Equity Share Capital

Equity share capital is the portion of a company’s capital that is raised by issuing shares to shareholders in exchange for ownership of the company. It is a type of financial instrument that allows companies to raise funds from the public. Equity share capital is an important part of equity capital markets. Companies use it to raise money for operations and expansion. Thus, companies can issue equity shares through initial public offerings (IPOs). They can also go for secondary offerings such as rights issues or private placements. Investors can benefit from this by receiving dividends, voting rights, and potential appreciation in value as the company grows over time.

What are equity shares?

Equity shares, also known as common shares or ordinary shares, represent ownership in a company and confer a proportional claim on its assets and earnings. When investors purchase equity shares, they become shareholders and, in essence, partial owners of the company. These shares are considered a vital component of a company's capital structure, alongside debt and preferred shares.

What is equity share capital?

Equity share capital is a fundamental component of a company's capital structure. The capital generated through the sale of equity shares becomes a long-term source of financing that can be used for various purposes, including business expansion, research and development, debt repayment, and operational needs.

Types of equity share capital

1. Authorised share capital: This is the maximum amount of share capital that a company is authorised to issue, as specified in its memorandum of association. Companies often have the flexibility to increase their authorised share capital through shareholder approval.
2. Issued share capital: Issued share capital refers to the portion of authorised share capital that the company has actually issued and allotted to shareholders. This represents the shares that are available for purchase in the open market.
3. Subscribed share capital: Subscribed share capital is the portion of issued share capital that shareholders have agreed to purchase. In some cases, not all issued shares may be subscribed, especially if investors choose not to purchase their allotted shares.
4. Paid-up share capital: Paid-up share capital is the portion of subscribed share capital for which shareholders have made the required payment. It reflects the amount of money that the company has received in exchange for the issued shares.
5. Right shares: Right shares are additional shares offered to existing shareholders, allowing them to maintain proportional ownership. This pre-emptive offering, priced at a discount to market rates, aims to raise capital while giving current investors the chance to participate in the company's growth.
6. Sweat equity shares: Sweat equity shares are issued to employees or directors as non-monetary compensation. Offered at a discount or for free, these shares reward individuals for their efforts, aligning their interests with the company's success. Regulatory restrictions and potential lock-in periods may apply.
7. Bonus shares: Bonus shares, or scrip dividends, are extra shares distributed to existing shareholders without payment. Utilising retained earnings, these shares enhance overall investment value by increasing the total shares held. Bonus shares are typically issued proportionally to existing shareholdings.

Example of equity share capital

Let us consider a hypothetical scenario involving a company listed on the Bombay Stock Exchange (BSE) in India, named XYZ limited. The company decides to issue 1,000,000 equity shares at a face value of Rs. 10 per share, with an issue price of Rs. 50 per share. The authorised share capital is set at Rs. 20,000,000.

• Authorised share capital: Rs. 20,000,000
• Issue price per share: Rs. 50
• Face value per share: Rs. 10

Calculation

1. Issued share capital:

Suppose that XYZ Limited decides to issue 800,000 shares out of the authorised 1,000,000 shares.

• Issued share capital = Number of shares issued × Issue price per share
• Issued share capital = 800,000 × Rs. 50 = Rs. 40,000,000

2. Subscribed share capital:

Assume that 750,000 shares are subscribed by investors.

• Subscribed share capital = Number of subscribed shares × Issue price per share
• Subscribed share capital = 750,000 × Rs. 50 = Rs. 37,500,000

3. Paid-up share capital:

If shareholders pay for 700,000 subscribed shares, the paid-up share capital would be calculated as follows:

• Paid-up share capital = Number of paid-up shares × Issue price per share
• Paid-up share capital = 700,000 × Rs. 50 = Rs. 35,000,000

In this example, the company has successfully raised Rs. 35,000,000 through its paid-up share capital, which can now be utilised for various business purposes. Shareholders holding these equity shares have become part owners of XYZ limited and have the potential to benefit from dividends, voting rights, and capital appreciation.

Additional read: What is Right Issue of Shares

Why a company issues equity shares?

Companies choose to issue equity shares for various reasons, each contributing to their overall financial strategy:

1. Capital infusion: Issuing equity shares allows companies to raise capital from the public or private investors, providing a significant source of funding for business operations, expansion, and strategic initiatives.
2. Ownership diversification: By issuing equity shares, companies can diversify their ownership base, distributing the ownership stake among a larger group of investors. This can lead to increased liquidity and a broader investor base.
3. Market presence: Going public through an Initial Public Offering (IPO) enhances a company's visibility and credibility in the market. It can also attract attention from institutional investors and analysts.
4. Debt reduction: Companies may issue equity shares to pay down debt, improving their debt-to-equity ratio and financial stability.

Advantages of equity share capital

1. Permanent capital: Equity share capital represents permanent capital for the company since it does not have a fixed maturity date. Unlike debt, which requires periodic interest payments and eventual repayment, equity capital is a perpetual source of funds.
2. Ownership control: Equity shareholders have voting rights, allowing them to participate in key decision-making processes during annual general meetings (AGMs). This gives shareholders a sense of control over the company's direction.
3. Risk sharing: Equity shareholders share the risks and rewards of the company. In times of profitability, they may receive dividends and capital appreciation, while in challenging periods, they share in any losses.
4. Flexibility in dividends: Unlike debt, where fixed interest payments must be made, companies can choose whether to distribute dividends to equity shareholders. This flexibility is valuable during periods of financial uncertainty.

Risks associated with equity share capital

1. Market volatility: The value of equity shares is subject to market fluctuations. Economic conditions, industry trends, and investor sentiment can significantly impact share prices.
2. Dilution: Issuing additional equity shares, as in the case of rights issues, can lead to dilution of existing shareholders' ownership. This dilution can reduce individual ownership percentages and influence over company decisions.
3. Dividend uncertainty: While equity shareholders have the potential to receive dividends, companies are not obligated to pay them. Dividend payments depend on the company's financial performance and management decisions.
4. Limited claims in liquidation: In the event of liquidation, equity shareholders have a residual claim on assets after all debts are settled. However, their claims are subordinate to the claims of creditors and preferred shareholders.

Conclusion

Equity share capital plays a crucial role in a company's financial structure, offering a range of benefits such as permanent capital, ownership control, and flexibility. However, it comes with inherent risks, including market volatility and dilution. Companies must carefully evaluate their financing needs and consider the preferences of investors. For investors, understanding the advantages and risks associated with equity shares is essential for making informed investment decisions based on their financial goals and risk tolerance. In the dynamic landscape of equity markets, a balanced and well-informed approach is key for both companies and investors.