A company will often issue equity stock to investors and owners in order to raise capital to expand and fund operations. There are several ways to raise capital, including debt and preferred shares; however, ordinary shares of common stock are most well-known by average investors. Ordinary shares, also known as common shares, have many benefits for both the investor and the issuing company.
Key Takeaways
- Three characteristic benefits are typically granted to owners of ordinary shares: voting rights, gains, and limited liability.
- Common stock, through capital gains and ordinary dividends, has proven to be a great source of returns for investors, on average and over time.
- Companies also benefit from issuing shares in that they do not incur debt obligations, although they do forfeit some of the ownership's stake.
Voting Rights
The first is voting rights.Common shareholders can participate in internal corporate governance through voting. Ordinary shares provide a small degree of ownership in the issuing company. Stockholders have a certain amount of say in how the company is run and are allowed to vote on important decisions, such as the appointment of a board of directors. For each share of common stock owned, the stockholder gets one vote, so the stockholder's opinion becomes weightier when they own more shares.
While this may be an important advantage for an individual or institutional investor who controls a large percentage of a company's stock, for the average retail investor, the main benefits of common shares are foundin their potential forcapital gains and dividends, which represent the two ways common shareholders profit from their ownership.
Capital Gains and Dividends
For individuals, investing in the stock market is a relatively straightforward way to generate income. While there are no guaranteed profits, almost anyone can open an online trading account to buy and sell shares of publicly traded stock.
In addition to its transactional simplicity, investment in ordinary shares has the potential for unlimited gains, while the potential loss is limited to the original amount invested.Selling shares at a higher price than the originalpurchase priceresults in the investorrealizing acapital gain. However, the opposite can also happen; shareholders may realize acapital lossif they sell shares for less than they paid for them.
When a company turns a profit, it often rewards its investors by paying a small portion of that profit to each shareholder according to the number of shares owned. While this dividend is not guaranteed, as with preferred stock, many companies pride themselves on consistently paying higher dividends each year, encouraging long-term investment.Shareholders may elect toreinvest dividendsor receive them as income.
Limited Liability
Other stockholders' rights includelimited liability, which means thatcommon shareholders are protected against the financial obligations of the corporation and are only liable for their shares' value. They also gainpreemptive rights. Shareholders with preemptive rights gain access to new share issues before the rest of the investing public, oftenat a discount.
Benefits for Issuing Companies
For businesses, issuing common shares is an important way to raise capital to fund expansion without incurring too much debt. While this dilutes the ownership of the company, unlike debt funding, shareholder investment need not be repaid at a later date.
Of course, shareholders do expect returns on their investments, either through stock growth or dividend payments. But the company always has the option to repurchase some or all of its outstanding shares if and when it no longer has need of equity capital, thereby consolidating ownershipand increasingthe value of shares still available by reducing the supply.
FAQs
They represent ownership in the company and give shareholders the right to vote on important decisions, such as the election of board members and major business decisions. Ordinary shares also entitle shareholders to receive dividends, which are a portion of the company's profits distributed to shareholders.
What are the advantages and disadvantages of ordinary shares by comparison to preference shares? ›
Do preference shares affect taxes? Are they also treated like ordinary shares?
| Preference Shares | Ordinary Shares |
|---|
| Dividend | Fixed rate of dividend | No fixed rate of dividend |
| Role in Management | No role in management | Has a role in management |
| Voting | No voting rights | Has voting rights |
| Bonus Shares | Not eligible | Eligible |
1 more rowKey Takeaways
- Ordinary shares of stock represent proportional ownership of a company.
- These shares come with voting rights equaling one vote per share.
- Owners of ordinary shares may or may not receive dividends based on a company's performance.
- Preferred shares come with guaranteed dividends at a set percentage.
What are the Advantages of Ordinary Shares
- Potential of Capital Appreciation. The ability of ordinary shares to increase in value is one of their main benefits. ...
- Dividend Income. ...
- Ownership & Voting Rights. ...
- Liquidity. ...
- Portfolio Diversification.
The infusion of capital access to expertise and enhanced reputation are among the notable benefits. However, the potential loss of control, dilution of ownership, shareholder expectations and disclosure requirements must weigh against these benefits.
What are the disadvantages of ordinary share capital? ›
The Disadvantages of Ordinary Shares are as follows:
- Ordinary shares are one of the riskiest types of investments because there can be no dividend payable during or at the end of the year.
- The shareholders will bear the operational risks of the organization.
The downside of ordinary shares
If the business is wound up then investors holding ordinary shares will be at the back of the queue when it comes to getting any of their money back. If there is no money left after all other creditors have been paid, then ordinary shareholders will receive nothing.
What are the rights of ordinary shares? ›
Ordinary shares are the most common type of shares. Owners of ordinary shares have the right to vote at meetings and receive dividends from the company's profits. Being able to vote at shareholder meetings means you will get a say in how the business is run and its future direction.
What is true about ordinary shares? ›
Ordinary shares generally have the same rights to capital, dividends and voting rights - but not always. Equal rights to capital, yes. But ordinary shares can be voting or non-voting, dividend or non-dividend bearing.
What are examples of ordinary shares? ›
Understanding Ordinary Shares
The number of ordinary shares an investor owns is proportional to the percentage of ownership he/she has in a company. For instance, if a company issues all of its 50 shares in the stock market and you own 30 out of them. You would have a 60% ownership of the company.
A dividend is a portion of a company's earnings that is paid to a shareholder. The most common type of dividend is a cash payout, but some companies will issue stock dividends. Dividends are typically issued quarterly but can also be disbursed monthly or annually.
What is the benefit of shares? ›
Benefits of Owning Shares
Potential for Capital Appreciation: Shareholders can benefit from an increase in the stock's price over time, resulting in capital gains. Dividend Income: Companies may pay out a part of their profits to shareholders in the form of dividends, providing a source of regular income.
Can ordinary shares have different values? ›
In some cases, different classes of ordinary share may be of different nominal values. For example, there may be £1 ordinary shares and £0.01 ordinary shares.
What are the advantages and disadvantages of being an ordinary and preference shareholder? ›
Preference shares are considered a unique security since they combine the advantages of both debt and equity capital. Preference owners are therefore entitled to dividend payments ahead of ordinary shareholders. One disadvantage is that they do not have the same voting rights as common shareholders.
Can I sell my shares to anyone? ›
Private limited companies which are registered with Companies House are able to sell, gift or transfer company shares to other individuals. A company share represents a proportion of the business which you own.
What are the advantages and disadvantages of issue of shares? ›
Advantages and disadvantages of issuing shares in your company
- new finance.
- an exit for founding investors who want to realise their investment.
- a mechanism for investors to trade shares.
- a market valuation for the company.
- an incentive for staff using shares or share options.
- an acquisition currency in the form of shares.
Pros and Cons of Preferred Stock
| Pros | Cons |
|---|
| Regular dividends | Few or no voting rights |
| Low capital loss risk | Low capital gain potential |
| Right to dividends before common stockholders | Right to dividends only if funds remain after interest paid to bondholders |
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Benefits Of Preference Shares
- Dividends Are Paid First To Preference Shareholders. ...
- Preference Shareholders Have A Prior Claim On Business Assets. ...
- Add-on Benefits For Investors. ...
- There Are No Voting Rights For Preference Investors. ...
- Higher Cost Than Debt For Issuing Company.
Preference shareholders are paid a fixed percentage of yearly dividends, which is decided during the signing of the share certificates, while ordinary shareholders are compensated varying amounts of dividends each year.
What are the advantages and disadvantages of common stock and preferred stock? ›
Is Preferred or Common Stock a Better Investment? Each type has pros and cons. Common stock tends to offer higher potential returns, but more volatility. Preferred stock may be less volatile but have a lower potential for returns.
