How Company Shares Work and the Riddle of Money in Stock Transactions
It is a common misconception that when you buy shares in a company, the company directly receives the money. This is not the case. To understand this concept better, let's delve into how stock transactions work and debunk some common misunderstandings.
Understanding Stock Transactions
When you buy shares from someone else, the money goes directly to the seller, not the company. The company only receives the bulk payment if they sell the shares to the public, typically through an Initial Public Offering (IPO) or a new issue.
Here’s a step-by-step breakdown of what actually happens:
Initial Investment: When the company is first formed, the original investors (usually the founders) fund the business. They then issue shares to raise additional capital. Purchase: You buy shares from a broker. The transaction involves a buyer and a seller on an exchange. The broker facilitates the transaction, and the exchange is responsible for the settlement of accounts 2-3 days later. No Direct Benefit: The company doesn't directly benefit from the sale of shares between buyers and sellers. They only receive payment when they sell shares to the public.Initial Public Offering (IPO) and Company Proceeds
The methodology changes when the company decides to go public. During an IPO, the company offers a portion of its shares to the public for the first time. This is when the company directly benefits financially. Here’s how it works:
Initial Offering: The company applies to have its stock listed on a public exchange. Brokers and investment banks help structure the offering, determining the price and arranging for the sale. Revenue Split: The bulk of the proceeds from the IPO go to the company. This capital can be used for growth, expansion, or other business needs. Founder Compensation: The company founders typically receive a portion of the proceeds, as they have already invested their time and money into the business. Brokerage Commissions: There are usually fees associated with the IPO process, which the company pays to the brokers and investment banks for their services.Additional Public Offerings and Market Support
After the IPO, companies can issue more shares to the public to raise additional capital. These are known as Secondary Offerings:
Secondary Sales: The company can sell new shares to the public at a predetermined price. This process is sometimes used to raise additional funds or to provide liquidity to the founders who may want to sell their shares. Market Impact: When you buy shares through a broker, you contribute to the overall demand for the stock. This can support the company’s share price, making it more attractive for the company to sell more shares in the future.However, individual transactions like yours do not directly give the company money. The effect of your transaction is minimal unless you buy a significant fraction of the company’s shares.
Conclusion
Stock transactions are complex, and understanding how they work requires delving into the intricacies of Initial Public Offerings and additional public offerings. The key takeaway is that the company doesn’t benefit from your purchase of shares on an exchange. It is only when the company sells shares to the public that they receive direct financial support.