How Does Shareholding Work: Everything You Need to Know
How does shareholding work is a common question for anyone wanting to purchase shares in a company. 3 min read
2. Types of Shareholders
3. Levels of Ownership Rights
How Does Shareholding Work
How does shareholding work is a common question for anyone wanting to purchase shares in a company. Specifically, a shareholder, also known as a stockholder, is an individual, business, or institution that owns some portion of a company’s stock.
Taken together, the shareholders are also referred to as the owners of the company. However, this doesn’t mean that the shareholders have overall management decisions over the company’s operations. Rather, the shareholders will have certain voting rights, particularly with voting for board members and other officers of the company who will then oversee the daily operations. The more shares someone owns, the more voting rights one has. Unlike the owners of a general partnership or sole proprietorship, the corporation’s shareholders are not personally liable for the outstanding debts and obligations of the business.
The shareholder’s primary goal is to increase their stock earnings, thus bringing in more money for themselves and the company as a whole. If the company does well financially, so too will the shareholders. If the company does poorly, however, the shareholders will lose money as the stock will go down in price.
Types of Shareholders
Most businesses issues two types of stock as follows:
Generally, shareholders are common stockholders since such stock costs less. Furthermore, common stock is more popular, thus there is a lot more opportunity to be able to purchase common stock as opposed to preferred stock. With that said, common stock has greater volatility, meaning it is more likely to generate a profit than preferred stock.
Shareholders take a risk in purchasing stock since any decrease in stock means money lost for the shareholder, especially if they sell the stock for less than what they purchased it for. Furthermore, if the company becomes insolvent, they might not stand to gain anything with the shares that were previously purchased.
With regard to preferred stocks, they usually have less price fluctuation; such shareholders also have no voting rights due to the preferred status. Essentially, preferred stockholders receive fixed dividends that are in larger amounts than ordinary common stock dividends. These dividends are paid out before the dividends given to common shareholders. Therefore, if there is nothing left after giving out dividends to the preferred shareholders, then the common shareholder might receive little to nothing.
Therefore, while the preferring shares offer no voting rights, the money that one can earn in terms of dividend payment is usually greater. Such preferred stock is good for those wanting to generate a substantial annual income from investments.
Levels of Ownership Rights
There are varying levels of ownership rights. As previously noted, shareholders have proportionate ownership rights with regard to the number of shares they own. All businesses operate with this type of hierarchy; as such, there are 3 classes of securities that companies issue, including:
- Preferred stock
- Common stock
While common and preferred stock are the two main classes of stock issued by corporations, bonds are another type of security that one can use to earn investment income.
The priority for each type of security is unique, and it is important for shareholders to understand their rights for each type of security they own in a corporation.
When it comes to the level of ownership rights, the common stock is at the bottom. As mentioned above, common stockholders are paid dividends after the preferred shareholders. Therefore, even though the common stockholders have voting rights, the preferred shares have greater priority. But when it comes to comparing the preferred stock with bonds, the bonds take priority. As such, if a corporation goes bankrupt, below is the level of priority given for each category:
- Preferred shareholders
- Common shareholders
Therefore, when determining what type of ownership you want to have in a corporation, you should consider your options regarding your rights and priorities for each type of security. Some other rights include the fact that a bondholder will have an actual written agreement between him and the corporation. Therefore, the bondholder should thoroughly read the contract to fully understand his rights and responsibilities. The payment terms for bondholders are identified in the actual indenture, which is part of the contract.
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