Understanding Equity Shares and Their Role in Business
Equity shares, also called ordinary shares, represent a stake in a company, giving shareholders part-ownership and a share in the company’s profits through dividends. Equity shareholders also have voting rights, allowing them to influence key company decisions during shareholder meetings. Unlike debt instruments, equity shares do not offer fixed returns, as their value depends on the company's performance and market fluctuations.
For businesses, equity shares are a crucial source of long-term capital, supporting growth and expansion. For investors, they are a preferred option due to the potential for wealth creation and involvement in the company. This page provides a clear understanding of equity shares, their features, benefits, and significance for both businesses and investors.
Every organization, whether public or private, issues different types of shares to sustain its operations and delegate management responsibilities. This also includes raising new funds for the business. To achieve this, equity shares are issued.
What are Equity Shares?
Equity shares, also called ordinary shares, are offered to the general public at a predetermined face value. They serve as a major source of investment for a company—more shares sold mean more investment inflow. In exchange, shareholders gain partial ownership of the company.
Equity shareholders have the right to vote in the company's Annual General Meetings. Since these votes influence key business decisions, they must be used wisely.
Equity Shares Capital's Characteristics
The corporation retains its equity share capital. It is only returned when the firm is shut down.
Equity shareholders have the right to vote and elect the company's management.
The dividend rate for equity capital depends on the availability of surplus funds. However, the dividend rate is not fixed.
The Goals of Financial Management
Financial management's main goal is to maximise shareholder wealth by increasing the current market value of equity shares.
Increase the Value of the Company's Stock
The basic goal of financial management, commonly known as "the wealth maximisation principle," is to achieve this.
This entails maximising the present market value of the company's equity shares, which is only feasible if funds are used efficiently to meet organisational goals.
The number of equity shares held by a shareholder multiplied by the current market value of each share equals the shareholder's wealth.
Obtaining Adequate Money at the Lowest Possible Cost
The funds must be obtained at the cheapest possible price.
The company should strive to minimize the expenses associated with securing funds.
The cost of capital plays a key role in shaping the long-term success of the financial plan.
Optimal Use of Resources Obtained
The main issue for a business is to make sure that the profits outweigh the expenditures.
This goal guarantees that available monies are used efficiently and effectively.
Ensure the Security of your Investment
The safety of the investment is the centre of a smart financial decision.
Companies must develop and preserve their financial reserves.
To receive the best return on investment, the money earned should be wisely invested.
How to Establish a Stable Capital Structure
To ensure a sound and equitable capital composition, an appropriate balance of equity and debt should be maintained.
Few Pointers of Equity Shares
Here are some key features of these shares:
These shares are permanent and are only taken back if the company shuts down for any reason. In the case of very large companies, they are considered practically permanent.
Shareholders who own these shares have the right to vote and choose the management as well as the Board of Directors. This usually happens once a year during the Annual General Meeting (AGM) or, in rare cases, during an Extraordinary General Meeting (EGM).
These shares can be transferred, meaning an existing shareholder can sell them to another person.
People holding such shares have the right to claim dividend, which is issued when the company makes profits.
Equity shareholders cannot decide the rate of dividend which they would like to get. This decision is taken by the company’s management.
The liability of such shareholders rests only on the extent of their investment.
Types of Equity Shares
Several types of equity shares exist. The most common ones are as follows:
Authorised Share Capital: This is the highest amount of capital a company is allowed to issue as shares. The limit on these shares can sometimes change based on factors like the company's profitability, the number of shares issued, legal rules, and other conditions.
Subscribed Share Capital: This refers to the part of the issued capital that investors have chosen to buy and agreed to invest in.
Paid-Up Capital: This is the portion of subscribed capital for which investors have actually made the payment. It represents the real amount of money invested in the company.
Issued Share Capital: This is the portion of the authorised share capital that the company offers to investors as shares.
Rights Share: These are extra shares given to existing shareholders as a benefit or reward for their investment. However, a company may also choose not to issue rights shares.
Sweat Equity Shares: These shares are given to exceptional employees or executives as a reward for their hard work, technical expertise, or valuable contributions such as intellectual property.
Bonus Shares: These are additional shares distributed to shareholders when the company is performing well, usually given during bonus payouts.
Equity Shares vs Preference Shares
Most companies also issue preference shares that carry some extra benefits including the right to claim a portion of the dividend first. Here are the key differences.
These should complete the basics of equity shares for students of commerce. For further knowledge on equity shares, students can look up related topics on Vedantu. Students can also participate in Vedantu’s advanced online classes for better and more effective learning.
Stock Exchanges In India
India's stock exchanges are listed below. The following is a list of Indian stock exchanges that operate:
The Bombay Stock Exchange (BSE): Established in 1875, the Bombay Stock Exchange (BSE) is the oldest stock exchange in India and Asia. It is India's largest stock exchange, with headquarters in Mumbai, Maharashtra. BSE's market capitalization was $2.8 trillion in February 2021.
National Stock Exchange (NSE): Established in 1992, the National Stock Exchange (NSE) is India's pioneering stock exchange, offering a decentralized electronic trading platform for investors. As of the latest data, the NSE boasts a market capitalization of $2.27 trillion and, similar to the Bombay Stock Exchange (BSE), is located in Mumbai, Maharashtra.
Calcutta Stock Exchange (CSE): The Calcutta Stock Exchange, often known as the CSE, was founded in 1908. Its headquarters are in Kolkata, West Bengal. The CSE has been asked to leave by the Securities and Exchange Board of India (SEBI). However, the Calcutta High Court is now hearing the case.
India International Exchange (India INX): India International Exchange (India INX) is a stock exchange based in India that was established in 2017. It was the first international stock exchange in India. It is a subsidiary of BSE and is based in Gujarat International Finance Tec-City.
The Metropolitan Stock Exchange: MSE (Metropolitan Stock Exchange) was established in 2008. The MSE is a contemporary clearinghouse that was established to handle the clearing and settlement of contracts involving a variety of asset types. Its headquarters are in Mumbai, Maharashtra.
Advantages of Equity Shares
Here are the key advantages of equity shares:
Equity shares can be easily bought and sold at any time, making them highly liquid.
When the company earns higher profits, shareholders receive higher dividends.
Every shareholder has the right to vote and influence management decisions, especially during challenging times.
Apart from receiving annual dividends, shareholders also benefit from the increase in the value of their shares over time.
Drawbacks of Equity Shares
There exist the following drawbacks or disadvantages of equity shares.
A company is not required to pay dividends every year. Whether dividends are given depends on how well the company performs.
Equity shareholders are often widely spread out, or they may own only a small portion of the company's total shares. In such cases, it can be challenging for them to have any control over the company's decisions or benefits.
Equity shareholders face the highest level of risk associated with the company.
Changes in market value can reduce the profits earned by these shareholders.
Conclusion
The general public is granted equity shares with a pre-determined face value. They offer shareholders the ability to vote at the company's Annual General Meetings. It is a company's most important source of investment since the more shares it sells, the more money it receives.
FAQs on What is Equity Share? Definition, Features, and Importance
1. What is an equity share in simple terms?
An equity share, also known as an ordinary share, represents a part-ownership stake in a company. When you hold an equity share, you own a small fraction of the company, which entitles you to a share in its profits (through dividends) and gives you voting rights in major company decisions. Unlike a loan, its value is not fixed and depends on the company's performance.
2. What are the main features of equity shares as per the CBSE syllabus?
The key features of equity shares for a Commerce student to know are:
- Permanent Capital: The capital raised from equity shares is not returned during the company's lifetime. It forms a permanent source of funds.
- Voting Rights: Equity shareholders have the right to vote in shareholder meetings, allowing them to participate in the election of the board of directors.
- Variable Returns: The dividend paid on equity shares is not fixed. It depends entirely on the company's profitability and the management's decision.
- Residual Claimants: In the event of the company winding up, equity shareholders are the last to be paid, after all creditors and preference shareholders.
- High Risk, High Reward: They bear the highest risk but also have the potential for the highest returns through dividends and capital appreciation.
3. How do equity shares differ from preference shares?
The primary difference lies in the rights and risks associated with each. Equity shares grant voting rights and have variable dividends, making shareholders the real owners who bear the most risk. In contrast, preference shares typically do not have voting rights but receive dividends at a fixed rate and have priority over equity shareholders in receiving payments, both for dividends and during liquidation.
4. What are the different types of equity share capital?
A company's equity share capital is classified into different types based on its status:
- Authorised Capital: The maximum amount of capital a company is legally permitted to issue, as stated in its Memorandum of Association.
- Issued Capital: The part of the authorised capital that the company actually offers to the public for subscription.
- Subscribed Capital: The portion of the issued capital that investors have agreed to buy.
- Paid-up Capital: The amount of money from the subscribed capital that the shareholders have actually paid to the company.
5. What is the importance of issuing equity shares for a company?
Issuing equity shares is crucial for a company as it provides a long-term, permanent source of finance without the obligation of repayment during its operational life. It enhances the company's creditworthiness, provides a financial base for borrowing, and does not create a charge on the company's assets, offering significant financial flexibility for growth and expansion.
6. Why are equity shareholders considered the 'real owners' of a company?
Equity shareholders are considered the real owners because they hold the ultimate power and bear the ultimate risk. Their ownership grants them fundamental control through voting rights to elect directors who manage the company. Furthermore, they are the residual claimants to the company's income and assets, meaning their fortunes are directly linked to the success or failure of the business, just like a real owner.
7. What role does equity share capital play in a company's overall capital structure?
In a company's capital structure—the mix of debt and equity financing—equity share capital forms the foundational layer. It acts as a financial cushion that absorbs business risks, making the company more attractive to lenders. A strong equity base reduces the company's financial leverage and risk of bankruptcy, signifying stability and a long-term commitment from its owners.
8. What are the main disadvantages or risks for an investor holding equity shares?
While potentially rewarding, investing in equity shares carries significant risks. The returns are highly uncertain, as dividends are not guaranteed and depend on company profits. The market value of shares can fluctuate dramatically, leading to potential capital loss. Most importantly, as residual claimants, equity shareholders are the last to be paid if the company fails, and they may lose their entire investment.
