Private and Public Companies
A business that is a corporation is a legal entity separate from its owners. The corporation is owned by shareholders that have limited personal responsibility for the debt of the company while sharing in its profits (and losses). Corporations may raise funds to finance their operations or new investments by raising capital through the sale of stock.
Those who buy the stock in a corporation become the owners, or shareholders, of the corporation. Stock represents equity, or ownership, in a firm. A person who owns 100 percent of a company’s stock, by definition, owns the entire company. The stock of a company is divided into shares. Corporate giants like IBM, Ford, Microsoft, and Exxon all have millions of shares of stock. In most large and well-known firms, no individual owns a majority of the shares of the stock. Instead, large numbers of shareholders—even those who hold thousands of shares—each have only a small slice of the overall ownership of the firm. However, it’s possible for a business to have very few shareholders as well.
stock as financial capital
A corporation receives money from the sale of its stock only when the company sells its own stock. However, when a shareholder sells stock, the shareholder receives money, not the corporation.
Privately Held Corporations
A private corporation is owned by the people who run it on a day-to-day basis. A private company can be run by a single individual or it can be run by a group. A private corporation’s stock is transferred privately and is not for sale on a public stock exchange (i.e. a marketplace where anyone may purchase stock). Most private companies are relatively small, but there are some large private corporations, with tens of billions of dollars in annual sales, that do not have publicly issued stock, such as farm-products dealer Cargill and the Mars candy company (the makers of M&M candies).
A private corporation may issue stock to employees as part of their compensation plan or incentive program. But this does not bring financial capital into the company. The private corporation would have to sell equity to someone who would become a part owner in the company in order to raise money to invest into the business operations.
Public Corporations
When a corporation decides to sell stock which in turn can be bought and sold by financial investors on a stock exchange, it becomes a public company. A corporation’s first sale of stock to the public is called an initial public offering (IPO).
The IPO is important for two reasons. First, the stock sold during the IPO provides the funds to repay the early-stage investors, like the angel investors and the venture capital firms. A venture capital firm may have a 40 percent ownership in the firm. When the firm sells stock, the venture capital firm can sells its ownership of the firm to the public. The early-stage investors’ hope is that the price of shares in the IPO will return back to them far more than they invested, making the risk of the investment worthwhile. A second reason for the importance of the IPO is that it provides the established company with financial capital for a substantial expansion of its operations.
Most of the time when corporate stock is bought and sold, however, the firm receives no financial return at all. If you buy shares of stock in Apple, you almost certainly buy them from the current owner of those shares, and Apple does not receive any of your money. This pattern should not seem particularly odd. After all, if you buy a house, the current owner gets your money, not the original builder of the house. Similarly, when you buy shares of stock, you are buying a small slice of ownership of the firm from the existing owner, and the firm that originally issued the stock is not a part of this transaction.
When a firm decides to go through with becoming a public company, it must recognize that investors will expect to receive a return on their investment. That return can come in two forms. A firm can make a direct payment to its shareholders, called a dividend. Investors also hope that the value of the stock will grow in the future. You might buy a share of stock in Amazon for $10 and then later sell that share of stock to someone else for $120, for a gain of $20. The increase in the value of the stock (or of any asset) between when it is bought and when it is sold is called a capital gain.
Shareholders own a public company. Since the shareholders are a very broad group, often consisting of thousands or even millions of investors, the shareholders vote for a board of directors, who in turn hire top executives to run the firm on a day-to-day basis. The more shares of stock a shareholder owns, the more votes that shareholder is entitled to cast for the company’s board of directors. In theory, the board of directors helps to ensure that the firm is run in the interests of the shareholders. However, the top executives who run the firm have a strong voice in choosing the candidates who will be on their board of directors. After all, few shareholders are knowledgeable enough or have enough of a personal incentive to spend energy and money nominating alternative members of the board.
What about the stock market?
You may be thinking, “Finally! You’re talking about stocks. Now I’m going to learn how to make money!” It’s not so simple. Plus, you have to be very careful about who is giving out financial advice. (Hint: No financial advice here!)
Watch Out for Investment Scams!
You can view the transcript for “Eight Financial Influencers Indicted in Massive Pump and Dump Scheme” here (opens in new window).
You can view the transcript for “Instagram users targeted for get-rich-quick investment scams” here (opens in new window).