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Negotiating Risk

How Shareholder’s Rights Impact Your Investing

When it comes to any business deal, know your rights.

Most renters wouldn’t take an apartment without understanding what’s in the lease, just like most buyers wouldn’t put a down payment on a condo without discussing the what, when and how of association rules.

Likewise, investors need to know their rights, too. Shareholders should understand the ins and outs of just what permissions come with those “slices” of a company that they buy.

Let’s take a look at what those are, and also at how they differ from one kind of stock to another.

The Basics:

While what kind of stock you buy will determine some of what you can do, certain core rights are a good way to start thinking about the subject.

Let’s say you purchase a common share of North American Outfitters, a fictional maker of wilderness hiking gear that’s selling at $80 a share.

A common share is different than a preferred share. We’ll look at how in a moment, but when it comes to a common share, what do you get for your money?

  1. Right to the Rewards of Ownership:  Bottom line is: you own a piece of North American now. If the company figures out a new way to make high-quality goods at a lower cost of manufacturing, and its worth increases because of that, as a “co-owner” you have the right to benefit from those asset-building changes. This manifests, for example, when you sell your $80 shares for $110.
  2. Right to Dividends: Another way your investment confers upon you the right to some reward is this: When North American does well, it may decide to pay out some of its profits to the people who’ve helped it along the way. Namely, its shareholders. Percentages and how this happens, exactly, differ according to the stock you hold. We’ll look at this in the next section.
  3. Right to Relinquish Ownership: As you bought a share, so may you sell it. Unlike other kinds of investment, North American Outfitters can’t stop you from liquidating your holdings for cash, and the turnaround is pretty much immediate.
  4. Right to Vote: While you hold stock in North American, you get a say. The company wants to merge with European Mountain Gear? The amount of stock you’ve got  determines how much voting power you have on the proposition.
  5. Right to Address Wrongdoings: Let’s say North American Outfitters gets caught over-reporting its earnings (boo, hiss). What you thought was the value of what you had in hand turns out to be a lot less when the accurate numbers come out. As a shareholder, you have the right to form or join a lawsuit against the company, seeking damages for what it’s done to you as an investor.

Equal Rights?: Preferred and Common Stocks

Be aware that not all stocks confer the same rights in the same way.

Preferred Shares: Say you come in as a shareholder with North American Outfitters and you buy preferred stocks instead of common. You might not get the right to vote, but on the other hand your right to dividends is augmented. For example, you get paid first when dividends are announced and you also are advised in advance about when they’re going to come. Similarly, say that North American, after it screws up on the reporting of its earnings, loses its footing in the marketplace and decides to close down. As it liquidates, preferred stockholders get paid first.

The Rights Plan: Another Key to Negotiating Your Risk

Everything we’ve looked at so far has been basically put in place by federal regulations. You need to look further into what you’re buying, however, to make sure the terms of your investment are clear.

Ask for the company’s shareholders rights plan. Read it, and look particularly at what the plan tells you about situations like hostile takeovers and what happens in those circumstances. Sometimes you get the right to buy stock at a discount if some other entity is attempting to scoop up too many common shares at once.

Once you’re armed with this kind of information, step out and take a chance. As always, the best kind of chance to take is the one about which you’re well informed. Understanding you shareholder rights helps you negotiate some of that risk. Learn them, and then happy investing!

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