Issue of SharesThe capital obtained by issuance of shares is generally known as share capital. The capital of an organisation is equally divided into small units called shares. Each share has its own nominal value. For instance, a company can issue 1,00,000 shares of Rs. 10 each for a total value of Rs. 10,00,000. The person who is holding the share is called the Shareholder. There are generally two types of shares issued by a company namely, equity shares and preference shares. The money obtained through issuance of equity shares is called equity share capital and the money obtained by issuance of preference shares is called preference share capital.
- Equity Shares
Equity shares are considered as a vital source of raising long term capital by a company. Equity shares symbolize the ownership of a company and thus the capital raised by issuance of such shares is called as ownership capital or owner's funds. Equity share capital is a must to create a company. Equity shareholders are not entitled for a fixed dividend but are paid based on the earnings of the company. They are referred to as 'residual owners' as they receive residual remains after all other claims on the company's income and assets are settled. They are entitled to enjoy the reward and simultaneously bear the risk of ownership too. Their liability, however, is restrained to the extent of capital invested by them in the company. Further, by the right to vote, these shareholders hold rights to participate in the management activities of the company.
The advantages in raising funds through issuing equity shares are given as below:
- Equity shares are appropriate for investors who share the risk factor for higher returns;
- Payment of dividend to the equity shareholders is not mandatory and shows no burden on the company;
- Equity capital serves as a permanent capital as it is to be repaid only at the time of insolvency of the company. It stands last in the list of claims and provides a cushion for creditors, in the event of termination of the company;
- Equity capital provides credit worthiness to the company and confidence to prospective loan providers;
- Funds can be raised by issuing equity and also by not creating any charge on the assets of the company. The assets of a company are, therefore, free to be mortgaged for borrowings, if enquired;
- Democratic control exerted on the management of the company is assured due to the right to vote y equity shareholders.
The main draw backs in raising funds through issue of equity shares are given below:
- Investors interested in steady income do not prefer equity shares as equity shares get varying returns;
- The cost of equity shares is usually more when compared to the cost of raising funds through other sources;
- Issuance of additional equity shares devoid the shareholder the right to vote and earnings of existing equity shareholders;
- More formalities and procedural delays are involved while raising funds through issue of equity share.
- Preference Shares
The capital raised by issuing preference shares is called preference share capital. The preference shareholders are entitled to enjoy a preferential position over equity shareholders in two ways:
- Entitled to receive a fixed rate of dividend, out of the net profits of the company, before any dividend is declared for equity shareholders; and
- Entitled to receive their capital after the claims of the company's creditors have been settled, at the time of termination of the company. On a comparison, the equity shareholders and the preference shareholders have a preferential claim over dividend and repayment of capital. Preference shares resemble debentures as they bear fixed rate of return. As the dividend is payable only at the discretion of the directors and only from the gains after tax, to that extent, these resemble equity shares. Thus, preference shares bear some characteristics of both equity shares and debentures. Preference shareholders generally do not enjoy the right to vote. A company can issue different types of preference shares (see Box B).
The advantages of preference shares are given as follows:
- Preference shares offer reasonably steady income in the form of fixed rate of return and safety of investment;
- Preference shares are constructive for those investors who want fixed rate of return with a comparatively low risk;
- It does not in any manner affect the control of equity shareholders over the management as preference shareholders are deprived of voting rights;
- Payment of fixed rate of dividend to preference shares may facilitate a company to proclaim higher rates of dividend for the equity shareholders in good times;
- The Preference shareholders hold a preferential right of repayment over equity shareholders in the event of termination of a company;
- The Preference capital does not generate any charge against the assets of a company.
The major limitations involved in preference shares as source of business finance are as follows:
- Preference shares are not appropriate for those investors who are willing to take risk and are attracted to higher returns;
- Preference capital dissolves the claims of equity shareholders over assets of the company;
- The rate of dividend on preference shares is usually higher than the rate of interest on debentures;
- The dividend on these shares is to be paid only when the company earns profit, there is no assured return for the investors. Thus, these shares may not be very attractive to the investors;
- The dividend paid cannot be deducted from profits as expense. Thus, there is no tax saving with respect to interest on loans.