You are meeting with your financial advisor for the first time. Your friends hectoring you about missing out on Facebook’s IPO has not stopped despite the fact it happened half a decade ago. But your advisor is talking about all these things from T-Bills to Preferred Shares and now Bonds. You thought this was about the stock market?
Well, it all is but that does not mean it is too complicated.
The easiest place to start is explaining what we are talking about at the beginning. What is the purpose of all these investing options? Regardless of what investing options we are talking about, the goal of each of these objects is generally the same: financing a corporation. The differences stem from what the corporation is giving the investor in exchange for the investment. As investors are generally only concerned with the return on their investment, any distinction can seem irrelevant, but there are legal differences in some of the terminology that have implications for when investors will get their return.
Stock and Shares: You say Stock, I say Shares, Let’s Call the Whole Thing Off
The most common confusion in terminology occurs between stock and shares. They refer to the same thing, but the technical term (to sound impressive at dinner parties) is equity financing. That is why they are sometimes called equities, but very rarely. Corporations issue shares or stocks to get people to invest money in exchange for certain rights, which can vary. It should be noted that in Canada’s federal legislation and provincial legislation, “shares” is the defined term used for these investment objects. Though stock and shares are synonymous terms, a simplification would be that stock refers to the general market or a number of these objects, hence the stock market, and share refers to a specific class or subset “shareholder”.
In terms of terminology, it is obvious that a shareholder is a person that owns a share. But a common misunderstanding is that shareholders are owners of the corporation. A share entitles the holder to a bundle of rights that depend on the type of share. The next set of terminology to explain are the different shares in existence.
Different Types of Shares: How You Get Your Money Back
The most common type of shares is very creatively called “common shares”. Common shares come with the baseline rights of voting, dividend (at time and amount at the discretion of the corporation’s Board of Directors), and the dissolution rights.
“Preferred shares” are also prevalent, and usually entitles the shareholder to a fixed dividend, for example, 4% of the price per year, and these holders have their rights in priority of those plebeians who hold common shares. In exchange for these financial benefits, these shares might have other features—they may or may not come with voting rights, or may require repayment of a preferred shareholder prior to the common shareholders if the business goes bust. Now, there is a tremendous of creativity allowed for shares (subject to minimal requirements in Canada), but a corporation would not want to design a share that would not attract a lot of investors by making it too specific or complicated.
Debt, Finally Explained, is Actually a Good Thing
To make it more complicated, there is another type of investment object, which are debt obligations. Loans, promissory notes, bonds, and debentures are all variations on basically the same thing—that being a promise to repay borrowed funds on specific terms, along with an entitlement to a fixed percent in exchange for borrowing money from the investor. Debt instruments do not typically receive voting rights and are considered external to ownership rights within a corporation. The right to repayment from the corporation in almost all circumstances supersedes all share classes. Amongst each other, lenders might complete as to the ordering of repayment, and details on subordination, priority and collateralizing assets is the topic of another article.
If you’re trying to borrow or lend money, simply describe the agreement as a loan, and you can’t go wrong. Debentures, defined, indicates a longer term debt, whereas “notes” colloquially used to mean a short term loan. When presented with one of these documents, we recommend that you read the recitals of the agreement, and dig into the agreement itself, to understand the intent of the agreement.
Now that you understand this terminology you can go on to enjoy Showtime’s Billions. Okay, well, you first need to learn about shorting a stock, but that should be easy now that you understand these terms! Written by Brendan Sheehan**Edited by Rajah Lehal and Alina Butt