Common stock represents a fractional share in the ownership of a company. If you own 100 percent of a corporation, you own 100 percent of the common stock in that corporation. If you need to raise money to expand your company, you can take out a bank loan, but that means you will have monthly loan payments, and bank loans are normally not large enough for any significant corporate expansion activities. Your other choice is to find investors who will give you money in return for part ownership in your company. They receive shares of common stock in return for their investment.
Your company is worth $1 million and you need an additional $1 million to fund your expansion. Investor "A" pays $500,000 and investors "B" and "C" each pay $250,000 for a total investment of $1 million. You have just privately sold 50 percent of your company because, with the investment, your company is now worth $2 million. Investor "A" owns 25 percent and investors "B" and "C" each own 12.5 percent.
Authorized vs. Outstanding Stock
When you created your corporation you authorized 10 million shares of stock and issued yourself 1 million shares, and each was worth $1.00 because your company was worth $1 million. When you decided to seek investment, you issued 1 million more shares and priced them at $1.00 each. This meant your company had 2 million shares outstanding plus another 8 million shares that had been authorized but not issued. Only issued shares count as ownership.
Publicly Trading Stock
Your company grows as a result of the private investment of $1 million and the company is now worth $10 million, which means each of the outstanding 2 million shares has a $5.00 value. You hire an investment banker and make an Initial Public Offering of common stock to obtain more money to expand your company. You issue 2 million more shares, leaving 6 million still authorized, and sell them at the current stock value of $5.00 per share. This brings $10 million new capital into your company, but it also dilutes the ownership percentage of you and your original investors. You still own 1 million shares, which is now 25 percent of the company. Investor "A" still owns 500,000 shares or 12.5 percent and investors "B" and "C" each still own 250,000 shares or 6.25 percent, and the public owns 50 percent of the company. Now that the stock is trading on the stock market, the share price rises to $10 per share and investor "C" decides to sell all 250,000 shares for $2.5 million. This is a profit of $2.25 million because investor "C" originally paid $250,000 for those shares. After investor "C" sold his shares into the market, the public now owns 56.25 percent of the company.
Voting vs. Non-Voting
If you didn't want to lose decision-making control of the company when you offered your IPO, you could have sold non-voting stock. In that case, investor "C" and the other original private investors, including yourself, would not own publicly trading stock, but your stock would allow you to vote for board members and key initiatives presented to the voting shareholders. Only the public investors would be able to trade their stock on the public market, but they could not vote on company matters. If investor "C" wanted to take his profits, he would either sell his voting stock back to the company or to another private investor.
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