Financing the Corporation
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The corporate lawyers at Adams Law Group can assist you in determining the best method of financing your corporation.
Equity vs. debt financing
Generally, a corporation receives capital in exchange for equity securities or debt securities or a combination of the two. Equity securities are also known as stock. Debt securities are commonly known as bonds. Although they are formally divided into bonds and debentures, the word "bond" is often used to refer to both.
A bond evidences a loan to the company, rather than a share of the company's equity. The money or other consideration received in exchange for a bond becomes both an asset and a liability to the company. In contrast, the consideration received for stock becomes an asset of the company without becoming a liability; it adds to the company's equity (the difference between assets and liabilities).
Holders of stock have two key rights: voting rights and residual rights. Voting rights enable stockholders to elect the board of directors and approve or reject certain fundamental transactions. Residual rights allow the stockholders to share the company's profits, as well as recover some of the company's assets in the event that it folds, although they generally have the lowest priority in recovering their investment.
Types of stock
Common and preferred stock
By default, stock in a corporation is common stock. Common stock is generally accompanied by a voting right and residual right proportional to the number of shares held in the corporation. If a corporation only offers common stock, an owner of 25 percent of the common stock would control 25 percent of shareholder votes, receive 25 percent of any dividend payout and be entitled to 25 percent of any post-liquidation assets after creditors are paid in full.
Stock can also be designated as preferred stock, which gives it a higher level of residual rights. Generally, common stockholders cannot be paid until preferred stockholders are paid. Preferred stock often, but not always, comes with restricted voting rights, or sometimes with no voting rights at all. It is commonly used by investors such as venture capitalists who wish to invest in new companies but also seek to minimize risk.
Preferred stock can be designated as convertible, meaning that it can be converted into common stock at a certain time or times (e.g. at the holder's option). This gives the preferred stockholder the ability to exercise more control over the business later in exchange for giving up their dividend and liquidation preference. Common stock can also be convertible into preferred stock, although such cases are rare.
Classes of stock
The articles of incorporation may also designate various classes (or series) of stock. Generally, this is done to apportion voting rights and liquidation preferences between various types of investor. For instance, in a small company, founders may have Class A common stock, one group of investors may have Class B preferred stock, and another group may have Class C preferred stock. Class A stock may be allotted a certain number of seats on the board so that the founders always have the power to remain on the board. Class B and Class C stock can be given separate allotments of board seats as the shareholders agree, and can be given different levels of liquidation and dividend preference as the shareholders agree.
A distribution is a transfer of the corporation's wealth to its shareholders. There are two types of distribution: dividends and stock repurchases. From the corporation's standpoint, the two transactions are very similar: they both involve a payment from corporate funds to the shareholders.