Types of equity shares available
Equity shares come in various forms tailored to meet different corporate and investor needs. These include:
1. Authorised shares
Authorised shares are the maximum number of shares a company is permitted to issue as stated in its corporate charter. This limit is set during the incorporation process and can be increased later with the approval of shareholders. These shares are not necessarily distributed to the public but provide flexibility for future fundraising. For instance, a company may authorise 10 million shares but initially issue only 5 million.
2. Issued shares
Issued shares are those that have actually been allotted to shareholders, including institutional investors, company insiders, and the public. These form a portion of the authorised shares and represent ownership in the company. If a firm has 10 million authorised shares and issues 5 million, it still has the option to issue the remaining shares at a later stage if additional capital is required.
3. Subscribed shares
Subscribed shares are the portion of issued shares that investors have agreed to purchase, often during public offerings or rights issues. When investors express their commitment to buy these shares, they become subscribed shares. For example, if a company offers 5 million shares in an IPO and all are taken up by investors, those 5 million are termed subscribed.
4. Paid-up shares
Paid-up shares are those for which investors have fully paid the purchase amount. These shares reflect the actual capital invested by shareholders and are recorded on the company’s balance sheet. If each of the 5 million subscribed shares is paid for in full at ₹10 per share, then the company has ₹50 million in paid-up capital to use for business operations.
5. Bonus shares
Bonus shares are additional shares given to existing shareholders at no extra cost, distributed from a company's free reserves. This move is intended to reward shareholders and enhance share liquidity. For example, in a 1:1 bonus issue, an investor holding 100 shares would receive another 100, doubling their total holding to 200.
6. Rights shares
Rights shares are offered to existing shareholders at a reduced price before being offered to the public. This allows shareholders to maintain their ownership percentage in the company. For instance, if a company proposes a rights issue of 1 share for every 5 owned, and an investor holds 500 shares, they can buy an additional 100 at a discounted rate.
7. Sweat equity shares
Sweat equity shares are issued to employees or directors in recognition of their technical know-how, innovation, or other significant contributions. These shares serve as a motivational tool and align employees’ interests with the company’s growth. For example, a lead engineer developing a key product may be rewarded with sweat equity shares.
8. Preference shares
Though not typical equity shares, preference shares are often grouped within equity instruments due to their hybrid nature. Preference shareholders receive fixed dividends before equity shareholders and have priority in case the company is liquidated. However, they generally do not carry voting rights. For instance, preference shares may offer a 5% annual dividend, paid before any dividend is declared for equity shareholders.
Features of equity shares
Equity shares have distinct characteristics that make them a vital financial instrument:
- Voting rights: Most equity shares provide investors with voting rights, allowing them to influence key decisions, such as electing the board of directors. Choosing capable leaders can directly impact a company’s performance and potentially increase dividend payouts.
- Profit participation: Equity shareholders are entitled to a share of the company’s surplus profits. If a business performs well in a given financial year, shareholders may receive higher dividends, thus increasing their overall wealth.
- Liquidity and capital gains: Although equity shares are not redeemable until the company is wound up, they can be freely traded on stock exchanges. This offers investors the flexibility to exit at any time, potentially earning significant returns through capital appreciation.
Additional read: Shares vs Debentures
Why should you invest in equity shares?
Investing in equity shares offers a range of financial and strategic advantages, including:
- Capital gain, income, and dividend: Investing in equity shares offers the potential for capital appreciation, regular income through dividends, and the possibility of earning from the sale of shares at a higher market price.
- Limited liability: Shareholders' liability is limited to the amount invested in the shares. In the case of financial distress or bankruptcy, the personal assets of shareholders are not at risk.
- Exercise control: Equity shareholders have the right to participate in crucial decisions by voting during annual general meetings. This gives them a say in the company's policies and major undertakings.
- Bonus shares: Companies may issue bonus shares as a gesture of sharing profits with existing shareholders. This enhances the shareholder's wealth without any additional investment.
- Liquidity: Equity shares are traded on stock exchanges, providing liquidity to investors. They can easily buy or sell shares based on market conditions.
- Stock split: Companies sometimes opt for stock splits to make shares more affordable for small investors. This does not impact the overall valuation but increases the number of shares outstanding.
Advantages of Investing in Equity Shares
- Capital Gain: Equity shares can increase in market value over time, allowing investors to earn profits when they sell at a higher price than the purchase cost.
- Limited Liability: Investors are only liable to the extent of their investment; they are not personally responsible for the company’s debts or losses.
- Exercise Control: Equity shareholders are real owners of the company and can vote on major corporate matters like appointing directors or approving mergers.
- Claim over Assets & Income: Shareholders have a claim on the company’s profits and assets. In case of liquidation, they receive what remains after settling all liabilities.
- Stock Split: A stock split increases the number of shares in circulation by dividing existing shares, often making them more affordable and potentially increasing market demand.
Disadvantages of Investing in Equity Shares
- High Risk: Equity investments carry a high degree of risk due to market volatility, policy changes, and economic shifts, which can lead to losses.
- Market Fluctuations: Share prices can swing sharply in response to investor sentiment and market conditions, making equity investment unpredictable.
- Limited Control: While shareholders can vote on key matters, individual investors usually have minimal influence over day-to-day business decisions.
- Residual Claim: Equity shareholders receive their share only after all other obligations are met. They bear the highest risk but also benefit most if the company performs well.
What are the risks associated with equity investment?
While equity shares offer significant advantages, they are not without risks. Market fluctuations, economic downturns, and company-specific issues can impact the value of equity shares. It is crucial for investors to be aware of these risks:
- Market risk: The value of equity shares is influenced by market dynamics. Economic conditions, interest rates, and geopolitical events can lead to fluctuations in share prices.
- Company-specific risks: The performance of a company, its management decisions, and industry trends can affect the value of its shares. Poor financial performance or governance issues can lead to a decline in share prices.
- Liquidity risk: While equity shares are generally liquid, there can be instances where trading volumes are low, making it challenging to buy or sell shares at desired prices.
- Currency risk: For investors in international markets, fluctuations in exchange rates can impact the returns on equity investments.
Alternative investment options
While equity shares are a popular investment choice, diversification is key to a well-rounded portfolio. Some alternative investment options include:
- Bonds: Fixed-income securities that provide regular interest payments and return of principal at maturity.
- Mutual funds: Investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities.
- Real estate: Investment in physical properties for rental income or capital appreciation.
- Precious metals: Gold, silver, and other precious metals are often considered safe-haven assets and can serve as a hedge against inflation.
Conclusion
In conclusion, shares play a pivotal role in the world of finance, serving as a means for individuals to participate in the ownership and profits of companies. Understanding the various types of equity shares, their features, and the associated risks are crucial for investors. While equity shares offer numerous advantages such as capital gain, limited liability, and control over decision-making, it is essential to diversify one's investment portfolio to mitigate risks. Whether it's through bonds, mutual funds, real estate, or other alternative investments, a well-balanced approach is key to building a resilient and profitable investment portfolio.
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