When investing in a company, individuals typically choose between stocks and bonds. Shareholders, who purchase stocks through a brokerage, become part-owners of the company and may profit from increased share value. Bondholders, on the other hand, essentially lend money to the company in exchange for interest payments and the eventual return of their principal. Both options offer potential returns.

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Who are Shareholders?

A shareholder is an individual, company, or institution that owns at least one share of a company's stock or a mutual fund. Shareholders essentially have ownership of the company, giving them the right to share in its profits.

When a company prospers, shareholders benefit from increased stock value or dividends. They also have the right to vote in corporate elections. Conversely, if the company loses money, the share price drops, leading to potential losses for shareholders. In the event of a company's failure, shareholders can claim any remaining assets after debts are settled.

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Who are bondholders?

Bondholders are individuals, companies, or institutions that own bonds issued by a corporation, government, or other entity. Unlike shareholders, bondholders are creditors to the issuer and do not own a stake in the company. Instead, they lend money to the issuer in exchange for periodic interest payments and the return of the bond's face value upon maturity. Bondholders have a higher claim on assets than shareholders if the issuer faces bankruptcy, giving them a relatively lower risk compared to equity investors.

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How do bondholders and shareholders work?

In the U.S., bondholders and stockholders play distinct roles within a company's financial structure.

Bondholders:

- Act as creditors who lend money to the company by purchasing bonds.

- Receive periodic interest payments and the return of the principal upon bond maturity.

- Have priority over stockholders in asset claims if the company goes bankrupt, making their investment less risky.

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Stockholders:

- Own shares of the company, giving them partial ownership.

- Benefit from profits through dividends and stock price appreciation.

- Have voting rights in corporate decisions but are last in line for asset claims during bankruptcy, making their investment riskier but with potential for higher returns.

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Functioning between shareholders and bondholders

While both shareholders and bondholders provide funding to companies, they differ in rights and responsibilities. Buying bonds makes one a creditor, not an owner, and bondholders are primarily concerned with buying or selling bonds for profit.

In contrast, shareholders enjoy ownership privileges, including voting rights at Annual General Meetings and influencing executive appointments. 

Regarding payments, companies must pay bondholders interest before paying dividends to shareholders. Bonds offer fixed returns, providing income stability with lower risk, while shares offer variable returns tied to company performance, carrying higher risk but potential for higher rewards. Each suits different investment goals and risk appetites.

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Difference between Bondholders and Shareholders

Ownership and Role:

• Bondholders: Are creditors who lend money to a company by purchasing bonds. They do not own any part of the company.
• Shareholders: Own a portion of the company through their shares, granting them ownership rights.

Returns:

• Bondholders: Receive fixed interest payments and the return of the principal upon bond maturity. Their returns are predetermined and less volatile.
• Shareholders: Earn returns through dividends and stock price appreciation. Their returns are variable and depend on the company’s performance.

Priority in Payments:

• Bondholders: Have a higher claim on assets and earnings. Interest payments to bondholders are mandatory and paid before dividends.
• Shareholders: Have residual claims, receiving dividends only after all obligations, including bond interest, are met.

Risk and Return:

• Bondholders: Face lower risk with a fixed income and a capped upside.
• Shareholders: Experience higher risk with the potential for greater returns if the company performs well.

Influence and Rights:

• Bondholders: Generally do not have voting rights or a say in company management.
• Shareholders: Have voting rights, allowing them to participate in corporate governance and decisions at shareholder meetings.

Bottom line

Investing in a company involves a choice between becoming a shareholder or a bondholder. Shareholders own a piece of the company and share in its profits or losses, while bondholders lend money to the company and receive interest payments. Understanding the distinct rights and benefits of each option is crucial for making informed investment decisions that align with your financial goals. As an investor, you can also invest in Compound real estate bonds, which offer fixed 8.5% APY and provide flexibility to withdraw your funds anytime without any penalties.