Equity Share Capital: Meaning, Types, and Benefits
Equity share capital is a critical component of a company's financial structure. Understanding the term “equity share capital” becomes essential for an Indian share market investor while making investment decisions. In this article, we will delve into the meaning of equity capital, and explore the benefits and types of equity share capital.
Table of Content
- Equity Share Capital: Meaning, Types, and Benefits
- What are Equity Shares?
- Why Do Companies Issue Equity Shares?
- What is Equity Share Capital?
- Types of Equity Share Capital Based on Balance Sheet Positioning
- Types of Equity Share Capital: Based on the Nature of Shares Issued
- Advantages of Equity Share Capital
What are Equity Shares?
Equity shares, also simply referred as stocks or shares, represent ownership in a company. So, by owning equity shares, you, as an investor, become a part-owner of the company. This gives you a claim on its profits and assets. That said, equity shareholders also bear the highest risk since they are last in line to receive a company’s proceeds in the event of a bankruptcy but also enjoy the potential for higher returns.
Why Do Companies Issue Equity Shares?
Companies issue equity shares for various reasons, and it is a crucial aspect of their financial strategy. One of the primary reasons for issuing equity shares is to raise funds for business expansion, new projects, research and development, or to meet working capital requirements. With equity, there are no fixed interest payments or strict repayment schedules. This allows companies to allocate resources more efficiently and focus on strategic decisions rather than meeting debt obligations.
When a company issues equity shares, it signals confidence in its future growth prospects. Investors view this move as a positive sign that the company believes in its ability to generate profits and increase shareholder value. Investors view this move as a positive sign that the company believes in its ability to generate profits and increase shareholder value.
What is Equity Share Capital?
Now, moving on, equity share capital refers to the total value of funds raised by a company through the issuance of equity shares. It represents the permanent or long-term capital invested by the shareholders in exchange for ownership rights and dividends. Equity share capital provides a financial backbone for a company's operations and capital expansions projects.
Types of Equity Share Capital Based on Balance Sheet Positioning
Authorised capital represents the maximum amount of share capital that a company is legally allowed to issue as defined by the authorities. It defines the upper limit of the company's equity share capital; that said, they can increase appeal to the concerned authorities to increase the number of authorised shares.
Issued Share Capital
This is the proportion of authorised capital that the company has actually offered and issued its shareholders—that includes retail investors. It represents the amount of capital subscribed by the shareholders.
Subscribed capital refers to the portion of issued capital that shareholders have agreed to purchase and pay for.
It denotes the amount of subscribed capital for which shareholders have made the necessary payment. Paid-up capital is the actual capital that the company has for its operations and investments.
Types of Equity Share Capital: Based on the Nature of Shares Issued
Ordinary shares, also referred as common stock, are the most common types of equity shares issued by companies. These shareholders have voting rights in the company's general meetings and are entitled to dividends after preference shareholders receive their dues.
Preference shares, in contrast, carry preferential rights over ordinary shares, ensuring a fixed dividend rate and priority during the distribution of profits or during the liquidation or bankruptcy of the company. That said, these shareholders usually do not have voting rights.
Bonus shares, also called scrip dividends, are additional shares issued to existing shareholders in the form of dividends, without any cost. Bonus shares are one of the ways companies utilise accumulated profits or reserves to reward shareholders.
Finally, right shares are issued by companies to existing shareholders, giving them the opportunity to purchase additional shares at a predetermined price.
Advantages of Equity Share Capital
A company’s equity share capital functions as its permanent capital; It is not like debt financing that comes with the obligation of repaying the lender. This helps stabilise the businesses capital structure, while also reducing financial risk.
Adding to the previous point, equity share capital is a more cost-effective source of finance compared to debt. since the latter mandates repairing the lender with interest. Therefore, equity share capital reduces the financial burden on the company, letting it allocate more funds towards growth projects.
Lures Long-term Investors
Equity share capital helps lure long-term investors who seek wealth appreciation by virtue of investing in the company’s stock. This leads to a fortified shareholder base creating stability.
No Mandatory Dividends
Finally, it is not mandatory for a company to pay dividends to its equity shareholders. This provides a degree of flexibility to the company, since it won;t have to pay out dividends if its going through a rough patch in terms of financial performance.
Improved Financial Ratios
Equity share capital does not create any financial burden in the form of interest payments. This can lead to improved financial ratios, such as debt-to-equity ratio and interest coverage ratio, making the company more attractive to investors and lenders.
Equity shareholders share the risk and reward of the company's performance. If the company performs well and its value increases, shareholders benefit from capital appreciation. On the other hand, if the company faces losses or declines in value, shareholders also share in those losses.
To conclude, equity share capital plays a critical role in the financial structure of a company. By understanding the types and benefits of equity share capital, you, as an investor, can make informed investment decisions and participate in the growth and success of companies. That said, it is essential that you manage your risks effectively since equity investments do not come without risks.
Benefits and Types of Equity Share Capital FAQs
No, equity shareholders losses are limited to the extent of their cumulative investment in the company.
No, besides bonus shares, dividends are also paid to equity shareholders in the form of cash, which is in fact a more common practice, and is directly transferred to the shareholders bank account.
Yes, some companies may offer convertible equity shares that can be converted into other types of equity shares like preference shares; however they are based on predetermined terms and conditions.
Yes, equity shares are widely regarded as suitable for long-term investment instruments as they provide the opportunity for capital appreciation and higher returns over an extended period.
Yes, you can very well lose money as an equity share investor if the company stocks in which you have invested loses its value. Hence it is important to perform thorough research before investing in equity.