What it is:
How it works/Example:
For example, let's assume that John invests $10,000 in Start-Up Company. About 500 other investors also invest in the new corporation.
Start-Up Company develops and takes its first product to market, but the product bombs and the company needs to raise some cash. It sells assets, lays off workers, and downsizes considerably. It also misses several debt payments and damages its credit rating, making it very hard and expensive to borrow. Eventually the company files for bankruptcy and it sells its assets to repay creditors, leaving shareholders with virtually nothing.
If John held his investment all the way from $10,000 to $0, he is a bag holder.
Why it matters:
Nobody wants to be a bag holder, but there are plenty of ways investors can become bag holders. This is why investors must take precautions to mitigate risk, such as reading financial statements, listening to conference calls and identifying the red flags that indicate it's time to sell an investment.