Equity shares are popular investment options among investors. Equity shares offer fraction ownership of the company. Therefore, equity shareholders are considered as part owners. Equity shares are issued to the general public for the first time through an Initial Public Offering (IPO). Upon listing, equity shares trade on the stock exchange. This article covers equity shares, their features and types in detail.
A company issues equity shares to raise capital at the cost of diluting its ownership. Investors can purchase units of equity shares to get part ownership of the firm. By purchasing the equity shares, investors will be contributing towards the total capital of the company and becoming its shareholder.
Equity shareholders are the owners of the company to the tune of the shares held by them. Through equity investing, investors benefit from capital appreciation and dividends. In addition to the monetary benefits, equity holders also enjoy voting rights in critical matters of the company.
The primary motive to issue equity shares is to raise funds for expansion and growth. Company issues equity shares to the general public through Initial Public Offer (IPO). IPO is a primary market offering. You can subscribe to the share by subscribing to the IPO. You can easily trade the stocks upon their allotment and listing on the stock exchange. The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are popular stock exchanges in India.
Equity shareholders receive the profits a company makes. Most large-cap and well-established companies pay dividends and bonuses to their shareholders.
The value of an equity share is the face value or book value. When more people buy shares of a company, the share prices will rise. While, if more people are selling, then the prices will fall.
However, when the shares start trading on the exchange, the supply and demand determine the prices.
If a company’s growth prospects seem promising, investors wish to invest in it to benefit from capital appreciation. Similarly, if the company is performing poorly, investors would want to exit their positions. As a result, they sell their holdings.
Following are the different types of Equity Shares:
Ordinary shares are those shares a company issues to raise funds to meet long term expenses. Investors get part ownership of the firm. It is to the tune of the number of shares held by then. An ordinary shareholder will have voting rights.
Preference equity shares are an assurance of the payment of a cumulative dividend to investors before ordinary shareholders. On the other hand, preference shareholders lack the voting and membership rights of a common shareholder.
Preference shares are classified as participating or non-participating. If an investor purchases participation preference shares, they get a specified amount of profits as well as bonus returns. These benefits are subject to the company’s success in a specific financial year. Non-participating equity shareholders do not get any such benefit.
Furthermore, preference shareholders receive repayment of capital when the company is dissolving or winding up its business.
Bonus shares are a type of equity shares a company issues from its retained earnings. In other words, a company’s distributes its profits in the form of a bonus issue. However, this doesn’t increase the company’s market capitalisation, like how other equity shares do.
Rights shares are not for everyone. The company issues these shares only for specific premium investors. As a result, the equity stake of such holders increases. The rights issue is done at a discounted price. The motive is to raise money to meet financial requirements.
Directors and employees of a company receive sweat equity shares. They get the shares at a discount for their excellent work in providing intellectual property rights, know-how, or value additions to the company.
Employee Stock Options (ESOPs)
A company gives ESOPs to its employees as an incentive and as a retention strategy. Employees are given the option to purchase shares at a predetermined price at a future date under the terms of an ESOP. Employees and directors who exercise their ESOP grant option receive these shares.
Following are the key features of equity shares:
- Permanent Shares: Equity shares are permanent in nature. The shares are permanent assets of a company. And are returned only when the company winds up.
- Significant Returns: Equity shares have the potential to generate significant returns to the shareholders. However, these are risky investment options. In other words, equity shares are highly volatile. The price movements can be drastic and are dependent on multiple internal and external factors. Therefore, investors with suitable risk tolerance levels should only consider investing in these.
- Dividends: Equity shareholders share the profits of a company. In other words, a company may distribute dividends to its shareholders from its annual profits. However, a company is under no obligation to distribute dividends. In case a company doesn’t make good profits and doesn’t have surplus cash flow, it can choose not to give dividends to its shareholders.
- Voting Rights: Most equity shareholders have voting rights. This allows them to select the people who will govern the company. Choosing effective managers assists the company to enhance its annual turnover. As a result, investors can receive higher average dividend income.
- Additional Profits: Equity shareholders are eligible for additional profits a company makes. It, in turn, increases the wealth of the investor.
- Liquidity: Equity shares are highly liquid investments. The shares are trade on the stock exchanges. As a result, you can buy and sell the share anytime during trading hours. Therefore, one doesn’t have to worry about liquidating their shares.
- Limited Liability: Losses a company makes doesn’t affect the ordinary shareholders. In other words, the shareholders are not liable for the company’s debt obligations. The only effect is the decrease in the price of the stocks. This will have an impact on the return on investment for a shareholder.
Following are the different types of share capital:
Authorized Share Capital
All firms must declare the amount of capital they seek to register in their Memorandum of Association. The number thus specified is the registered, authorized or nominal capital. In simple terms, it is the amount of money that a company can raise through a public subscription.
Issued Share Capital
Issued Share Capital is the portion of the nominal capital that is available for public subscription as shares. However, a company doesn’t have to issue all of its registered capital at once. They may go for further issues, as well. Therefore, it depends on the financing requirements of the company.
Issued capital must never exceed authorized capital in any circumstance. In general, it refers to all of the shares that the signatories of the memorandum of association, the general public, and vendors etc., hold.
Unissued Share Capital
Unissued Share Capital is that portion of the authorized capital that is not yet issued. In other words, it is the difference between the authorized share capital and the issued share capital.
Sometimes, the entire issued capital is not subscribed to by the general public. Only a part of issued capital that is subscribed by the general public is subscribed capital. Therefore, the subscribed capital is not always the same as the issued capital.
It is a common practice that shareholders pay the share price in instalments. For example, application allotment, first call, final call, etc. Therefore, called up capital is the portion of subscribed capital that the company calls upon or demands the shareholders to pay.
Uncalled capital is the unpaid portion of the issued capital that will be considered as subscribed capital upon payment. In simple terms, these are shares that have been issued but haven’t been claimed. Only upon receiving payments against these shares they will become part of the subscribed capital.
Paid-up capital is a part of called-up capital. It refers to the amount of money paid by shareholders in response to a company’s call. Typically, a company’s paid-up capital is calculated by deducting outstanding calls from called-up capital.
The existing assets of the company are part of the fixed capital. For example, building, land, furniture, machinery, intellectual property rights, plants, etc.
A company cannot access the reserve capital until it is in the process of liquidating or winding up. Only through a special resolution with a 3/4th majority vote in favour, a company can establish reserve capital.
The Articles of Association cannot be changed to make the reserve liability available at any time after they have been constituted. Also, the company cannot use such capital as collateral for loans. Furthermore, the company requires a court order to change it to ordinary capital, and it’s only available to creditors when a business is closing down.
Circulating Capital is part of a company’s subscribed capital. Operation assets like receivables, book debts, bank reserves, etc., form part of the circulating capital. Furthermore, it is the capital that the company uses for its fundamental operations.