To understand basic principles of investment it is necessary to have a clear idea of what is meant by ‘corporate securities’.
Corporate law distinguishes two types of capital:
- Ownership capital or shares (equity) and
- Loan capital (debt).
Ownership capital or shares is capital that is committed to a corporation (a company or a co-operative) in the hope that it will be successful and will return a profit resulting in a dividend. If the corporation is not successful this capital may be lost or reduced. For this reason it is often referred to as ‘risk capital’.
In return for risk capital, shareholders will generally have a vote in the corporation’s affairs, can expect a dividend if it is profitable and may also make a capital gain, if the shares are in a company (because the value of these shares is linked to the perceived value of the company’s net assets).
The value or price of a company share is initially set by the company and an investor buys shares either individually or in multiples of the share price. Large and successful companies may list their shares on a stock exchange to facilitate the issue of shares and share owners have the opportunity to trade their shares in an attempt to maximise any capital gain. Shares listed on a stock exchange are freely transferable and therefore have high liquidity.
Share capital is considered to be ownership or equity in the company, even though the company is a separate legal entity, because if the company is wound up, the remaining assets are distributed to the shareholders.
Loan capital is simply money that the corporation borrows. It may be from a bank or credit union or it may be from members or other individuals. The capital is usually repayable after a period of time and the loan agreement will usually require the payment of interest at regular intervals.
From the perspective of the company the loan is a debt and this type of capital is usually referred to as ‘debt capital’ or ‘debt financing’. Debt capital obligations are set out under a contract that will specify repayment date and interest. These contract terms will apply whether the company is profitable or not.
Loans can be structured in many different ways. They can carry a fixed rate of interest payable periodically, a variable rate or a combination of the two. The interest rate might be linked to a dividend rate. They may carry no interest during the loan period, but the repayment amount might be higher than the capital loaned – a bit like a calculation of a deferred interest payment.
Loan or debt capital can be issued under a variety of different terms and names, and for different unit amounts. For example, a company wishing to borrow $10,000 might issue debt securities in units of $100. An investor may ‘buy’ one or multiple securities at $100 each. The most common name for a debt capital security is a debenture.
Together, shares and debentures are referred to as ‘securities’. This term is used to describe the document (either on paper or notionally via electronic means) issued by the corporation that is evidence of the rights of the investor’s claim against the corporation for capital, dividend or interest, as the case may be.
A co-operative can issue both equity and debt securities, although shares in a co-operative are significantly different from shares in a company.