Under some circumstances, however, a corporation that is not a family affair may successfully finance itself. Especially if it had a surplus and its stock has a market value substantially above par, it may, on condition of cutting down the surplus, suc cessfully appeal for funds. It may do this by taking advantage of the fact of the surplus, in connection with the right of its shareholders to purchase any additional capital stock the corporation may be issu ing for cash.
We will have to delay at this point to ex plain, for the benefit of those who may not be familiar with them, the various proce dures possible in the issuance of corporate stock. The chapter on "Watered Stock" in the first volume on Capitalization gave some indication of the process of "getting stock out" as fully paid on the transfer of property to the corporation. Ordinarily the incorporators transfer the property at the time of incorporation in order "to get the stock out," as the phrase is, and put the cor poration in a position legally to begin busi ness.
The organizers of the corporation may, as described in the earlier chapter, distribute none or only a part of this stock, to satisfy the interests of the various parties to the launching of the corporate enterprise. The organizers may have had the stock issued as fully paid stock on the transfer of the prop erty only to get the corporation into a better strategic position for future financing. If that is the case, they will hand back to the corporation such part as they do not require for the purpose of carrying out the bar gain under which it was formed. Stock so turned back to the corporation, or "donated" as the process is termed, carries the name of "treasury stock." Of course the lawyer in charge of the incorporation proceedings must be careful to comply with all legal require ments, and must incorporate in some juris diction which enables him to carry the trans action through without jeopardizing the po sition of directors and shareholders.
To explain the matter more clearly, let us consider a supposed situation of a corpora tion which has provided for future finan cial requirements. We will assume that the charter of the corporation authorizes 000 of preferred and $6,000,000 of common stock. The organizers had the corporation issue and distribute all the preferred stock. They had property transferred to the cor poration for which it issued $4,000,000 of common stock. Of this common stock, so issued, they had $2,000,000 donated back to the corporation. We will assume, too, that the corporation has given a mortgage under which it may issue $5,000,000 bonds, of which it has actually issued and sold $1,000,000. The capitalization, then, will
stand in this way: — Let us now also assume a balance-sheet for our corporation. We do not recommend this balance-sheet as a model for account ing practice, but present it simply to illus trate certain financial facts: — The NO0 shares of common stock which have been issued and given back to the cor poration are not, of course, an asset. When outstanding they will become a liability rep resented on the assets side by whatever are the proceeds of their sale. Rather than be ing placed in the assets column, a notation might be made to indicate the situation. They do represent a greater freedom of ac tion on the part of the corporation in its financing. If the corporation has only au thorized and unissued stock to dispose of, in order to raise cash it must get par for that stock. It may generally, to be sure, pay a reasonable commission for selling it. Even with this limitation the corporation obvi ously must realize a certain minimum on cash sale of any of its authorized but not theretofore issued stock. If the corporation, however, has some so-called treasury stock, it may generally deal with that stock sub stantially as it pleases. Of course the direc tors must obtain a price fair to the corpora tion and otherwise see that the sale does not injure existing stockholders.
Many jurisdictions, both by statute and by judicial interpretation, have been making it increasingly difficult for the managers of a corporation to arrange any way for the cor poration to sell any stock for less than par. On the other hand, some jurisdictions have come to a recognition of the true business situation as outlined in the earlier chapter on "Watered Stock." Though at the time of this writing the idea of "stock without par value" has not received much legislative recognition, the fact of an increasing num ber of people who appreciate the truth back of it gives rise to the expectation that it will receive more general legal adoption. The difficulty and often impossibility of steering a legal course for a corporation to sell stock for less than par causes much of the unsound capitalization plans. If the stock of a cor poration is not worth par, and yet the di rectors may not legally arrange for its sale at less than par, they must resort to bor rowing, — that is, to the issuance of bonds. So the fixed charges become disproportion ate, as explained in the discussion of "Trad ing on the Equity," and endanger the con trol of the shareholders.