As a potential investor, you may wonder, "What is a Share?" - Let us explain. A share represents part ownership of a company or financial asset. Investors buy shares in a business or fund and are then known as shareholders.
Shares represent equity in a company and the terms stocks, shares, and equity are often used interchangeably. Most companies have shares, but only the shares of publicly traded companies list on stock exchanges.
If the company declares profits, management may opt to distribute a portion of these profits to shareholders in the form of dividends. In addition to dividends, investors may receive capital gains if the company's value increases.
Shares are usually issued as common or preferred shares, each of which has slightly different advantages.
Common shares (also known as ordinary shares) come with voting rights but are last in line to receive a payout in the event of liquidation.
Preferred shareholders receive a specified dividend and shareholder priority but are not usually entitled to voting rights or the opportunity to capitalize on a soaring share price.
How a Share Works
In return for capital investment, owners of a corporation may choose to issue preferred shares to key investors or staff, while also issuing equity to external investors privately or via the public markets. This investment is then used to grow and operate the firm.
Unlike finance obtained through a loan or bond issue, equity has no legal requirement to be paid back to investors.
Almost every company, from small partnerships to LLCs and multinational corporations, issues some form of shares.
Shares of privately-held companies are initially owned by the owners or founders, although as they grow, they may choose to sell shares to outside investors in the primary market. This is often to friends and family but may also extend to angel or venture investors.
As the company continues to grow, it may want to seek further equity capital by selling shares to the public. This would take place on a secondary market such as the New York Stock Exchange (NYSE). An Initial Public Offering (IPO) is the most common route to taking a company public. Alternative routes include an RTO (reverse takeover), a direct listing, or a qualifying transaction through an acquisition corporation program, such as G-Corp or SPAC.
If the company goes the IPO route, it would become a publicly-traded company and be listed on a stock exchange. Historically, shareholders were issued with a physical paper stock certificate. Today these have been replaced with an electronic record of shares.
The Securities Exchange Commission (SEC) oversees the issue and distribution of shares in public and private markets. Trading on the secondary market is governed by the SEC and FINRA.
Types of Shares
As we previously mentioned, the two main types of shares are common and preferred. Typically, the majority of companies issue common shares. These shares provide shareholders with a residual claim on the company and its profits.
Common shares provide potential dividend and capital gains returns for investors. They also come with voting rights, giving shareholders more control over the business in areas such as electing members of the board of directors or approving the issue of new securities or dividends.
Certain common shares also include pre-emptive rights, meaning they give shareholders the right to buy new shares and retain their percentage of ownership when the company issues new stock.
In comparison, preferred shares do not generally offer much market appreciation in value or voting rights in the company. However, these types of shares generally have set payment criteria and a dividend that is paid out regularly. For this reason, many investors consider preferred shares to have lower risk exposure than common shares.
Another factor that makes preferred shares less risky is that in the case of bankruptcy, the company would be obligated to pay its preferred shareholders before common shareholders.
Advantages of Shares
There are many advantages of investing in shares, including:
Depending on the number of shares you hold, you will partly own the company you have bought shares in. Over time, if you increase your investment, the greater that percentage will become and the better return you could receive.
Reinvest Dividends or Take Income
Investors may receive regular dividend payments if they own common or preferred shares in a company. These payments can be taken either as income, or investors can opt to reinvest to buy more shares.
Disadvantages of Shares
The disadvantages of investing in shares include:
The value of shares go up and down. Share price can be influenced by internal company news or external events. General market sentiment can also influence share price volatility.
When investing in shares, investors can stick to one company, product type or industry, but that can lead to investments becoming too concentrated. Investors should diversify their portfolios to help protect against volatile markets.
You May Lose Money
As with all investments, there is a chance or a risk that you could lose some or all of your investment. If the company underperforms or the market experiences volatility, the value of your shares could decrease and may take a while to recover.
To raise funds a business may opt to issue new shares. This dilutes the existing share count, potentially reducing the share price value.
Last updated: 22 Jun 2022