Common Stock: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
Common stock a representation of owning a part of a corporation (“equity ownership”) and is sometimes called "voting shares" or "ordinary shares."4 min read
2. Why Is Common Stock Important?
3. Reasons to Consider Not Using Common Stock
4. Reasons to Consider Using Common Stock
7. Common Mistakes
8. Frequently Asked Questions
9. Steps to File
Updated November 26, 2020:
Common Stock: What Is It?
Common stock a representation of owning a part of a corporation (“equity ownership”) and is sometimes called "voting shares" or "ordinary shares." It's a type of stock that gives partial ownership and voting rights to a corporation during corporate meetings. The amount of ownership is equal to the amount of common stock an individual owns compared to the amount issued.
Common stock is considered riskier than preferred stock (another type of stock). However, it often gives investors the ability to select members of the board of directors, and they may also vote on issues, such as company objectives and stock splits.
Preferred stock owners typically do not receive voting rights, but they usually have a steady dividend payment and have priority on company assets over common stock.
Why Is Common Stock Important?
Selling common stock is one of the best ways for a company to raise equity and grow. For investors, common stock allows you to immediately invest in a company. If the business does well, you may see a high return on your investment.
Common stock is typically the kind issued to founders and. Venture capitalists are more likely to receive preferred capital.
Reasons to Consider Not Using Common Stock
Common stock is issued at what's called a "par" value, which is technically the legal price below which a share of stock cannot be sold, but is typically the minimum possible amount and may not be required under incorporation law in some states. However, it has no guaranteed value once it's on the market.
If you own common stock in a company that's had a bad year, then you might not get paid dividends at all due to the lack of available cash. In the case that a business fails, or liquidation happens, you might lose all of your money since secured lenders get paid first, then unsecured lenders, followed by preferred stockholders, and finally the common stockholders (assuming there’s anything left for the common stockholders).
Reasons to Consider Using Common Stock
Well-purchased common stock is a valuable addition to your investment portfolio. The return on investment for common stock, in the long run, is usually greater than bonds or preferred shares, and there is no limit to the amount you may receive other than limits imposed by the government, lenders, or the financial status of the firm. It may also pay dividends, and these may be paid alongside preferred stock. Dividends mean that each quarter, the company pays you a certain amount of money for each share of stock you own. No fixed dividends are paid out to common stockholders, and so the return on investment is based on how much the company earns, fluctuations in the market, and how the company reinvests its profits.
Usually, common stock also gives you partial ownership of the corporation, which comes with voting rights and the ability to elect the board of directors. (However, some companies do issue "non-voting" common stock, which does not carry this privilege.). Stockholders also receive a copy of the corporation’s annual report.
Buying common stock also sometimes gives stock owners "pre-emptive rights." This means that if your company ever issues more stock, stockholders have the right to pre-emptively buy up enough of the new stock to retain their percentage ownership in the company.
If you are a company, you may issue common (and other) stock when you go public. If you are an investor, you may buy and sell common stock by engaging directly with the company, or by engaging in transactions with other investors.
If investors choose to buy common stock from your company, they will usually receive the ability to vote at your company meetings, including electing members of your board of directors. They will be making an investment that typically has a greater yield in the long run. However, in the short run, there is a greater risk. If your company goes under, paying off your common stockholders is your last priority. As a result, they may see no money at all.
Most companies that issue stock issue at least some common stock, in addition to preferred stock. If you do not choose to issue stock, you will not see the influx of capital that you get when your company goes public. However, because you will not be allowing investors voting rights, you will retain greater control over your company.
Some investors buy common stock expecting a rapid return on their investment. This does sometimes happen, especially because common stock pays out dividends and increases in value.
But common stock is a risky short-term investment. In the long run, it is a much safer investment. It's generally best to buy some common stock and hold onto it until later.
Frequently Asked Questions
- Are companies obliged to pay back common stock owners?
Not necessarily. If a company files for bankruptcy or otherwise liquidates, common stock is the last thing to be paid back. In these situations, common stock owners often receive no money.
- What's the difference between preferred and common stock?
Preferred stock usually does not give voting rights as common stock does. However, if the company goes under, preferred stock is paid out before common stock. Common stock is sometimes referred to as junior equity since it ranks behind preferred stock on its claim to dividends.
If a company issues only one kind of stock, it issues common stock.
- Is all common stock the same?
Not necessarily. Some companies issue different classes of common stock, which give different proportions of voting rights. Some classes of common stock offer one vote per share, while others may offer one vote per 10 shares, for example.
- Do common stock owners receive stock certificates?
Yes. These may be paper or electronic certificates.
Steps to File
If your company is considering going public, your first step is to contact an investment bank which will help with determining both the type and price of the stock. However, before doing that, it's best to consult with a lawyer. UpCounsel matches its customers with the top 5 percent of lawyers in the field. UpCounsel's attorneys include prestigious law school graduates who have worked with companies like Google and Menlo Ventures, and who will advise you to ensure your company's success.