Source of Fund

Every firm must raise money before it can invest. The long-term money it uses to buy fixed assets and finance permanent operations is called long-term capital, and it comes from three main sources: common stock, preferred stock and debt. Each source carries a different bundle of features, rights and risks, and the financial manager chooses among them to build a suitable capital structure. This chapter examines the concept and features of the three sources and weighs the advantages and disadvantages of each.

Common stock

Concept and features

Common stock, also called equity share or ordinary share, represents the basic ownership of a company. A person who buys common stock becomes a part owner of the firm and is called a shareholder. Common stockholders are the true owners because they bear the ultimate risk and enjoy the ultimate reward of the business.

Its main features are:

• Ownership and voting rights: each common share usually carries one vote, so common stockholders elect the board of directors and control the company.
• Residual claim on income: they receive dividends only after all other claimants, that is creditors and preferred stockholders, have been paid. Their dividend is not fixed and is declared out of profit at the board's discretion.
• Residual claim on assets: in liquidation they are paid last, after all debts and preferred capital are settled, so they stand last in the queue.
• Limited liability: a shareholder's loss is limited to the amount invested in the shares. Personal assets are not at risk.
• No maturity: common stock is permanent capital. The company is not obliged to return the money, and the shareholder recovers it only by selling the share to another investor.
• Pre-emptive right: existing shareholders often have the first right to buy new shares issued, so their proportion of ownership is protected.