Capital stock: Overview, definition, and example
What is capital stock?
Capital stock refers to the total amount of stock a company is authorized to issue, representing ownership in the company. It is the equity ownership divided into shares and is a key component of a company’s capital structure. The capital stock is divided into two main types:
- Common stock: Represents ownership in the company and gives shareholders the right to vote on corporate matters, such as electing the board of directors, and to share in the company’s profits through dividends.
- Preferred stock: Represents ownership but typically does not provide voting rights. Preferred stockholders have a higher claim on assets and earnings, such as receiving dividends before common stockholders.
The capital stock of a company can be issued in various amounts, depending on the company's charter and the approval of its board of directors. It is typically set forth in the company’s articles of incorporation or other founding documents and is used to raise capital for business operations and growth.
Why is capital stock important?
Capital stock is important because it represents the primary means by which a company raises funds and provides ownership interests to shareholders. It is a foundational element in a company’s financial structure and is critical for:
- Raising capital: Issuing capital stock allows a company to raise funds by selling shares to investors, which can be used for business expansion, product development, or operational needs.
- Ownership and control: The ownership rights associated with capital stock determine how control is exercised within the company. Shareholders with larger amounts of capital stock typically have greater influence over the company’s decision-making.
- Valuation: The total number of shares issued and the price at which they are sold help to determine the company’s market value or market capitalization. Investors look at capital stock to gauge the company’s financial standing.
Understanding capital stock through an example
Imagine a technology startup that needs to raise $1 million to fund research and development for its new product. The company decides to issue 100,000 shares of common stock at a price of $10 per share. In doing so, the company raises the necessary capital and gives shareholders a stake in the company, with the potential for dividends and voting rights in the future.
In another example, a corporation issues preferred stock to investors as a way to raise funds for a large expansion project. Preferred stockholders are promised a fixed dividend and have a higher claim on the company’s assets in case of liquidation, but they do not have voting rights in the company’s decision-making process.
An example of a capital stock clause
Here’s how a capital stock clause might look in a contract:
“The authorized capital stock of the Company shall consist of 1,000,000 shares of common stock, with a par value of $1 per share, and 500,000 shares of preferred stock, with a par value of $1 per share. The Board of Directors may issue common or preferred stock at its discretion, subject to the terms and conditions of this Agreement.”
Conclusion
Capital stock is a critical component of a company’s financial structure, representing ownership and the means by which a company can raise capital. It allows companies to fund operations, incentivize shareholders, and establish ownership and control within the business. By issuing shares, companies can access the capital they need to grow, expand, and meet business objectives, while shareholders gain ownership interests and potential profits from the company’s success.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.