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Equity Shares- One Of The Main Source Of Funds For Companies

October 14, 2019
Equity Shares

Equity Shares and Equity Share Capital

Equity shares are one of the main sources of funds for Companies. Equity shares represent the ownership of a company and capital raised by the issue of such shares is known as ownership capital or owner's funds. The following are its basic features of Equity Share Capital:
  • Right to vote
  • Right to receive dividend
  • Right to transfer freely without any restriction.

Equity shares are issued by Companies

Company as defined under Section 2(20) of the Companies Act, 2013 means a company incorporated under this Act or any previous company law.

Types of Companies in India:

The following are the types of companies that can be incorporated in India:
  • One Person Company
  • Private Ltd Company
  • Public Ltd Company

Private & Public Companies can be further classified into:

  • Limited Liability Company or Company Limited by Shares - Limited liability is when the liability of the members is limited to the extent of unpaid amount on shares held by them.
  • Unlimited Liability Company- Liability of its members being unlimited
  • Company Limited by Guarantee - The liability of the members is limited to such amount as the members undertake to contribute to the assets of the Company in the event of winding up. Thus, the liability of the members will arise only in the event of its winding up.

What is Share Capital?

Section 2(84) of the Companies Act, 2013 defines Share as "share" means a share in the share capital of a company and includes stock. In relation to a Company limited by shares, the word ‘capital' means the share capital i.e., the capital in terms of rupees divided into a specified number of shares of a fixed amount each. For example share capital of a company is Rs. 1,00,000 which can be divided into 10,000 shares of Rs. 10 each or 1000 shares of Rs. 100 each, whichever is feasible to the company.

What are the types of Share Capital?

Authorized Capital: Authorised capital is the maximum amount of share capital which a company is authorized to issue by its Memorandum of Association. This limit is outlined in its constitutional documents and can only be changed with the approval of the shareholders. The company cannot raise more than the amount of capital as specified in the Memorandum of Association. The authorized capital can be increased or decreased as per the procedure laid down in the Companies Act. Issued Capital: Capital that is issued from time to time for subscription and is a part of the authorized capital. It includes subscription shares, shares issued for consideration other than cash and shares subscriber by investors and the public.  Issued capital cannot exceed the Authorised capital. Subscribed Capital - It is that part of the issued capital which has been subscribed by the members of the company. Paid-Up Capital – It is the amount of money paid by the shareholders for the shares issued to him.

Nature and Classes of Shares

Shares, as applied to the capital of a company, refer to the units into which the total share capital of a company is divided. Thus, a share is a fractional part of the share capital and forms the basis of ownership interest in a company. The persons who contribute money through shares are called shareholders. The Companies Act, a company can issue two types of shares

              (1) Preference shares, and

              (2) Equity shares (also called ordinary shares)

Preference shares

Preference share is one, which fulfills the following conditions :
  1. a) That it carries a preferential right to dividend to be paid either as a fixed amount payable to preference shareholders or an amount calculated by a fixed rate of the nominal value of each share before any dividend is paid to the equity shareholders.
  2. b) That with respect to capital it carries or will carry, on the winding-up of the company, the preferential right to the repayment of capital before anything is paid to equity shareholders.

Equity Shares

Equity shares are those which are not Preference shares. In other words, shares which do not enjoy any preferential right in the payment of dividend or repayment of capital, are termed as equity shares. Equity shares are the most commonly issued class of shares and carry maximum risk and rewards. The equity shareholders are entitled to the distributable profits of the company after satisfying the dividend rights of the preference shareholders.

Equity Shares - Sub-division

The Equity share capital is sub-divided into shares with equal voting rights and shares with differential rights as to dividend, voting or otherwise. Equity Shares with Equal Voting Rights: The voting rights attached to shares are voting rights at general meetings of the company, i.e. at meetings of the shareholders rather than the directors. Voting at general meetings can be done in two different ways. Many resolutions are decided by a show of hands. This will give each shareholder one vote, regardless of the number of shares held. It is a useful practice for the passing of routine resolutions where there is no (or very little) opposition, but this does not reflect the actual voting strength of individual shareholders. For the voting to reflect the actual voting strength, there must be a poll, by which the actual votes owned by each shareholder voting are counted. Equity Shares with Differential Voting Rights:  Section 43 of Companies Act, 2013 enables companies to issue equity shares with differential rights as to dividend, voting rights, etc. Rule 4 of Companies (Share Capital and Debentures) Rules, 2014 states the following conditions regarding shares with differential voting rights: Only a Company limited by shares can issue equity shares with differential rights as to dividend, voting or otherwise. Such a company has to comply with the following conditions namely:-
  • The Articles of Association of the Company authorizes the issue of shares with differential rights.
  • The issue of shares is authorized by an ordinary resolution passed at a general meeting of shareholders.
  • The shares with differential rights shall not exceed twenty-six percent of the total post-issue paid up equity shares capital including equity shares with differential rights issued at any point in time.
  • The company should have consistent track record of distributable profits for the last three years
  • The Company has not defaulted in filing Financial Statements and Annual Returns for three financial years immediately preceding the financial ear in which it is decided to issue such shares.
  • The Company has no subsisting default in the payment of a declared dividend to its shareholders.
  • The Company has not defaulted in payment of the dividend on preference shares or repayment of any term loan from financial institution or scheduled bank.
A company may issue shares with differential rights upon expiry of five years from the end of the financial year in which such default was made good.
  • The Company has not been penalized by Court or Tribunal during the last three years of any offence under the RBI Act, 1934, the SEBI Act, 1992, the Securities Contracts Regulation Act, 1956, the Foreign Exchange Management Act, 1999 or any other special Act, under which such companies being regulated by sectoral regulators.

Various modes of offering shares

Employee Stock option scheme

The term ‘Employee Stock Option’ (ESOP) has been defined under sub-section (37) of Section 2 of the Companies Act, 2013, according to which it is an the option given to the officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees the benefit or right to purchase, or to subscribe for the shares of the Company at a future date at a pre-determined price.

Sweat Equity Shares

As per Section 2(88) sweat equity shares" means such equity shares as are issued by a company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called;

Bonus Shares

A Company may if its Articles provide, capitalize its profits by issuing fully-paid bonus shares. When a Company is prosperous and accumulates large distributable profits, it converts these accumulated profits into capital and divides among the existing members in proportion to their entitlements. Members do not have to pay any amount for such shares. Bonus shares are not an income. Hence it is not a taxable income.

Advantages of Equity Shares

  • The Equity Shareholders can control the affairs of the Company by the voting right power
  • The liability of Equity Shareholder is limited to the extent of their unpaid capital
  • The shares of the company which is listed on stock exchanges have the benefit of any time liquidity, hence are easily tradable instruments in the stock market
  • With the growth of the Company, the value of the equity share increases
  • Equity shares are easily transferable with or without consideration to another person.

Disadvantages of Equity Shares

  • Equity is comparatively riskier as it is attributable to the ownership of the Company, so equity shareholders are directly facing the complexities faced by the entity.
  • Equity shareholders get dividends only if there remains any profit after paying debenture interest, tax and preference dividend. Thus, getting dividends on equity shares is uncertain every year.
  • An equity shareholder has a residual claim over both the assets and the income. Income which is available to equity shareholders is after the payment of all other stakeholders’ viz. debenture holders etc.
Disclaimer: The entire contents of this document have been developed based on relevant information. Though the authors have made utmost efforts to provide authentic information however, the authors expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.

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