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.
When a corporation is organized, and usually from time to time during its life, it is necessary to dispose of some of its securities. The initial capital must, of course, be raised by the sale of securities; subsequent capital may come either by savings out of profits or by fresh sales of securities. We shall take up for review, in the order named, the four methods of sale commonly used:
1. Allotment to insiders or to previous shareholders.
2. Direct sale to the outside public.
3. Sale to banking houses, which in turn dispose of the securities by direct sale to the outside public.
4. Sale to banking houses or brokerage houses, which in turn dispose of the securities through the machinery of stock exchanges.
By the term "insiders," as used above, are meant all those who are themselves familiar at first hand with the affairs of a corporation and are either active in, or closely connected with, the management of the corporation. The term is not used in any derogatory sense, but merely as a convenient designation for those who have intimate relations, so to speak, with the concern. In very small or closely held corporations - assuming that there is good feeling among the various persons interested - it is customary to allot securities as they are issued, to all those actively interested under some kind of mutual agreement. The universal rule of law is that, where new voting shares are issued by an established corporation, every voting shareholder must have an opportunity to take up a proportion of the new shares equivalent to his proportion of the shares previously outstanding. Unless there is some recent or mutual agreement to the contrary, it is generally found advisable in close corporations to allot new issues of common stock on this basis. Preferred stock or obligations are more likely to be sold to outsiders. There seems to be nothing more that requires explanation in connection with this very common situation.