Capital Structure and Liquidation Priority

Last but not least in this chapter is a discussion about how a company gets the money it needs to operate and grow its operations, including when it initially starts up. In short, a company can either borrow money from commercial institutions or private individuals, or sell ownership of the company in the form of stock. Both of these methods put money in the company’s pocket that then can be used to grow or stabilize the company.

When a company allows investors to become owners, the company issues shares of stock as evidence of their ownership. These shares are generally of two types of stock, known as common stock and preferred stock. The primary difference between these two shares is that preferred stock owners are entitled to receive their stated dividends (division of company profits) before common stockholders. Both parties are still ultimately treated as owners of the company.

When a company borrows money, it does it in two primary ways. Either it borrows it in large amounts from institutions (banks, insurance companies, etc.) in the form of loans, or it borrows it from the investing public in bite-sized loans called bonds. Aside from bonds being issued in much smaller amounts (usually $1,000) compared to loans, bondholders hold far less ability to individually demand the seizure and sale of company assets in the event of a default. In either case, parties that have lent money to a company are called creditors