First, to understand the broad meaning of Equity share capital, It is important to understand what are equity shares and what rights do they give the investor. In this article, we will discuss all the concepts related to Equity share capital and what is the use of equity share capital for companies and what are the disadvantages of equity share capital for companies.
Equity shares are the stocks which investors buy either from the primary market or from the secondary market. These shares represent a portion of the ownership of the company. For example, you are owning shares of a certain company, then you own a certain fraction of ownership of the company depending on the total number of equity shares of the company and several other factors.
These shares representing the ownership of the company are given by the company to the public investors to get capital for the business. And also there are other benefits for the shareholders from equity share capital which are as mentioned below
Profitability: when the valuation and the profits of the company increase, then the price of the shares increase and investors can benefit from this increase. And also with the growth of the company, there are benefits to the shareholders such as dividends and bonus shares.
Fair Liquidity: There is increased liquidity and easy to exit options for the early investors because of listing in the stock exchanges when raising the equity share capital. And also the share price of the company is subject to fluctuation which represents the actual valuation of the company based on the performance.
Control on Management: As buying the shares means that a part of ownership is brought. This also means that you have voting rights in proportion to the number of shares you are holding. If you have large proportions of shares, then with your voting you can influence the management decisions.
Now after understanding what are equity shares, it must have been clear what is Equity share capital. The capital that is raised by the company by issuing equity shares of the company to the investors. Investors who are interested in the company will buy these shares from the company and in this manner company will be able to raise capital depending on the price of each share and the number shares. The company have to mention beforehand the reason why it is raising the capital and for what different purposes the capital so raised will be used for.
Though capital generation is the primary reason why the company will issue shares to the public and get equity share capital, there are other reasons why a company will issue equity shares. these are, The issuing of shares to the public will be an option for the investors who have invested in the company during the early stages to exit from the investment by selling their shares. It also provides a true market value of the company as the share price will be fluctuating in the stock markets concerning the performance of the company over time. It also increases transparency and credibility of the company as to comply with a lot of regulations as prescribed by the stock exchanges and SEBI. And also the brand value of the company will increase as there will be a lot of discussions both offline and in digital media among the investor’s community.
There are different types of equity share capital. They are
Authorized share capital: This is the maximum amount that can be raised by the company by issuing shares to the investors. This maximum limit can be increased by the company subject to that the company is eligible and also need to furnish all the required documentation to the respective authorities and also pay the associated fees.
Issued share capital: This is the capital which the company is issuing to the investors. This is decided based on what is the requirement of capital for the company.
Subscribed share capital: this is the amount of capital which the investors have subscribed out of the total issued share capital by the company. not always the entire issued capital by the company will be subscribed by the investors. Some times only a portion of it is subscribed and it is called as subscribed share capital.
Sweat equity shares: these are the shares that are issued by the company to the employees as a token of appreciation based on their performance and the importance of their role for the organization.
Right Shares: These are the shares that are issued to investors after they have invested in equity shares of the company. These are issued to the investors to safeguard the existing ownership of the company.
Paid-up capital: It is that part of the subscribed capital which the company invests in their business.
Bonus shares: Bonus shares are the extra shares that are issued to the existing shareholders in the form of a dividend.
Risks associated with Equity share capital
Though equity share capital is a good option for the enterprises to raise capital that is required for their business, there is a downside to this. These areas discussed below:
When the company decided to raise capital by issuing shares to the investors it goes for an IPO and the size of the IPO depends on the amount of capital that is required by the business. But not always do all the shares are subscribed by the investors. sometimes the business which is raising the capital is of less interest to the investors at the price mentioned. and hence only very less number of investors subscribe to the equity shares. and hence the company may not be able to raise the required amount of capital.
Only when the business is very attractive and the pricing is very reasonable, then there will be a large number of investors who will be investing. for this to happen the company has to show positive results and good hope for the investors that the business will grow in the coming days.
When the shares are issued to different investors, then each of these investors because an owner of the company and have certain voting rights based on the number of equity shares he is holding. And in this case for any decision that is taken in the business, each investor has given the chance to vote and the decision will be finalized only if a large number of voter vote in favour of the decision.
In such cases, it will be a difficult task for the management to take a key decision for the business. Because the same decision has to be favoured by a large number of investors who may not be ready to vote in favour and hence the management may not move forward with the decision. This happens in most of the times. This ownership dilution of the business makes it hard to take any crucial decision regarding the business.