Corporations are entities that are legally distinct from their owners. Because of this and the significant case law governing shares and shareholders, corporations offer their owners a good vehicle for raising capital to grow a business. When a shareholder invests cash in a corporation, the corporation obtains cash to finance operations and purchase assets, according to Nerd Wallet. In return, the shareholder gets an ownership stake in the corporation and a chance to receive dividends and participate in any value increase.
Shareholder's Equity Increase
Shareholder's equity is also referred to as stockholders' equity and represents your corporation’s net worth. Shareholders' equity appears on your corporation's balance sheet and documents the funding your corporation has received from the sale of common or preferred stock. It includes retained earnings, which are the profits your company kept and did not distribute to shareholders.
Shareholders' equity increases with stock sales and profit retention and decreases with net loss generation or dividend distribution, according to Fresh Books. When a shareholder invests cash, shareholders' equity increases by the amount of cash invested.
Cash Increase
On the balance sheet, your corporation's assets equal its liabilities plus shareholders' equity. Cash appears on the balance sheet as a short-term, or current, asset. Therefore, when a shareholder invests cash, the investment increases the amount of cash showing under the asset "Cash" by the amount of the investment or share purchase.
If stockholders are willing to buy more stocks at increasing prices, perhaps due to perceived future successes of the business, it acts as a capital injection without issuing shares, preserving long-term stockholders' value. A capital injection example could also include one where new shares are issued, diluting current stockholder value. In some special cases, a capital injection by the government may occur, perhaps as a part of a stimulus package in the face of a pandemic or natural disaster.
Stock Certificate Issuance
Stock certificates, or shares, are the legally required written proof of a shareholder's ownership in a corporation. When you or another shareholder invests cash in your corporation, your corporation or its management must issue a stock certificate that specifies the number of shares the cash investment purchased. For example, if the shareholder invested $10,000 in your company at $10 per share, the treasurer would issue a stock certificate representing 1,000 shares.
Ownership Increase
When a shareholder invests cash, the stock certificate she receives denotes an increase in ownership. If she is an initial investor, the stock certificate represents an increase from zero ownership. If she has invested in the corporation before, the amount represents an increase in ownership percentage based on the company's valuation at that time.
Cash Investment Example
Your corporation's shareholders' equity is $500,000, and cash is $50,000. You need additional equity to strengthen the balance sheet and qualify for a $250,000 bank loan. An existing shareholder agrees to invest another $100,000 in cash, bringing her total investment to $200,000. Your corporation's shareholders' equity increases to $600,000 and the cash to $150,000.
Your corporate treasurer issues additional shares to the investor. Her ownership stake, using shareholders' equity or company net worth for the valuation, increases from 20 percent – the $100,000 investment divided by the $500,000 in shareholder's equity – to 33 percent. The 33 percent is the shareholder's new investment amount, $200,000, divided by the new increased shareholder's equity of $600,000.
