Stocks, company shares, equities. These investments go by a few different names and are a fundamental part of many investors plans to build wealth. But that doesnt mean theyre easily understood. To help get you up to speed, were here to share (get it?) some knowledge about stocks and how different types could be useful to you as an investor.
Stocks are a type of security that gives stockholders a share of ownership in a company. Depending on the stock type, they may also grant shareholders the right to vote on certain decisions affecting the company.
Ever wondered how companies get their hands on those millions (or billions) of dollars from the stock market? I sure did. For years, I thought companies somehow collected cash each time their stocks got traded on Wall Street. Boy, was I wrong!
After researching this topic extensively for our blog readers, I’ve put together this comprehensive guide that explains exactly how businesses benefit financially from stocks and why going public can be such a game-changer for growing companies.
The One-Time Cash Injection: How Companies Actually Get Money From Stocks
Let’s clear up the biggest misconception right away companies don’t make money every time their stock is bought and sold on the stock market Shocking, right?
Here’s how it actually works
Companies only receive money from stocks during specific events:
- The initial public offering (IPO) – the first time they sell shares to the public
- Additional stock offerings after they’re already public
- When they issue new shares for specific purposes
As one financial expert explained it: “The company got its money for those shares when it issued them. When they’re subsequently sold (assuming it’s not the company doing the buying or selling), that sale doesn’t change the company’s bank account balance — the proceeds from the sale go directly from buyer to seller.”
The Initial Public Offering (IPO) – The Big Payday
An IPO is essentially a company’s debut on the stock exchange. This is the main event where a private company transforms into a public one by selling shares to outside investors for the first time.
Here’s what happens during an IPO:
- The company works with investment banks to determine how many shares to offer
- They set an initial price for those shares
- Investors buy these newly created shares directly from the company
- The company receives the money from these sales (minus fees to the investment banks)
For example, when Facebook (now Meta) went public in 2012, they raised over $16 billion by selling shares to initial investors. That money went straight into Facebook’s corporate treasury to be used however the company wanted.
What Happens After the IPO? The Secondary Market Explained
After the initial offering, things change dramatically. All subsequent trading happens on what’s called the “secondary market” – the regular stock exchange where investors trade with each other.
Here’s the crucial part that confuses many people: When stocks are traded on the secondary market, the company doesn’t get any of that money.
Let me illustrate with a simple example:
- Company XYZ issues 1 million shares at $10 each during their IPO
- They collect $10 million (minus fees) – this goes to the company
- Later, Investor A sells 100 shares to Investor B for $15 each
- Investor A gets $1,500, Investor B gets 100 shares
- Company XYZ gets $0 from this transaction
As one financial analyst puts it: “Stocks are simply a way of breaking ownership of a business into tiny pieces called ‘shares’. To raise money the founders sell off a bunch of these little pieces of the business. The owners of these little pieces can sell them to other people if they decide they want to use their money for something else, but this does not take any money away from the business.”
But Wait… If They Don’t Get Ongoing Money, Why Do Companies Care About Stock Prices?
You might be wondering – if companies only get money during the initial offering, why are CEOs and executives so obsessed with their stock price? There are several important reasons:
1. Future Fundraising Potential
Companies with higher stock prices can raise more money when they decide to issue additional shares in the future.
For instance:
- If Company A’s stock trades at $10, they need to issue 1 million new shares to raise $10 million
- If Company B’s stock trades at $100, they only need to issue 100,000 new shares to raise the same amount
This is a huge advantage for Company B, as they don’t have to dilute existing ownership as much.
2. Executive Compensation and Motivation
Many executives receive a significant portion of their compensation in company stock or stock options. When stock prices rise, they personally benefit.
My cousin works at a tech startup, and he told me that over 60% of his total compensation is in stock options. That’s why he’s so invested in seeing the company succeed – his financial future depends on it!
3. Protection Against Hostile Takeovers
Companies with higher stock prices are more expensive to acquire, making them less vulnerable to hostile takeovers by competitors.
4. Credibility and Borrowing Power
A strong stock price reflects market confidence in the company, which can lead to better loan terms, business deals, and partnerships.
Other Ways Companies Can Raise Money Through Stocks
While the IPO is the most well-known way companies raise money through stocks, there are other methods they can use:
Secondary Offerings
After a company is already public, they can still issue additional new shares to raise more capital. This is called a secondary offering or follow-on offering.
For example, Tesla has conducted several secondary offerings over the years, raising billions in additional capital to fund their ambitious growth plans.
Rights Issues
Companies sometimes offer existing shareholders the opportunity to purchase additional newly issued shares, usually at a discount to the current market price. This allows them to raise capital while giving current investors the chance to maintain their proportional ownership.
Employee Stock Purchase Plans
Many companies offer employees the opportunity to purchase company stock, often at a discount. This simultaneously raises capital for the company and helps align employee interests with company success.
How Companies Use the Money They Raise From Stocks
So when a company does receive money from selling shares, what do they typically do with it? Here are some common uses:
- Funding expansion – opening new locations, entering new markets
- Research and development – creating new products or services
- Paying down debt – reducing interest costs and improving the balance sheet
- Acquiring other companies – buying competitors or complementary businesses
- Working capital – funding day-to-day operations and inventory
Tesla is a great example – they used billions raised from stock offerings to build massive factories (called Gigafactories) around the world, fund R&D for new vehicles, and expand their global presence.
The Stock Market as an Ownership Exchange, Not a Cash Machine
The fundamental concept to understand is that the stock market is primarily an ownership exchange, not a direct funding mechanism for ongoing company operations.
As one financial educator explains: “Stocks work like this: Companies sell shares of their business to investors. Investors buy those shares (called stock), which in turn provides companies with money to expand their businesses through creating new products, hiring more employees or other business initiatives.”
But this only happens during specific events like IPOs and secondary offerings – not during regular trading activity.
Practical Example: Tracing the Money in Stock Transactions
Let’s follow the money through a simplified example:
Scenario 1: Initial Public Offering (IPO)
- StartupX decides to go public, offering 1 million shares at $20 each
- Investment banks help market and sell these shares to initial investors
- The offering is successful, raising $20 million
- After paying $1.5 million in fees to investment banks, StartupX receives $18.5 million
- This money goes into the company’s bank account to be used for expansion
Scenario 2: Secondary Market Trading
- Investor Johnson buys 1,000 shares of StartupX during the IPO for $20,000
- Six months later, the stock has risen to $25 per share
- Johnson sells all 1,000 shares to Investor Williams for $25,000
- Johnson makes a $5,000 profit
- StartupX receives $0 from this transaction
Common Misconceptions About How Companies Make Money from Stocks
Let me clear up some other misconceptions I’ve encountered:
Misconception 1: “Companies get money whenever their stock price goes up.”
Reality: A rising stock price doesn’t directly put money into a company’s bank account. However, it does increase the company’s market value and makes future fundraising more efficient.
Misconception 2: “Stock dividends cost companies nothing.”
Reality: When companies pay dividends to shareholders, this is real cash leaving the company’s bank account. It’s a distribution of profits to the owners (shareholders).
Misconception 3: “Companies can just print more shares whenever they need money.”
Reality: Issuing new shares dilutes the ownership stake of existing shareholders, which usually causes the stock price to fall. Companies must be strategic about when and how they issue new shares.
Benefits of Being a Public Company Beyond Initial Fundraising
While the immediate capital raise is important, there are other benefits to being publicly traded:
- Increased visibility and prestige – Being listed on major exchanges brings attention and credibility
- Liquidity for founders and early investors – They can more easily sell portions of their ownership
- Currency for acquisitions – Companies can use their stock as payment when acquiring other businesses
- Employee recruitment and retention – Stock options and equity grants become more valuable
- Market validation – Public valuations provide third-party confirmation of business strength
The Bottom Line: A One-Time Feast, Not an Endless Buffet
To sum everything up: companies primarily get money from stocks during their initial public offering and any subsequent new share issuances. The day-to-day trading of their shares on stock exchanges doesn’t directly put money in their corporate coffers.
It’s more like a one-time feast rather than an endless buffet. But that feast can be enormous – many companies raise billions of dollars when going public, providing crucial capital for growth and expansion.
And while they don’t directly benefit from subsequent trading, maintaining a healthy stock price creates numerous indirect benefits that can significantly impact a company’s financial future.
So the next time you buy shares of your favorite company on a stock trading app, remember: your money is going to another investor selling their shares, not to the company itself. The company got its cash injection when those shares were originally issued, possibly years or even decades ago.
Have you ever invested in an IPO? Or maybe you’ve wondered how stock prices affect company operations? Share your thoughts in the comments below!
How to buy stocks
These days, you can buy stocks by opening a brokerage (or regular investment) account online. Picking a broker is an important decision that you shouldnt take lightly. You may want a firm that wont hold you back with fees, hidden costs, or a lack of investment availability. For more information, check out our guide on where to open a trading account.
Once you have an account, your next move is to research stocks you may want to buy. Check out these 4 steps to picking your investments. And remember: You dont have to stick with buying individual shares. Mutual funds and exchange-traded funds (ETFs) can provide easy access to hundreds of different stocks at once, providing broad market exposure.
How do stocks work?
Companies issue stock to raise funds to operate their businesses. This cash infusion can help companies in a variety of ways, such as helping to pay off existing debt and funding growth plans they cant—or dont want to—finance with new loans.
Stockholders, or shareholders, can primarily make money in 2 ways:
- Share appreciation. When a company does well financially or becomes more desirable, the price of its stock can increase. This allows investors to sell their shares to other investors for more than they paid.
- Dividends. Some companies may decide to share a portion of their profits with investors through cash payments called dividends. A dividend yield is expressed as a percentage, which can range from less than 1% to over 5%, though a typical range for many established companies is 1% to 3%. Its a calculation based off of the annualized dividend payout of a stock compared to the stock price. Companies may pay dividends one quarter and skip the next, depending on their goals and financial situation.
Keep in mind that stock values dont always go up. Share prices can also fall, leaving investors with stocks worth (sometimes a lot) less than they paid for them. You can help decrease this risk by diversifying your investments and through a strategy called dollar-cost averaging, where you regularly invest a specific sum of money over time. When prices are low, you can afford to buy more shares. When theyre high, youll buy fewer.
That said, dollar-cost averaging doesnt assure a profit or protect against loss in declining markets.1
Publicly traded stock
Publicly traded stock is probably what you have in mind when you think about stocks. Its the kind of stock typically purchased through brokerages and investment apps, and its price movements may be reported in the news.
A stock is “public” when its company lists it on a major exchange, like the New York Stock Exchange (NYSE) or Nasdaq. This enables everyday investors to buy and sell it, but it also opens companies up to more regulation. If companies are accessible to everyday investors, the Securities and Exchange Commission (SEC) requires that the companies disclose certain aspects of their finances to help investors make informed decisions.
Private companies can go public through processes like initial public offerings (IPOs) and direct listings, or if theyre acquired by special purpose acquisition companies (SPACs).
Feed your brain. Fund your future.
Private stock
Private stock represents ownership in a private company. Unlike public stock, private stock cant easily be bought or sold through a normal brokerage account. Usually, any sale of private stock needs to be approved by the company itself.
Private stock is less commonly encountered by the typical investor, which can be a good thing. Private companies are much less regulated than public ones and have no obligation to inform the public of their financial health, making it harder for outsiders to judge investment potential. If you work for a private company, however, you may receive private stock as part of your benefits or compensation package.
Common stock
Common stock is the “average joe” of equity. Its the public and private stock type youre most likely to buy and sell.
Common stock represents ownership of a company and gives the shareholder voting rights, letting them influence that companys future. A stock derives value based on the fundamentals of the company and market forces. Return on investment can be broken down to appreciation and dividends.
Common stockholders are the last people—behind bond holders, preferred stockholders, and other debt holders—to be compensated if a company goes bankrupt and must sell its holdings.
Preferred stock
Preferred stocks are like a mix between a common stock and a bond. They can offer predictable income through fixed dividends—like a bond might with interest payments—that are typically paid at regular intervals. Their shares also grant you ownership of a company like common stocks and may appreciate in value as the company becomes more desirable. And “convertible preferred stock” may be converted to common shares by the company or by you if certain conditions are met.
Unlike common stocks, preferred stocks dont come with shareholder voting rights. Another difference: Preferred shareholders always receive dividends and asset payouts before holders of common shares.
Growth stock
Growth stocks are shares of companies that investors expect to grow sales or earnings faster than the market average. Usually, growth stocks belong to smaller, newer companies that have a lot of potential but (at least in the moment) not a lot of profit. Growth stocks typically dont pay dividends, as the companies may prefer to invest extra cash in themselves to grow faster.
Growth stocks tend to have relatively higher stock prices compared to their earnings. When you buy one, youre hoping that companys growth exceeds current expectations, which can drive the share price up. Theres no guarantee that a growth company will get there. And if it doesnt, investor favor may fade, sending prices down. This makes them riskier investments.
Value stock
Value stocks are associated with companies that investors think trade below what theyre really worth based on their earnings, and tend to have relatively lower stock prices compared to their earnings. They tend to be larger, more established companies with solid financial histories. Some even pay dividends.
If you own a value stock, youre hoping the market eventually realizes the stock is undervalued, and its price bounces up. If it doesnt, you may be left holding a stock with good financial fundamentals but that never realizes its potential.
Income stock
Unlike growth or value stocks, investors who buy income stocks are focused on income, generating profit primarily from dividend payments. Share price appreciation is an added bonus.
Income investing can be risky because companies can reduce their dividend or choose not to pay one at any time. To help decrease that risk, income investors focus on companies dividend history, making sure theyve consistently paid or raised their dividend even in down markets.
How a Company Benefits from the Stock Market
FAQ
Can you make $1000 a month with stocks?
What is the 7% rule in stocks?
The “7% rule” for stocks is a risk management strategy that dictates selling a stock when it drops 7% below the purchase price to limit losses and preserve capital. This rule, popularized by investors like William O’Neil, is based on the observation that even strong stocks typically don’t fall more than 7-8% below their ideal buy point. It can be implemented by setting a stop-loss order with your broker or through manual monitoring. Another related, but distinct, “7% rule” is a retirement planning concept where you assume a 7% annual withdrawal rate from your investments to determine how much you need to save for retirement, as explained in this YouTube video.
Who owns 90% of the stock market?
How much is $1000 a month invested for 30 years?