Equity Shares

Contents

Introduction

Types of Equity Shares

Merits & Demerits

Features of Equity Shares

Evaluation from the Company’s view point

Introduction

What are equity shares?

An equity share, commonly referred to as ordinary share also represents the form of fractional or part ownership in which a shareholder, as a fractional owner, undertakes the maximum entrepreneurial risk associated with a business venture. The holders of such shares are members of the company and have voting rights.

The holders of such shares are members of the company and have voting rights. A company may issue such shares with differential rights as to voting, payment of dividend, etc. 

Types of Equity Shares Rights Issue/ Rights Shares: The issue of new securities to existing shareholders at a ratio to

those already held. 

Bonus Shares: Shares issued by the companies to their shareholders free of cost by capitalization of accumulated reserves from the profits earned in the earlier years. 

Preferred Stock/ Preference shares: Owners of these kind of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid regularly before dividend can be paid in respect of equity share. 

They also enjoy priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank below the claims of the company’s creditors, bondholders / debenture holders. 

Cumulative Preference Shares. A type of preference shares on which dividend accumulates if remains unpaid. All arrears of preference dividend have to be paid out before paying dividend on equity shares. 

Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company. 

Participating Preference Share: The right of certain preference shareholders to participate in profits after a specified fixed dividend contracted for is paid. Participation right is linked with the quantum of dividend paid on the equity shares over and above a particular specified level. 

Security Receipts: Security receipt means a receipt or other security, issued by a securitization company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitization.

Government securities (G-Secs): These are sovereign (credit risk-free) coupon bearing instruments which are issued by the Reserve Bank of India on behalf of Government of India, in lieu of the Central Government's market borrowing programme. These securities have a fixed coupon that is paid on specific dates on half-yearly basis. These securities are available in wide range of maturity dates, from short dated (less than one year) to long dated (upto twenty years). 

Debentures: Bonds issued by a company bearing a fixed rate of interest usually payable half yearly on specific dates and principal amount repayable on particular date on redemption of the debentures. Debentures are normally secured/ charged against the asset of the company in favour of debenture holders.

Merits of equity shares

Company need not have the forced obligation to pay dividend to equity shareholders.

Equity share is a permanent source of funds which facilitate flexibility in usage of funds.

The obligation to repay the equity capital arises only at the time of liquidation of the company.

The shareholders can participate in the management of the company through voting rights.

Equity shares can be issued without creating any charge over the assets

Demerits of Equity Shares:

Equity shares always associated with the expectations of the investors. It is practically a difficult task to fulfill the expectations of the investors.

Equity shareholders have to bear all the losses at the time of liquidation. Interruptions of many persons are involved in the company working. So, in some cases, it creates delay in decision-making.

When the finance has to be raised for less risky projects, then this is not a good source of raising finance. If only equity shares are issued then the company can not avail the benefits of trading on equity.

Investors who have a desire to invest in safe or fixed returns have no attraction of such shares.

Features of Equity Shares

1. Right to income

2. Right to control

3. Pre-emptive Right

4. Right to Liquidation

Features of Equity Shares

1. Right to income :

The equity investors have residual claim to the income of company. The income left after satisfying the claims of all other investors belongs to equity shareholder. This income is simply equal to profit after tax minus preference shares dividend. The income of equity shareholders may be retained by the firm or paid out as dividends.

Equity earnings which are retained in firm tend to increase market value of equity shares & earnings distributed as dividend provide current income to equity shareholders.

2. Right to control

Equity shareholders are owners of the firm. So they can elect the board of directors & have right to vote on every resolution passed before the company. The board of directors selects the management & management controls the operations of firm. Hence, equity shareholders indirectly control the operation of firm.

3.Pre-emptive right

The pre- emptive right enables existing shareholders to maintain their proportional ownership by purchasing the additional equity shares issued by company. According to law, existing shareholders have first priority to purchase additional shares on pro rata basis before the others. Ex. if company has 10,00,000 outstanding shares of equity & proposes to issue 3,00,000 additional equity shares, an equity shareholder owing 100 shares has the first right to purchase 30 of 3,00,000 new shares before those are offered to anyone else

4.Right in liquidation

Equity shareholders have a residual claim over the assets of the firm in the event of liquidation. Claims of all others- debenture holders, secured lenders, unsecured lenders, other creditors, & preference shareholders – are prior to the claim of equity shareholders.

Evaluations from the view point of Company:

Advantages :

Permanent capital :

It represents permanent capital. Hence there is no liability for repayment.

No obligation to pay dividend :

Equity shares impose no obligation on the company to pay a fixed dividend to the equity shareholders. They get dividend if adequate profits are available.

No charge on property :

The company is able to procure capital without creating charges on its property, which remain free & can be utilized when additional funds are required by the company.

Wide scope of marketability :

Equity shares are lower denominations, hence they can be purchased by persons of limited income also. So there is a wide scope of marketability of equity shares.

High credit worthiness :

The equity capital increases the company’s financial base & thus it’s borrowing limit increase. Lenders generally lend in proportion to the company’s equity capital. By issuing Equity shares, the company increases its financial capability. It can borrow when it needs additional funds.

High premium :

The company can easily sell equity shares on premium in times of boom. Even in such circumstances , people are most eager to buy equity shares. Hence company can easily & quickly raise fixed capital through equity shares.

Evaluations from the view point of Company:

Disadvantages: Cost of equity :

Cost of equity is generally highest. The rate of return required by equity shareholders is generally higher than rate of return required by other investors.

Floatation cost :

Floatation cost means cost of issuing equity shares, which is higher than cost of issuing other types of securities. Underwriting commission , brokerage costs & other issue expenses are higher for equity capital.

Interference in management :

Equity shareholders have voting rights. Hence there may be interference in existing pattern of management.

Speculation :

There are the higher chances of speculation because it is traded in stock market.

Dividend is not tax deductible :

Equity share dividend is not tax deductible payment

Dilution of control :

Sale of Equity shares to outsiders may result in dilution of control of existing shareholders