Common Stock and Additional Paid-in-Capital

Common Stock (aka ‘ordinary shares’, ‘common shares’ or ‘voting shares’) refers to securities that give their owners (a) voting rights in a company that issued the stock in question and (b) residual (after creditors and holders of hybrid securities) claim to corporate assets. In other words, corporate ownership rights.  

It is called "common" to distinguish it from preferred stock. If both types of stock exist, common stock holders cannot be paid dividends until all preferred stock dividends are paid in full. That’s why the latter are caller ‘preferred’, by the way. Dividends are paid at company’s discretion; therefore, unlike with preferred shares, there is no guaranteed cash inflows for common stock investor. However, statistically, common stock is a better investment than either bonds or preferred stock over long periods of time (in terms of ROI).

Common stock usually carries with it the right to vote on certain matters, such as electing the board of directors. However, a company can have both a "voting" and "non-voting" class of common stock.

Why would you want to issue common stock? First, you absolutely have to issue it when you form (incorporate) your company. Second, you also absolutely have to issue new stock when you take your company public via an IPO on a major stock exchange.

And third, you will have to do it to finance a major expansion of your company (also a quantum leap of sorts) that you simply can not finance in any other way. Because it is way too big and way too risky for any bank loan (even a syndicated one), bond issue or issue of hybrid securities.

In this case, you will have to do a private placement of a minority stake in your company with private (‘direct’) equity investors – either individuals or institutions (private equity investment funds). When choosing your investors, you must make sure that they are a good match with your company in their values, principles, preferences and overall behavioral patterns.

Private placement process requires development of extensive documentation – information memorandum, valuation model, presentations and the like. In practically all cases, you would want to hire a financial advisor – a competent investment bank – to do this job for you.  

Common stock is represented on your balance sheet by not one, but two accounts – ‘Common Stock @ par value’ and ‘Additional Paid-In Capital’. ‘Par value’ (aka ‘stated value’ or ‘face value’) has no relation to market value and, as a concept, is somewhat archaic. But still has to be used and reported.

The par value of a share of stock is the value stated in the corporate charter below which shares of that class cannot be sold upon initial offering; the issuing company promises not to issue further shares below par value, so investors can be confident that no one else will receive a more favorable issue price.

Thus, par value is the nominal value of a security which is determined by the issuing company to be its minimum price. This was far more important in unregulated equity markets than in the regulated markets that exist today.

Par value is always much lower than the price at which shares are distributed to founders when the company is incorporate or sold to private equity investors or to the public at IPO. The difference between what founder or investor actually paid for common shares and the stated par value of common stock is called ‘Additional Paid-In Capital’ and reported in the corresponding account of your balance sheet.