Why a company sells shares

A business needs money to grow. It has three ways to get it: earn it, borrow it, or sell a share of itself.

The third one is what a stock market exists for, and the whole structure follows from it.

Selling a piece of the company

When a company sells shares, it is selling ownership — not a loan, not a promise to repay. Whoever buys gets a proportional claim on what the company owns and earns, and a vote in how it is run.

This is a real trade, in both directions. The company gets money it never has to repay. The buyer gets a claim on profits that may be enormous, nothing, or negative.

Contrast that with borrowing: a lender must be repaid with interest, whatever happens, and gets nothing extra if the business does brilliantly. Chapter 5 of Finance 101 priced that arrangement from the borrower's side.

The primary market: the one time money reaches the company

The primary market is where new shares are sold by the company itself. An IPO is the most visible example — a company offering shares to the public for the first time.

Money flows from investors to the company. That money becomes a factory, a hiring plan, repaid debt, or whatever the offer document said it would.

This happens rarely. Most companies do it once, occasionally a few more times.

The secondary market: everything else

The secondary market is where shares already issued change hands between investors. This is the stock market as everyone pictures it — prices moving all day, on screens.

Here is the part that surprises people, and it is worth stating plainly:

When you buy shares of a listed company, the company receives none of your money.

You buy them from another investor who wants out. Your money goes to them. The company is not a party to the trade and does not even know it happened until its shareholder register is updated.

So the daily price movement is not the company receiving or losing money. It is investors disagreeing with each other about what the company is worth.

Then why does a company care about its share price?

If trading sends it no money, why does any management team watch the price at all? Four reasons, all real.

Raising money again. A company issuing new shares later gets more for them if the price is higher. The primary market's terms depend on the secondary market's prices.

Borrowing. Lenders look at the market value of a business when deciding what it can borrow and at what rate.

Paying people. Employee share options are worth what the market says they are worth.

Being bought, or not being bought. A depressed price makes a company cheaper to acquire, which concentrates minds.

Why the secondary market has to exist

If shares could only be bought at issue and never sold, almost nobody would buy them. Committing money to a company for ever, with no way out, is a very different proposition from being able to change your mind.

The secondary market provides liquidity — the ability to convert a holding into cash at a knowable price — and liquidity is what makes the primary market possible at all. Investors fund new companies because they know they can exit.

That is the actual social function of all the screen-watching: it is the price of being able to leave, and the reason capital is available to businesses in the first place.

What this means for you

Your buy price is set by other investors, not by the company. There is no official price. There is what someone will pay.

A rising price does not mean the company received anything. It means opinion changed.

Your return comes from two places only: the company's profits reaching you as dividends, and someone later paying more than you did. Chapter 2 of the equity subject takes that apart properly.

The point

A company sells shares once, in the primary market, and gets money. After that, investors trade with each other in the secondary market and the company gets nothing. Both are necessary, and confusing them is the source of a great deal of muddled thinking about what prices mean.