Claim

A Claim is a legal right to a company's assets and/or its future profits. Think of a company as a pie. Various parties have a “claim” to a slice of that pie, but not all slices are created equal, and not everyone gets to eat at the same time. These claims are the fundamental building blocks of a company's capital structure, which is the specific mix of debt and equity it uses to finance its operations. The two main groups with claims on a company are its creditors (lenders) and its owners (shareholders). Understanding the type, size, and priority of these different claims is absolutely essential for any investor, as it directly determines how much risk you're taking and what your potential reward might be. For a value investor, analyzing the hierarchy of claims is a critical step in assessing a company's financial health and calculating its true worth.

Imagine a company fails and has to sell everything it owns in a process called liquidation. The cash raised is used to pay back everyone who has a claim on the company. However, there’s a strict “pecking order” that dictates who gets paid first. This hierarchy is one of the most important concepts in finance. If you're standing at the back of the line, you might get nothing, even if you're an owner of the company. The general rule is simple: Creditors first, owners last. A company's balance sheet provides a roadmap to these claims. The liabilities side shows the claims of creditors (what the company owes), and the equity side shows the claims of the owners (what's left over).

Creditors are lenders who have provided capital to the company in exchange for a promise of repayment, plus interest. Their claim is generally considered safer than an owner's because they have a higher priority in the pecking order. If the company misses an interest payment, creditors can even force it into bankruptcy.

• Secured Debt: This is the king of claims. It sits at the very front of the line because it is backed by specific collateral, which is an asset the lender can seize if the company defaults. A common example is a mortgage on a company's headquarters. The lender has a direct claim on that building.
• Unsecured Debt: This is a more common type of claim for large corporations, often taking the form of a corporate bond. It is not backed by a specific asset. Instead, bondholders have a general claim on the company's overall assets after the secured creditors have been paid. They are paid before any shareholders.
• Subordinated Debt: This is the riskiest type of debt. As the name implies, its claim is “subordinated” or ranked below other, more senior debt. These lenders only get paid after all secured and unsecured creditors have been fully repaid, putting them just one step above shareholders.

Owners, or shareholders, have a claim on the profits and assets of the company after all debts have been paid. This is why their position is often called a residual claim—they get whatever is left over. This makes ownership riskier than lending, but it also offers the potential for much greater rewards.

• Preferred Stock: This is a hybrid security that acts a bit like debt and a bit like equity. Holders of preferred stock have a claim that is senior to common stockholders but junior to all debt holders. They typically receive a fixed dividend payment, and these must be paid before any dividends can be distributed to common stockholders.
• Common Stock: This is the claim you have when you buy a share of a company on the stock market. Holders of common stock are the true owners of the business, but they are last in line. They have a claim on all the profits and assets remaining after every other claimant has been paid. While this position carries the most risk, it also holds unlimited upside potential. If the company prospers, the value of the residual claim can grow enormously.

For a value investing practitioner, understanding claims is not just academic; it's the bedrock of risk analysis. A key principle, famously championed by Benjamin Graham, is the margin of safety. A company with a mountain of debt has huge, powerful claims sitting ahead of your equity claim. This dramatically reduces your margin of safety. A small dip in the company's business performance could wipe out all the value available to you as a common stockholder, as the profits are eaten up by interest payments. Conversely, a company with little or no debt has a clean and simple capital structure. The claim of common stockholders is much stronger and less risky. When you calculate a company's intrinsic value, you are essentially estimating the present value of its future profits available to shareholders. The more claims that stand in front of you, the more uncertain and fragile that value becomes. Therefore, a wise investor always scrutinizes the pecking order of claims before putting a single dollar to work.