An equity share signifies ownership of a company, which entitles the shareholders to a vote and an interest in profit through dividends. What is equity share capital? Equity share capital is the money a company mobilises by selling equity shares to investors. Equity share capital is the main source of funds for most businesses. It symbolises the shareholders’ ownership interest in a company. When a company raises funds by offering equity shares, it does not need to return the money since shareholders become partial owners. This renders equity share capital a crucial part of a company’s financial structure.
What are Equity Shares?
Equity shares, or ordinary shares, are company ownership shares. Shareholders of these shares are entitled to a portion of the company’s profits, voting rights in company matters, and a claim on the company’s assets in the event of liquidation.
Example of Equity Shares: Assume a firm offers 1,00,000 equity shares of ₹10 each. When you purchase 1,000 shares, you hold 1% of the firm. Your earnings are subject to the profitability of the firm and the movement of the stock prices.
What is Equity Share Capital?
Equity share capital is the sum of money a company raises through issuing equity shares. It is a significant component of the company’s capital structure and plays an important role in business operations and growth.
In addition, companies can raise funds by offering equity shares in two ways: privately or, if a listed company, through an Initial Public Offering (IPO). After they invest through an IPO, the investors will benefit from their equity investment in dividends, acquiring voting rights, and acquiring potential increases in value as the company grows. Understanding what equity shares are and how they benefit is crucial to any investor.
Features of Equity Share Capital
Equity share capital is the source through which a company funds its activities (and growth) through the ownership of the business. It has multiple features that determine its function in shareholders’ finance, profit sharing, and risk management.
- Permanent Capital: Unlike loans, the company does not repay equity share capital. As long as the company is there, it is financial support and long-term.
- No Fixed Dividend: Dividends are paid only if the company earns profits. A shareholder does not get any dividends if the company makes no profit.
- Risk-bearing instrument: The Use of Company’s Financial Risks Fall Under Shareholders If the company incurs losses, equity stockholders may write down the value of their investment.
- Residual Claims: Equity shareholders are the last to get paid in case of liquidation after settling all debts and preference shares. They are paid any remaining assets only after all obligations have been settled.
- Risk of Market: The market influences the price of ordinary share capital. Based on business performance and investor sentiment, stock prices do not rise and fall.
- No Repayment Obligation: Unlike debt shares, equity shares do not have a maturity date, which means the company is not obliged to repay the amount. An investor walks away from an investment in the stock market by selling their shares.
Cost of Equity Share Capital
The equity share capital cost is the amount a company has to provide to entice investors. It is normally obtained from the Dividend Discount Model (DDM) or Capital Asset Pricing Model (CAPM).
Why Do Companies Issue Equity Shares?
Businesses sell shares to the general public to fund different business operations. It is a method of financing that is preferred over debt financing because of its benefits.
- Capital for Business Growth: The companies use the proceeds for expansion, mergers, and acquisitions. Companies use equity capital to fund new projects and investments in new ventures. It also promotes the R&D that drives innovation and market competitiveness.
- No Debt Responsibility: It is not repayment pressure like loans. That makes it easier for companies to stay financially sound as they do not need to pay fixed interest on share capital. This enables companies to reinvest earnings in growth rather than in paying on debt.
- Improved Creditworthiness: A solid equity base raises a company’s pay. A well-funded company is viewed as financially stable by lenders and investors. This makes it simpler to understand how to raise more in the future.
- Investor Liquidity: Shareholders can buy and sell shares on the stock market. Investors can buy or sell shares anytime, giving equity investment a liquid asset structure. This liquidity draws in additional investors seeking profitable ventures.
- Ownership Diversification: It helps a company to distribute ownership over several owners. This minimizes control risk and adds other perspectives. Having a wide base of shareholders also bolsters investor confidence.
- Investor Magnetism: Equity shares create demand from both retail and institutional investors. Strong stock performance leads more people to invest. An ideal company will gain long-term investor trust with good governance and profitability.
Types of Equity Share Capital
Types of equity share capital determine how funds are raised, and ownership is allocated among investors. Knowledge of the types assists in managing finances appropriately by businesses and enables investors to make informed decisions.
Authorized Share Capital
It is the maximum amount of capital that a company can issue, as stated in its articles of incorporation. This cap is specified in the company’s Memorandum of Association (MoA) and may be raised with the appropriate approvals. A company is not required to issue all of its authorized capital immediately. Instead, they can issue shares, as needed, to raise money over time. This means businesses can establish authorized capital well above their current to allow for future growth without the constant need for legal adjustments.
Issued Share Capital
Issuance Capital or Issued share capital is part of the component of authorized capital, which the company issues to shareholders. This is the sum of the total capital that the company has been circulating by selling shares to the investors. Capital may be issued lower than authorized capital, as company shares need not be issued simultaneously. The number of shares a business makes depends on its financial requirements and market demand.
Subscribed Share Capital
Subscribed share capital is the portion of issued capital investors have committed to purchasing. This metric indicates the number of shares shareholders have contracted to be purchased. Not all shares issued will result in subscriptions immediately, as some investors will decline to purchase. Shareholders subscribe to shares they agree to pay a certain amount, which becomes a debt they are legally obligated to pay. Subscribed capital is a measure that companies use to judge the interest and support of investor Approval.
Paid-up Share Capital
Paid-up share capital is the money the company collects from shareholders. It is never more than subscribed share capital (less any amount unpaid by investors). Shares may be partly paid. Paid-up capital is the amount invested in the company, representing its actual funding for business operations and growth. Unlike borrowed money, this capital must not be repaid.
Bonus Share Capital
Bonus share capital refers to shares offered to existing shareholders without further investment. Companies issue bonus shares out of their accumulated profits or reserves to benefit their shareholders. These shares add to the total number of shares owned by investors but have no effect on the company’s cash flow. The bonus shares enhance the liquidity of stocks and confidence among the investors. They also enable companies to cut per-share prices, making shares easier for new investors to purchase.
Rights Share Capital
The rights share capital means that the shares are priced below and are given to existing shareholders before they are offered in the open market. It gives existing investors a right to keep their ownership stake in the company. Companies offer Right shares to raise extra funds for expansion or pay off debt. The cheaper price these shares are offered makes it a lucrative investment opportunity. The shareholders can purchase the rights shares or sell their rights to other investors.
Sweat Equity Share Capital
Sweat equity share capital comprises shares issued to employees, directors, or other key contributors in exchange for expertise, contributions, or ideas. This is a great way for businesses to keep top talent in rewarding and incentivized positions for long-term commitment. Instead of receiving a direct payment of their salary, these shares are paid out as compensation for their skills and efforts. Startups and tech companies often deploy sweat equity to win talent. It aims to improve employee motivation and align their interests with company growth.
Example of Equity Share Capital
Let’s assume ABC Ltd. has an authorised share capital of ₹50 lakh and issues 4 lakh shares at ₹10 each.
- Issued Share Capital = 4,00,000 × ₹10 = ₹40 lakh
- Subscribed Share Capital = 3,50,000 × ₹10 = ₹35 lakh
- Paid-up Share Capital = 3,50,000 × ₹10 = ₹35 lakh
ABC Ltd. has successfully raised ₹35 lakh from equity shareholders, which forms its equity share capital.
Risks Associated with Equity Share Capital
Risks in Equity Share Capital can affect investor returns. Knowing these risks allows investors to make educated decisions and handle their investments properly.
- Market Risk: The prices of stocks vary with market conditions, which can influence investors’ returns. Economic changes, political events, industry trends, etc, influence share price adjustments. To minimize risk, investors should monitor market trends and diversify their portfolios.
- No Guarantee of Dividends: While preference shares offer guaranteed dividends, equity shareholders only pay when the company is profitable. Its investors don’t get dividends if a firm does not earn profits. Thus, equity shares are a much less predictable source of income than fixed-income investments.
- Dilution of Ownership: New shares issued by a company dilute shareholders’ voting power. This affects big investors’ control over decision-making.
- No Volatility Risk: Equity shares are much more volatile than debt instruments. Market conditions can impact share price to a large extent. Investors should expect price swings and be long-term players with a risk management plan.
- Long-term Capital Gain on Equity Shares: If the long-term capital gain on equity shares of a listed company exceeds the exemption limit, investors need to pay tax on it. This is based on government regulations and the effects of taxes. Knowledge about tax regulations enables investors to plan their investments prudently.
Equity Share Capital FAQs
1. What is the difference between equity share capital and preference share capital?
Equity share capital is ownership with voting rights, whereas preference share capital gives fixed dividends but no voting rights.
2. How is the cost of equity share capital calculated?
It is calculated by employing models such as the Dividend Discount Model (DDM) or the Capital Asset Pricing Model (CAPM).
3. Is long-term capital gain on equity shares taxable?
Yes, long-term capital gain on equity shares over ₹1 lakh is charged at 10% in India.
4. Can a company issue equity shares without raising funds?
Yes, by way of bonus shares or sweat equity shares.
5. Why do investors like equity shares?
Investors like equity shares due to their growth and voting rights, though with risk.
