Last editedJun 20212 min read
Common stock represents an interest in a business in the form of securities that, once purchased, give the common stockholder voting rights in the future of this business and a financial return. This return will be either dividends paid periodically or simply the rise in value of the common stock between purchase and final resale.
Common stock vs preferred stock
Common stock is not the only option when purchasing equity in a business, as preferred stock is often offered as an alternative. There are two main differences between common stock and preferred stock. While common stock offers a better potential return than many other financial investment products, preferred stock is more reliable. If you want a lower but more reliable cash flow over a longer period of time, then preferred stock is probably the option to go for. Note that preferred stock brings no voting rights with its ownership, while common stockholders may vote on some of the decisions the business takes.
The pros and cons of common stock
Whether to purchase or issue common stock or preferred stock will be driven by a range of factors, from the cash flow being sought to the amount of risk an investor is willing to carry.
What are the pros of common stock?
Other forms of investment such as bonds and deposit certificates offer a guaranteed return, but because the return is guaranteed the gains offered have minimum and maximum limits. With a common stock the amount of return on offer is literally limitless, which opens up the possibility of extremely large gains if common stock is purchased carefully, although the risk of losses is also present. Thus common stock puts the onus on the investor to choose the businesses they invest in with great care.
From the viewpoint of a business, issuing common stock is a means of raising money that costs less than taking on debt. Whereas all debt comes with the obligation of paying interest, dividend payments on common stock are only payable at the discretion of the owners when the extra cash is available.
The investment anyone makes in common stock comes with limited liability. Put simply, the amount an investor could lose is only ever as high as the initial amount invested. This is guaranteed by the fact that common stock can only be purchased using cash rather than on a leveraged basis.
As a holder of common stock an investor carries no liability for the activities of the business they have invested in. If any regulations are breached or standards not met, the owners of the business and not the investors will face the consequences, although the value of the common stock itself may be affected.
Common stock is known as a liquid investment, which means an investor can buy or sell the stock they hold when they want, and the purchasing process itself is relatively simple.
What are the disadvantages of common stock?
Common stock represents a higher risk investment than many others. The price of these stocks can be volatile, rising and falling sharply, and investors panicked into selling at a loss when the price drops can often be dismayed to see it rise again sharply. The other inherent risk is that the investment will vanish if the business goes bankrupt.
Place in the queue
If a business does enter into liquidation, holders of common stock will be placed behind HMRC, supplier, employees and creditors when it comes to getting any repayment.
We can help
The choice of issuing preferred stock or common stock can be driven by the wider financial condition of a business. Keep that condition as first rate as possible by partnering with a payment platform like GoCardless. We make it simple to ensure that cash keeps flowing into your business, and this includes the more complex aspects such as dealing with ad hoc payments or recurring payments.