Key Takeaways

  • Shares represent units of ownership in a company and provide varying levels of rights and responsibilities depending on the type and number of shares held.
  • Common and preferred shares differ in voting rights, dividend payments, and risk exposure, with bonds ranking above both in liquidation priority.
  • Shareholding gives investors potential profits through dividends and capital gains, but also exposes them to risks if company performance declines.
  • Shares originated historically as a way to finance large projects and continue to be traded on stock markets globally.
  • Shareholders may benefit from rights such as voting, dividends, and access to company reports, but they do not manage daily operations directly.

How Does Shareholding Work

How does shareholding work is a common question for anyone wanting to purchase shares in a company. Specifically, a shareholder, also known as a stockholder, is an individual, business, or institution that owns some portion of a company’s stock.

Taken together, the shareholders are also referred to as the owners of the company. However, this doesn’t mean that the shareholders have overall management decisions over the company’s operations. Rather, the shareholders will have certain voting rights, particularly with voting for board members and other officers of the company who will then oversee the daily operations. The more shares someone owns, the more voting rights one has. Unlike the owners of a general partnership or sole proprietorship, the corporation’s shareholders are not personally liable for the outstanding debts and obligations of the business.

The shareholder’s primary goal is to increase their stock earnings, thus bringing in more money for themselves and the company as a whole. If the company does well financially, so too will the shareholders. If the company does poorly, however, the shareholders will lose money as the stock will go down in price.

History and Purpose of Shares

Shares emerged historically as a means for businesses to raise large amounts of capital without relying on a single investor. In the 17th century, companies like the Dutch East India Company pioneered the issuance of shares, allowing multiple investors to contribute funds and share in the profits and risks of trading voyages. This concept of dividing ownership into smaller, tradable units remains the foundation of how shares work in a company today.

Shares serve two primary purposes:

  • For companies: They provide a way to raise capital for expansion, research, or operations without taking on debt.
  • For investors: They offer the chance to share in a company’s growth through dividends and stock price increases, while also spreading financial risks.

Types of Shareholders

Most businesses issues two types of stock as follows:

  • Common
  • Preferred

Generally, shareholders are common stockholders since such stock costs less. Furthermore, common stock is more popular, thus there is a lot more opportunity to be able to purchase common stock as opposed to preferred stock. With that said, common stock has greater volatility, meaning it is more likely to generate a profit than preferred stock.

Shareholders take a risk in purchasing stock since any decrease in stock means money lost for the shareholder, especially if they sell the stock for less than what they purchased it for. Furthermore, if the company becomes insolvent, they might not stand to gain anything with the shares that were previously purchased.

With regard to preferred stocks, they usually have less price fluctuation; such shareholders also have no voting rights due to the preferred status. Essentially, preferred stockholders receive fixed dividends that are in larger amounts than ordinary common stock dividends. These dividends are paid out before the dividends given to common shareholders. Therefore, if there is nothing left after giving out dividends to the preferred shareholders, then the common shareholder might receive little to nothing.

Therefore, while the preferring shares offer no voting rights, the money that one can earn in terms of dividend payment is usually greater. Such preferred stock is good for those wanting to generate a substantial annual income from investments.

How Shares Are Bought and Traded

Shares can be purchased directly from the company during an initial public offering (IPO) or later on secondary markets such as stock exchanges. In modern practice, most investors acquire shares through brokerage accounts, where trades are executed electronically within seconds.

Trading shares on stock exchanges increases liquidity—meaning investors can easily buy or sell their holdings. The price of shares fluctuates daily based on supply and demand, market conditions, and company performance. While short-term investors may speculate on price changes, long-term shareholders often prioritize dividends and sustained growth.

Levels of Ownership Rights

There are varying levels of ownership rights. As previously noted, shareholders have proportionate ownership rights with regard to the number of shares they own. All businesses operate with this type of hierarchy; as such, there are 3 classes of securities that companies issue, including:

While common and preferred stock are the two main classes of stock issued by corporations, bonds are another type of security that one can use to earn investment income.

The priority for each type of security is unique, and it is important for shareholders to understand their rights for each type of security they own in a corporation.

When it comes to the level of ownership rights, the common stock is at the bottom. As mentioned above, common stockholders are paid dividends after the preferred shareholders. Therefore, even though the common stockholders have voting rights, the preferred shares have greater priority. But when it comes to comparing the preferred stock with bonds, the bonds take priority. As such, if a corporation goes bankrupt, below is the level of priority given for each category:

  • Creditors
  • Bondholders
  • Preferred shareholders
  • Common shareholders

Therefore, when determining what type of ownership you want to have in a corporation, you should consider your options regarding your rights and priorities for each type of security. Some other rights include the fact that a bondholder will have an actual written agreement between him and the corporation. Therefore, the bondholder should thoroughly read the contract to fully understand his rights and responsibilities. The payment terms for bondholders are identified in the actual indenture, which is part of the contract.

Key Benefits and Risks of Shareholding

Owning shares in a company can be rewarding, but it also involves inherent risks:

Benefits:

  • Potential income through dividends.
  • Capital gains if the share price rises.
  • Voting rights and influence in company decisions (for common shareholders).
  • Limited liability, meaning personal assets are not at risk for company debts.

Risks:

  • Share values can fall if the company performs poorly.
  • Common shareholders receive the lowest priority in liquidation after creditors, bondholders, and preferred shareholders.
  • Dividends are not guaranteed and may be reduced or suspended during downturns.

These advantages and disadvantages highlight why investors should assess their risk tolerance and investment goals before purchasing shares.

Frequently Asked Questions

1. How does shares work in a company for new investors?

Shares represent ownership units. Buying shares gives investors potential profits through dividends and stock price increases, but also exposure to losses.

2. What is the difference between stocks and shares?

“Stock” generally refers to ownership in one or more companies, while “shares” are specific units of ownership in a single company.

3. Do all shareholders get voting rights?

No. Common shareholders typically receive voting rights, while preferred shareholders often do not, though they may have priority in dividends.

4. Can a company issue unlimited shares?

No. Companies authorize a maximum number of shares in their corporate charter, though they may later increase this limit with shareholder approval.

5. How risky is shareholding compared to bonds?

Shares carry higher risk because dividends and returns depend on company performance. Bonds are generally safer, as they guarantee repayment terms, but offer lower returns.

If you need help learning more about the rights and responsibilities of a shareholder, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.