How can a company use money from stock investors when they are constantly being bought and sold?

Question

I am interested in the mechanisms which a company can use the money that investors give them when they buy a public stock since they are being bought and sold constantly. How can a company spend other people's assets when the shareholders still own their stocks and they still retain a liquid value? To me it seems like stocks are a case of "having your cake and eating it too".

Answer 1

A simplified version of what's going on is the company raises capital (money) by selling a portion of itself (an ownership stake) to the investors — the first purchasers of the stock. The existing owners allow this in the belief the capital raised from this one time sale will be used to increase the value of the company enough so they are better off than before.

This kind of thing must be approved by the company's board of directors, who are selected by shareholders (owners) and exist to act on behalf of the shareholders rather than the management team, employees, or public. One of the board's primary duties is the hiring and firing of the senior management team. In this way, shareholders can be said to have ultimate ownership and set ultimate direction for a company: shareholders select board members, board members select the management team, and the management team sets priorities and operates the business in line with shareholder interests.

Therefore, when you buy a stock, you're buying a very small ownership stake in the company¹. Buy enough of a company's stock, and you get a say in who gets to sit on the board of directors for the company, and therefore a say in what the company does and how it behaves, or even a potential claim on its assets. This is part of what gives a stock value on the open market². But the money spent to buy the stock went to the stock's previous owner, which is usually not the company itself.

The other way a stock has value is through dividends. A business exists to make money for it's owners. That is it's purpose. Large public corporations are no exception, and they do this by sometimes taking a portion of their profits and paying it out to shareholders. That is a dividend. So owning the right stocks means sometimes getting "free" money above and beyond the value of the stock itself. A stock with a reputation for paying dividends may have more demand, and therefore a higher stock price³.

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The important thing to understand relative to this question is the stocks are a one-time sale for the company. The company receives capital once from the initial sale⁴, and doesn't get any input or return when (or if!) the stocks are bought/sold afterwards.

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The company does still care about the stock price, though, because the shareholders who own those stocks (and therefore own the company) care about the price. If the stock performs poorly, the shareholders will get the board to replace the company's management team (by first replacing board members if necessary). Or they'll sell the stock in order to purchase another stock that is more valuable, which helps the stock price trend lower-still, which will further encourage other shareholders to take action.

The other thing that can happen if the stock prices trends too low is the company becomes vulnerable to take-over by a rival. Remember ownership of stock is ownership of the company, and a rival need only purchase 51% of the stock to control the board — often even less if there is a sympathetic investor with the ailing company. Thus a low stock price can be dangerous for a company's very existence.⁵

In other words, if a C-level executive wants to keep that nice six or seven figure salary package, they better keep that stock price healthy⁶.

Of course, you, I, or any other average Joe are unlikely to ever reach the level where we have a meaningful reason to attend a shareholders meeting and actually vote on anything that matters to us⁷. We don't really care about the ownership stake so much. We do care that stocks have shown stable and even increasing value over time. This makes them a useful place to park savings, that might even provide a good return.

As a practical matter, the stock market as a whole cannot indefinitely out-perform the general economy, relative to the portion of said economy devoted to investment practices. Over time the stock market and larger economy should rise or fall at about the same rate. But there are variances between the two, where sometimes the stock market can lead or trail what the larger economy is doing, and some individual stocks can out-perform the economy while others languish. Individual investors can sometimes do very well for themselves this way (and the reverse is also possible). Sometimes the tail can even wag the dog, and investment behavior can actually spur real economic growth or decline.

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<sub>1. This is gross over-simplification. In reality, there are different classes of stock, and the casual investor rarely ends up with stock that grants any meaningful ownership interest
2. This has interesting implications in the face of investment vehicles like mutual funds, where you don't own shares in the fund companies directly. Instead, you own a share in the fund. You give up any ownership voting rights you may have had, and instead help the fund managers (often banks) amass larger stakes in a company than they could using their own money.
3. In practice, dividends also have some negative attributes, such as higher tax rates, that don't attract as many investors as you might think.
4. Often, the capital actually comes from a bank or banking group, and the bank then sells the initial stock.
5. There are more reasons for a company to be concerned about their stock price.
6. "Healthy" here means not simply stable, but steadily increasing. Once a company sells itself in this way, where ownership in the company has primarily become an investment vehicle, it's no longer good enough for a company to be simply stable and profitable. If a company is not also growing as quickly as it can, it's in trouble. More than that, just showing good growth is often not enough. It must also beat expectations to keep investors happy, because stock prices have often already accounted for expected growth. To raise the price further, you must exceed your own projections, which were already often optimistic in order to keep investors happy in the first place. This never-easing pressure has a profound impact on how corporations behave.
7. The prevalence of small investors can have an interesting impact on corporate ownership structures. If most of a company's stock is spread around among these small investors, a comparatively small investment stake in a company might be enough to effectively control it. Think about this point some more in relation to footnote #2. This also helps explain the reasoning behind the need for different classes of stock as described in footnote #1.</sub>

Answer 2

The company got its money for those shares when it issued them. When they're subsequently sold (assuming it's not the company doing the buying or selling), that sale doesn't change the company's bank account balance -- the proceeds from the sale (minus commissions) go directly from buyer to seller.

Answer 3

I think you are missing something about how stocks work. I myself was confused about this for a long time, and so I think I know where you are coming from.

Most of the time when investors buy and sell stock the company is not a party to the transaction. To understand how this can be, lets reduce it to a simple example with two investors:

Imagine you need $10,000,000 to start a business, but have only $5,000,000. So you find someone else with $5,000,000 who wants to own half of the business. Now say that the business is successful and ten years later the two of you sell it to a larger company for $25,000,000. You get $12,500,000 and he gets $12,500,000. You have each make $7,500,000 profit.

But what if five years ago someone offered your partner $7,000,000 for his half. He decided to take the $2,000,000 profit and get out. Now when the business is sold the person who bought your partner's half gets the $12,500,000 and so earns his own $5,500,000 profit.

When your partner sold his half, no money was added to or removed from the business. The buyer gave your partner money and your partner gave him a document showing that he is the new owner of half the business.

Stocks are simply a way of breaking ownership of a business into tiny pieces called "shares". To raise money the founders sell off a bunch of these little pieces of the business. The owners of these little pieces can sell then them to other people if they decide they want to use their money for something else, but this does not take any money away from the business. The business still has the money it got from selling the shares in the first place.

So once a company has sold stock, the investors generally cannot get their money back from the company. Investors who want out have to find someone who will take their place as investors. This is what stock markets are for. On the stock market buyers pay according to what they think that little piece of the company is worth now.

Answer 4

The company still owns more shares, and can sell them on the open market at the higher price to new investors. The company gets the new investor money, and the new investor gets shares. The company doesn't get any money when two private investors buy or sell shares to each other, but they do get advantage as the stock price goes up.

The company can keep the shares. Those shares have an increased market value, so the total value of the company's assets is increased. This increased "valuation" could get them loans at a better rate, and the shares can be used for collateral.

Answer 5

To add to the existing answer, in simple terms (there are complex rules and regulations, I am skirting over) -

1. Can potentially have a rights issue - more shares are issued by the company which are bought, often by existing investors - this is one way a company raises capital.
2. The more the stock is worth, the more valuable the company is perceived, which can then lead to it being easier to secure funding/debt for the company, which makes it potentially easier for the company to operate successfully.
3. Regarding liquidity - The shares only have a liquid value if people are buying and selling them, if a share is unpopular you might find that they are not that liquid at all (a simple example is a big margin between buy/sell prices, a more complicated one during a crash is when trading is suspended due to massive price swings)

Answer 6

When a company initially goes public (sells shares), the company receives the investments (minus the cut from the investment banker that structures and markets the deal). Once trading takes place in the secondary market (the stock exchange) the trades have no impact on the capital raised and held by the company during the initial public offering (IPO).