This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
The typical corporation starts in much the same way as the typical partnership - through an agreement on the part of two or more men who are acquainted with each other, to join forces in a business enterprise. In a partnership, these men sign a formal partnership agreement and pool part or all of their capital and other resources; in a corporation they mutually agree upon the amount of capital required, the amount of capital stock to be authorized, and the issuance of the stock for cash, property, and services. No matter which financial form is adopted, the essential fact common to both is that the money and the business ability required for the enterprise are both supplied by the same group of men.
As the corporation expands - assuming that it is a success - and fresh capital is needed, it may come in whole or in part from the same group of men. In case their capital has been exhausted or is otherwise tied up, the next move, frequently, is to find some other man who has capital to invest and at the same time will be a valuable addition to the executive staff of the business. Some concerns keep on growing in this way for a long time. Other concerns - by far the vast majority - soon attain their normal volume of business and thereafter need little if any fresh capital. In both these cases, the source of capital plainly is the man or group of men who are themselves active in the management of the business.
A second source of capital, which usually operates in connection with the source just named, consists of savings out of the profits of the business. Practically every concern saves and adds to its permanent capital a portion of its profits. In corporations which are owned by the people active in the business, the tendency is strong toward putting a large proportion of the profits back into the business. The active men realize the needs and the possibilities in the business better than outside stockholders could possibly do. Sometimes they are willing to put back practically all the profits and to keep up this policy over a period of years. The enormous capital of the Carnegie Steel Company was, for example, almost wholly built up by this method. Much the same thing is true of the Winchester Arms Repeating Company and of many other closely held and highly successful concerns. A conspicuous recent example of the great results which may be achieved by the patient saving and reinvesting of good profits over a series of years, is the Bethlehem Steel Corporation.
Most companies that are successful on a large scale reach the point, in the course of a few years, where more capital is needed than can possibly be supplied by the people who are directly engaged in handling the business. Some corporations, as we shall see, reach this stage at the very beginning; that is to say, they start full blown as publicly owned enterprises. They are, however, exceptional. Whenever it is necessary to go outside the group of men who are directly connected or directly familiar with the enterprise, the capital may be said to be raised from the public at large. For our purpose we may divide this public - as is customarily done in nearly all writing or thinking on financial subjects - into two fairly distinct groups - those who invest and those who speculate. The investing public consists of the people who are more concerned over getting back their principal than they are over making profits. The speculative public consists of those who are chiefly concerned in making profits, and for this purpose are willing to accept more or less risk with the principal. It has previously been noted that distinct types of security issues are designed to appeal to these two groups. There is, of course, no sharp dividing line.
So far as the issuance of securities is concerned, there is little to be said at this point in connection with the first and second sources of funds named above - persons close to the business and the profits of the business. Some attention must be given, however, to the forms of securities that should be selected if an appeal is to be made to the third source, the investing public, or to the fourth source, the speculative public.