My (possibly incorrect/incomplete) understanding is that if a pre-IPO company needs $1000, they can issue 100 shares for $10 each. If people outside the company actually buy all 100 shares at that price (which I think almost always happens), then the company gets the needed $1000. Thereafter, if the stock price becomes $15 or $2, how does it matter to the company? They’ve already received the $1000 they needed, right? Any subsequent trading isn’t actually generating money to run the company, right?
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The replies above/below are missing a few parts to the story, and surely mine will too, but this might offer some extra insight. The following applies to UK shares, and US/EU shares have broadly similar forms. All numbers are illustrative and don’t reflect realistic values.
First off, we need to understand what a share is. At a surface level, it is ownership of a fraction of a company. But what does “ownership” mean? And how is a fraction of it useful?
“Ownership” is generally viewed in 2 ways:
1. Financial benefit (and financial liability)
2. Control over the company (and criminal/civil liability)
We need to understand the ways in which investors (i.e. owners of a company) can make money from the company and how they might exert control over the company.
Financial:
* stock can (usually but not always) be bought/sold at the stock price between different “people”
* “people” generally means any legal person, which includes individuals, companies, governments, etc.
* a company that has generated an overall lifetime profit has the right, each year, to issue “a dividend”. This is an amount of that year’s profit to be paid out to shareholders.
* So if a company makes a £100m profit in a year, and allocates 10% of that as a dividend, it allocates a £10m dividend. If you own 5% of the shares, you *might* get 5% of the dividend – £500k in this example. We’ll see in a moment why owning 5% of the shares might not mean 5% of the overall dividend – there are different “kinds” of shares.
* a company could “exit” – IPO or another company buying all of the issued shares to “take over” that company (merger/acquisition known as M&A). This is similar to buying/selling stock, but the value received for your shares might not be their market value.
* For example, Elon Musk recently offered shareholders a buyout share price higher than the market share price.
* And, again, different kinds of shares might entitle you to different value. Additionally, an IPO is a major transition moment that can trigger payouts to (typically earlier) investors.
* a company could “go under” (collapse, liquidate, etc) – in this case, the “assets” of the company are sold off, creditors (people the company owes money) are paid, and there might be some assets (money, unsold property, machines, etc) left over.
* Shareholders may be liable for the company, which can expose them to the cost of paying back creditors.
* Also, companies which collapse usually have assets left over (even if they went bankrupt). In this case, certain kinds of shares may have rights to be paid the value of those assets before other shareholders.
* Suppose two investors put £10m and £15m into a company each, owning 40% and 60% of the shares respectively. The company collapses and has £5m left over. With equal kinds of shares, the investors would receive their 40% and 60% of that £5m respectively.
* But suppose the first investor put money in 2 years before the second? They took a much bigger risk so were given what’s known as a “preferred share”, entitling them to be paid out first in a liquidation event. As a result, they receive 80% of the £5m (i.e. they get £4m) and the second investor receives the remaining £1m.
Control:
* voting at shareholder’s meetings (not the same as board meetings!)
* Usually at minimum there is an Annual General Meeting (AGM), where the Board of Directors (“the board”: CEO, CFO, COO, CTO, etc) report on the company’s performance (usually from a financial perspective) and then set out motions for changes to the company’s Articles of Association, Board Directives, Company Goals/Strategy documents and other such governance documents. Shareholders get to vote on them to influence how the company will be managed – they are effectively instructions, guidelines and rules for how the board has to manage the company.
* board assignments
* Shareholders can (usually) vote members onto and off of the board.
* Boards are made up of
* “executives”: members of the board that are also employed within the company, usually CEO, CTO, CFO, etc – generally responsible for the day to day running of the company and the interface between the board and the company’s senior management. Usually also end up being the interpreters translating board motions into actual actions.
* “non-executives”: members of the board that are no employed within the company but who may vote on motions. Usually these people have experience or expertise relevant to the business and attend regular board meetings to oversee how the company is run.
* “observers”: not board members but people with privilege to observe board meetings (or just receive copies of the minutes of each meeting).
* “advisors”: not board members but people who advise the board on specialist areas or in general.
* N.B. all board *members* are liable for failings of the company joint and severally. I.e. each is wholly and individually liable for any failing, and every board member may be pursued for any single failing. It is a position with a huge amount of responsibility. Being a board member is not something people usually take lightly as a result. Criminal prosecutions do happen and can result in board members receiving jail time for actions taken by employees of the company. The board is usually ultimately responsible for anything and everything “the company” does, no matter how small.
* Although conventionally C-level roles are board members (CEO, CFO, etc) not all will be and it’s not unheard of for a CEO to not be a member of the board. I’m sure someone will have a nice flame war over this idea.
* board compensation
* Shareholders usually get to vote on whether board members are paid for their time or not, and if so, how much they get paid.
* share issues
* Shareholders vote on whether new shares should be issued.
* Other situations such as a company buying back its own stock (e.g. from a public market) to reconsolidate or reduce liquidity of its own shares (lots of reasons why this might happen)
* dividends
* Shareholders may sometimes vote on dividend-related issues
* legal responsibility
* Shareholders have a liability to the company equal to the value of their shares, along with any other clauses attached to their class of shares. This is usually less relevant for publicly traded companies.
That’s an intro to the investor’s view of things.
So ownership is made up mainly of these two parts. A percentage ownership (simplistically speaking) entitles you to a %age of the financial value of the company (inc. dividends) and a portion of the votes at a shareholder’s vote. Through these two things, the investors receive their rewards and exert control over the company. So naturally boards, CEOs etc worry about the share price because upsetting investors might result in them losing their jobs.
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