Securities: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
Securities are a financial instrument that gives people a form of company ownership. There are several types of securities including stocks, bonds, and options.5 min read
Securities: What Are They?
Securities are a financial instrument that gives people a form of company ownership. There are several types of securities, including stocks, bonds, and options. The issuer of the security is usually a company trying to raise revenue. The issuer can also be a state or local government as well. Due to state laws, the definition of a security can sometimes differ.
Securities are classified as either debt, equity, or derivatives.
Debt securities are like loans provided by investors. Examples of debt securities include government and corporate bonds or certificates of deposits. Rating companies such as Standard & Poor’s, Moody’s and Fitch’s evaluate how likely the bond will be repaid with rating such as AAA, BBB, or junk bonds). Corporate bonds are loans to a company, sovereign debt are bonds to a country, and treasury bonds are bonds issued by the U.S. government.
Equities are actual ownership interests of a company. Stocks traded on the stock market such as the New York Stock Exchange or NASDAQ are the most common example of an equity security.
Derivatives are contracts, and their value comes from the assets they represent. For example, you can purchase an option to buy a stock at a certain price without actually buying the stock upfront. Other examples of derivatives are: call options, put options, futures contracts, mortgage-backed securities, asset-backed commercial paper, collateralized debt obligations (CDOs), or auction-rate securities.
Securities do not include financial items that are backed by other assets. Home mortgages are not securities. Debts that are secured by an account receivable are also not considered securities.
Securities are heavily regulated in the United States by the Securities Exchange Commission (SEC). The SEC operates under a series of federal laws that have roots in the Securities Act of 1933. State laws, known as Blue Sky Laws, also regulate the securities industry in that state.
Investors trade securities in both the primary and secondary markets. The primary market is where the company or government offers their securities for sale for the first time. The secondary market, like the New York Stock Exchange, sells securities among a variety of secondary investors.
The issuing company typically receives money for securities in the primary market during an initial public offering (IPO). After the IPO, any newly issued stock while still sold in the primary market is also called the secondary offering. Securities may also be offered privately to a restricted and qualified group though a private placement.
In secondary markets, securities are transferred as assets between investors which could mean selling securities for cash or other profits. Private securities may also be traded among qualified investors, but is less liquid for privately placed securities.
Classes of Securities
Certified securities: securities in physical, paper form or held in a direct registration system using a transfer agent which holds the shares in book-entry form without physical certificates. The Depository Trust Company (DTC) is a universal depository allowing issuers to deposit a single global certificate representing all outstanding securities in an electronic format. Certified and uncertified securities do not differ in the rights or privileges of the shareholder or issuer.
Bearer securities: fixed income security where no ownership information is recorded and the security is issued in physical form to the new owner who is entitled to the coupon payments. The coupons are submitted by clipping the coupons attached to the bond and submitted for payments. These have not been legal in the U.S. municipal or corporate markets since 1982 and are typically only available in the secondary market.
Registered securities: have the name of the holder, issuer, and necessary details. Transfer between holders occurs through changes to the register.
Why Are Securities Important?
Securities are important because they provide companies a chance to raise capital. Many startups want to avoid taking out business loans, and they turn to securities for this possibility. Debt and equity securities are popular because of the benefits they provide.
Investors are attracted to debt securities because they provide a stream of payments at a specified interest rate payable at a certain date, regardless of how a company is doing and, further, may be secured by company assets to protect against a default. However, your upside is limited by not sharing in the company’s value appreciation. Equity securities are also appealing because investors share in the upside of the company, receive distribution of profits, get voting rights on important business matter, and the chance to see large profits if the stocks, bonds, or other assets do well. On the other hand, if the company goes under, equity securities share in the proceeds of any asset sale after the debt securities are paid off.
Securities are easy to trade, which makes the economy as a whole more efficient. It also makes determining which businesses are doing well easier. For example, you can tell a business may be in financial trouble if the value of its stock is going down.
Reasons to Consider Not Using Securities
Companies can go in debt if unable to make interest payments.
Having too much debt can scare away potential investors.
Shareholders will have some form of control over the company.
You may be more worried about making shareholders happy in the short term instead of considering the company's long-term success.
Reasons to Consider Using Securities
Ownership isn't diluted like it is when issuing shares.
Investor has no right to the company's profits.
You avoid taking on any debt.
Paying dividends is not required.
Frequently Asked Questions
- Is there anything between debt and equity securities?
Hybrid securities have qualities of both equity and debt securities. Examples of hybrid securities including equity warrants (which are contracts with the company to issue additional stock upon payment of an agreed-upon price), convertible debt (which is a bond that converts into equity upon the happening of a certain event, typically an equity financing), and preference shares (which provides a preference of payment over other equity holders).
- Do I have to file anything?
Securities usually have to be registered with the Securities and Exchange Commission (SEC). You may qualify for an exemption to this rule.
- Are securities negotiable?
This feature depends upon the security in question. Some are negotiable.
- Do securities have to be public?
Many securities are offered to the public, but others can be traded privately if regulations are followed.
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