Companies which become incorporated become a legal entity, apart from the owners. Corporations are persons to a certain extent, apart from the personhood of the individual owners. One’s equity in a company becomes measured by the percentage of shares one owns or controls of this legal entity.
So companies issue a certain number of shares their shareholders, the business owners in the case of a privately held company. The distinction of private here means that the shares are not offered for sale on any stock market, and if one wished to buy into the company they would have to make a direct offer to the current owners, or shareholders.
Sometimes a company will offer a certain number of shares in exchange for private investment, but shares of private companies do not generally change hands very much at all.
Most of the time, these shares do not represent a source of fund raising, for instance a company issuing more shares to the market to raise funds, as is the case from time to time with some public companies. Instead, they are just assigned according to one’s ownership stake, and remain held by the owners over time.
Being private, private companies are pretty much limited to borrowing to raise capital, aside from taking on additional investors and giving them partial ownership in exchange for the funds invested. This is infrequent and generally only happens during a startup, as private companies generally manage things without inside investment once they are fully up and running.
While there are some very large and successful private companies, they tend to be family owned and controlled and for whatever reason have chosen to not have their shares traded on the open market, or raise the enormous amount of capital that this usually brings.
There is a price to be paid for that though, as you give up the percentage of control of the company that you issue as new shares, and in that sense the public issue of stock is selling off a portion of the business to the public.
Depending on how much is given up, a company can be subject to a takeover, or be subject to the wishes of the masses, if the owners do not retain enough stock to maintain a majority.
There are also some regulatory issues involved in a public offering, where if one’s company is private much more of the business can be kept private as well. To be approved to have one’s stock sold on exchanges though, regulators require much more transparency, and the company has to open up its books more.
This is sometimes felt as a restraining factor in the operation of one’s business, and may also be seen as disclosing too much information that may be used by one’s competitors perhaps. There are certainly some disadvantages to going public, but generally speaking, the majority of companies that qualify for listing on major stock exchanges do decide to take advantage of this.
While the principles of the company do give up control, they often get handsomely rewarded. Bill Gates for instance is famous for both being a founder of Microsoft, although these days he only owns a couple of percent of the company, having sold almost all of it off. Steve Ballmer is actually the company’s biggest shareholder these days. His 330 million shares only represent about 4% of the company, but 330 million times $72 a share is over 20 billion dollars.
Many people have started companies and have become very rich, and have cashed in their riches by selling a large portion or even the entire amount of equity they have in a company. If cashing in isn’t the biggest reason why companies go public, it’s certainly way up there.
Selling off a portion of a company isn’t really something you can do very easily as a private company, and this ranges from a difficult proposition to one that perhaps cannot be achieved at all in any sort of timely manner. The price you end up getting may be considerably less than fair value as well, due to the enormous lack of liquidity in these transactions.
There may be one or two suitors for such a deal or perhaps even none at all. Offering your shares on the stock market though brings in millions of suitors, and allow people to buy as little or as much of the company as one desires, subject to only the number of shares issued and the market.
While the company itself only gets the amount of the initial offer, the principals of the company usually retain a pretty large stake to be sold later at a higher price. So they may want to speculate on the stock in other words and very often this speculation leads to some big additional personal windfalls.
What the Company Gets for Their Stock
What a lot of people don’t realize is that when you buy a company’s stock, the company does not get any of your money. The person who sold you the shares does, net of trading costs.
Whenever a company’s stock is first issued, either during their initial public offering which kicks off their stock being placed on the open market, or future stock issues, this is where they get paid, net of the costs involved.
The stock is initially sold at a certain price and once these costs are deducted, this is their remittance, what they add to their capital. This is the only time they collect from the sale of their shares, and at that point they are sold and the market trades them.
Companies both issue new stock and buy back stock at various times though, so while they do not directly benefit from their shares trading higher, or get hurt directly from their trading lower, price movements in their stock certainly does affect their business in several meaningful ways.
The shareholders, who own the company, certainly care about the performance of the stock, because their personal net worth depends on it. This may be the only thing that shareholders care about actually.
Corporations are by nature profit focused, and this can be said to be even more the case with publicly traded corporations, as the power to make decisions tends to reside in the masses, instead of maybe a couple of people who may have competing personal goals.
This is good news for people who do own a company’s stock, their investors, because they are interested in capital accumulation over time, and everyone works together at the company to give yourself the best chance of making this happen.
Should the company wish to raise more money later, seeing their stock trade at a higher rather than lower price is certainly to their benefit. As far as stock buybacks go, this can be used strategically as well, as the conditions warrant, and it also tied in closely to where a company’s stock is trading, where they can capture value by selling it later at a higher price.
Other Company Benefits of Issuing Stock to the Public
There is a certain level of prestige involved in being a publicly traded company. This also places a company in the spotlight more often as their business activities become much more of a public interest if the public is financially involved in them, or potentially could be if they wished.
Public stock issues of course raise a lot of capital for companies, and although this is added to the books as paid up equity, and does not in itself add to its value, this very large influx of capital can be used to further grow the business significantly.
This is one of the biggest reasons why the stock of companies tends to often go up a lot in the years following the initial stock issue, as this future growth potential does not tend to be priced into the stock price, but the market does price it in over time as this comes to pass.
Expansion often breeds further expansion as the increased profits that it can generate gets re-invested, which increases the profit potential. Companies can of course borrow money for this, and they often do, but equity capital does not require interest payments to be made like debt does, and the ability to service debt is a limiting factor in a company’s growth.
Money raised through offering equity does not have to get paid back though, it results from a sale of part of the company and a portion of this could be bought back on the open market if desired, but it never has to be.
Having a company’s shares trade on the market also allows its stock price to increase simply due to the greater amount of money in the stock market. A certain percentage of income will tend to be invested in the stock market, and as income rises, the amount of equity held by the public goes up. This can raise all or almost all boats so to speak, as this has an expansionary effect upon both the stock market and stocks in the market.
This phenomenon effects both the value of the shares held by the principals of the company as well as providing further income from future stock issues.
A publicly held company also has the ability to offer stock as compensation, which helps a company attract better talent. As the share price increases, this compensation ends up growing in value along with the company. This is of course tied into performance, serving to further inspire business results.
With so many benefits, it is no wonder why so many companies offer their shares for sale on the market. Investors also may benefit, by sharing in the success of a company that does well over time.