ELi5: Why would someome buy stocks from a share holder of a company, instead of using that money to invest in the company themselves?

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ELi5: Why would someome buy stocks from a share holder of a company, instead of using that money to invest in the company themselves?

In: Economics

Because if you just write a check to a company, they might give you a thank you letter and that’s it – at the end of the day you don’t have anything to show for your investment in the company.

When you buy a stock, you’re actually buying some level of ownership in the company, which has *some* value to it – the company might pay dividends to shareholders, or it might strike it super rich and in turn the value of the stock could shoot up, and then you sell it for money.

For the average investor like you and me, this is the only way to purchase shares in a public company.

Shares are authorized and issued via investment banks who sell large blocks of them to large investors then to smaller investors in what we call an IPO, an Initial Public Offering. This is the only time money paid for that specific lot of shares goes to the company itself. Since the markets are also regulated, all trades between parties are tracked so there is always a record of ownership.

For more info I suggest checking out Investopedia.

There are two types of corporate ownership: Publicly traded and privately traded.

With a publicly traded company, the only way to “invest” in the company is by buying stock. Companies normally have initial public offerings so they can raise money. They sell off part of the company to anyone who wants in, and in return the company gets money. After that, people play their stock market games to try to get money by buying and selling stocks.

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If the company is privately held, then the company can do what ever they want with the ownership of the company. This often happens with small start ups. They pitch to wealth funds and investment groups to invest in them. The investment company gets some sort of partial ownership, or other consideration to be paid back later. So when the start up either goes public with an IPO, the investment group already has a chunk of stock in the company on day on. Or the start up can get bought out and part of the buy out is paying off the investment group before anyone else gets their cut. The exact nature of these deals is closely held and can have lots of quirks and sometimes lawsuits depending on who though they got frozen out of the buyout.

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I believe you are mixing the two different options together.

Corporations are capitalized through the sale of stock. Capitalization means raising money to run the business. Corporations start out with a set amount of stock to sell to raise their startup money, say a million shares (it can be whatever they want.) In a small private corporation, you and your sister and your mom and dad put in $1,000 each, and you get 100 shares of stock ( example numbers.) If you need more money, you offer uncle Bob and aunt Sue part ownership of the company if they put in $2,000, for which they get 200 shares of stock. Very simple. Large corporations do the same thing, but they initially offer stock through a big investment firm that has lots of clients with money to invest. They are limited by their charter as to how many shares they can offer, so let’s say they sell all they can. Now they can’t raise any more money, because doing so would affect (water down) the ownership rights of current stockholders (owners.) If you want to own some of the company because you think it has just invented the greatest widget and will make a fortune, you can’t buy in by buying shares from the company because they don’t have any more shares to sell. So, you have to find someone who already has shares and buy them from her. Maybe she doesn’t really want to sell, but if you give her $4 per share more than she paid for her shares, she will make some money, so then she will sell them to you. It’s really hard to go around and find sellers on your own, so there are middle men (brokerage firms) who have big networks of customers who buy and sell shares for people all the time, so you put in an order for 100 shares of XYZ stock, and they match it up with someone else’s order to sell 100 shares of XYZ stock (if you agree on the price the other person wants.) There are also networks of middle men called stock markets, where middle men share information about the stocks that their customers have to buy and sell, which makes it very easy to own a little piece of a company. That is why you don’t buy directly from the company – unless they do happen to be selling some more shares, but then they use the middle men to sell those new shares, and for the same reason it gives them access to lots of buyers.

Investing in a company involves the company giving out newly printed shares for money. The shares always add up to 100%, so the newly printed shares reduce the ownership of everyone else’s shares.

In 5-year-old language, it’s like this:

You have a pie and you want to sell it to some other kids.

You charge 6 friends $1 each for 1/6 of the pie.

Then before you cut it another kid shows up. If you offer the new kid $1 for a slice, it’s not just a deal you’re making with him. You have to re-negotiate the rest of the kids, since you’re reducing their slice (there are now 7 people so they’ll now get 1/7 of the pie instead of 1/6). Some of them might not be OK with that slightly smaller slice [1].

If you cut the pie into 6 pieces, then the new kid can buy a slice from any of the other kids. That’s a private deal between the new kid and the seller, it doesn’t affect how much pie anyone else gets.

[1] In fact, if the kids are businessmen, they’d never agree to give away something for nothing. So maybe the 7th kid has a packet of sugar in his pocket, and he offers to sprinkle sugar on the whole pie to…sweeten the deal. Now there’s division, some of the 6 kids think the sugar the new guy brings is a great value and are happy for a smaller slice of a better pie. Others think the sugar doesn’t add anything and want to tell the 7th kid to go away and find another pie.