A substantial percentage of all new corporations practically fail before they get under way, owing to faulty or fraudulent promotion. In many cases, the promoter very generously pockets the entire capital in exchange for a patent which he has purchased for little or nothing. One promoter was heard to re mark that the investor always got his money's worth, but that he usually got it in experience. This is un doubtedly true, and it is also true that experience is the most costly school in the world. It is a very im portant financial fact, too, that very few people are smart enough to learn from the experience of others. If this were not true, there would be neither so many worthless promotions nor such a large number of "lambs" constantly led to the slaughter. Fatherly advice has never played a large part in corporation finance. The average man dies just about the time his experience has become valuable. The new gen eration then begins all over again, without analyzing the experience of their predecessors or profiting much from it.
11. Payment for are the risks of business, and for assuming this risk, the investor must be paid. Therefore, loaned capital demands not only an interest rate for its use, but also an added rate to compensate for the risk assumed. The rate paid for the use of the capital may be called the true interest rate. It averages perhaps between 3.5 and 4 per cent in this country. The balance of the interest paid upon bonds, and of dividends paid upon preferred stock above the true interest rate, repre sents the compensation to the owners of those securi ties for assuming the risk of investing in them. The only reason why some securities sell below the true interest rate is that they are limited in amount and are prescribed by law for certain purposes, such as the investment of trust funds, the circulating privilege upon two per cent government bonds, etc. The fact that bondholders and other holders of preferred se curities receive anything for the risk of their invest ment shows how hazardous must be the common stock, which assumes the marginal risk.
12. Management and must be differentiated from control. Certain stockholders owning a majority interest may control a corporation, and yet not manage it. The management is usually vested in a certain few chosen officials who are satis factory to the controlling interests, but who them selves may not possess the actual control of the busi ness. The manager has a 'double inducement for in vesting in the company. First, it secures him an income as manager, and secondly, it enables him to watch his investment and guard it intelligently.
Since, however, only a very limited number may be managers,, the influence of this factor upon the plan of securing capital is very slight in the aggregate. Usually control, risk and income are mentioned as the factors which determine the financial plan, and management is omitted entirely.
Income is the chief purpose of investment and is received in the form of dividends or interest. These will be treated at length in succeeding chapters.
13. Capital for new deciding how capital shall be obtained for a corporate enterprise one must consider not only the various forms of cap ital and the various persons from whom it may be secured, but also the stage to which the enterprise has developed. The latter will to a considerable extent determine the means by which money can be obtained, as well as the persons to whom an appeal can profit ably be made.
When an enterprise is wholly new and is not•formed to take over some existing concern, capital is obtained usually in the form of cash and by the issue of com mon stock. The enterprise being new and its earn ing capacity untested, it involves a large element of risk, which all who participate must be willing to share. In such cases the capital stock is usually sub scribed in small amounts by a relatively large num ber of persons. Particularly is this true of industrial corporations.
The conditions under which preferred stock can be issued do not obtain in such case. On the one hand, investors have no guarantee that the dividends on the preferred stock will be paid. On the other hand, the subscribers to the common stock cannot afford to promise a definite return to the holders of other stock while the success of the undertaking is still problem atical.
14. Incorporating existing enterprises.—As a mat ter of fact, few corporations outside of the banking business and a few other limited fields start as abso lutely new ventures. More commonly the corpora tion is formed to take over an existing concern. When this is done the past record of the concern which is ab sorbed in the new corporation often gives a basis for issuing preferred stock.
Under these conditions the two forms of stock are frequently employed, and in this case cash subscrip tions are apt to be only a part of the total contribu tion to the capital stock, the remainder consisting of the assets of the concern which is being taken over by the new corporation. In the case of holding com panies, the new bonds or stocks are given in exchange for the securities of the constituent companies.