenture or bond is actually a loan to the company in which the investor receives interest and repayment of the face amount of the bond when it matures.

All shareholders are not created equal and it isn’t necessarily based on how much they’ve invested. If you decide to take on investors, your company will need to create bylaws and a charter to establish the rights of each class of investor. An example is when a company’s charter states that only the common stock has voting privileges or possibly that the preferred stock must receive dividends before any amount is paid to common stockholders. Even the rights of bondholders are treated differently: the specific bond agreement represents a contract between the issuer and the bondholder therefore allowing the type of payments and privileges of a bondholder to be governed by the bond agreement (also known as the “indenture”).

Furthermore, you may want to note that if a company goes bankrupt, the class system of shareholders is most certainly held in place. Common stock shareholders are at the very bottom of the corporate food chain if a company is forced to liquidate. The creditors get first dibs on the company’s assets to settle their outstanding debts, next the bondholders get whatever may be left, followed by preferred shareholders, and finally the common shareholders.

How will having these different levels of shareholders impact you business overall? Consider these seven rights that are bestowed upon investors in most states:

1) Shareholders can vote on major events affecting the company as a whole including electing directors or merging with another company. If the investor is unable to attend the annual meeting, they also have the option of doing so by proxy and can mail in their vote.

2) As the profits are reinvested in additional assets, shareholders will see an increased share value since they hold a proportionate ownership in the assets of the company.

3) Shareholders can transfer ownership of their shares on an exchange and because stocks are so liquid, they can move their money into other places almost instantaneously.

4) Investors can receive dividends when declared by the board of directors but before this happens, you have two options: funds can be reinvested back into the firm (which will possibly increase the company’s overall value) or you can pay out the profit in the form of a dividend.

5) Through an annual report, investors can inspect the corporate books and records.

6) Investors have the right to sue the corporation for wrongful acts in a shareholder class-action lawsuit if they feel that the company has not had their best interests in mind.

7) If your company unfortunately goes bankrupt, investors may share in the proceeds of a corporate liquidation (as mentioned earlier).

If you decide that you want to have the option of bringing investors on as partners in your company, be sure to hire a competent business lawyer to go over all of the details since shareholder’s rights vary from state to state. With the right business plan in place, the company and investor relationship can be successful and profitable for both sides

About the author

Christina Morales

Christina helps provide useful business and legal tips on UpCounsel for our customers and visitors. Having over a decade of writing experience in a variety of industries, she has also been very close to the legal space from a young age with family members who continue to practice business and tax law.

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