Equity Share Capital: Meaning, Types, Features & Benefits

Understanding Equity Share Capital

You must have heard of an Initial Public Offering (IPO), a significant event where a company sells its shares to the public for the first time. But what exactly happens during an IPO, and why is it so important? This process involves raising equity share capital, a crucial component of a company's financial structure and growth strategy.

Let's break this down with a simple example.

Imagine you and three friends decide to start a small business selling homemade sweets. Each of you invests ₹10,000 into the business, making a total capital of ₹40,000. This pooled money is your business's equity capital, representing the ownership each of you has in the business. Now, if your business grows and you need more money to expand, you might decide to bring in more investors by selling them shares of your business. These new investors become part-owners, just like you and your friends, and the money they invest becomes additional equity capital.

Equity share capital works similarly for companies. When a company wants to raise money, it sells shares to investors in exchange for ownership stakes in the company. This capital is crucial as it provides the necessary funds for a company to start or expand its operations. In return for their investment, shareholders gain the right to vote on major company decisions and receive a portion of the profits, known as dividends.

Equity share capital is a vital part of a company's financial structure, offering a way to fund growth without incurring debt. This blog will delve into the meaning of equity share capital, its types, features, benefits, and more, helping you understand its importance in the world of finance.

Types Of Equity Share Capital

Let's explore the various types of equity share capital using an example to make it clearer. Consider a company, XYZ Ltd., which is planning to raise funds through an IPO.

1. Authorised share capital: This is the maximum amount of share capital that XYZ Ltd. is authorised to issue, as stated in its memorandum of association. For example, XYZ Ltd. has an authorised share capital of ₹50 crore. This means the company can issue shares up to this value.
2. Issued share capital: Out of the authorised share capital, XYZ Ltd. decides to issue shares worth ₹20 crore to the public. This portion is known as the issued share capital. For example, if each share is priced at ₹100, XYZ Ltd. will issue 20 lakh shares (₹20 crore / ₹100 per share).
3. Subscribed share capital: Investors agree to buy shares worth ₹18 crore out of the ₹20 crore issued by XYZ Ltd. This agreed-upon amount is called subscribed share capital. For example, if each share is priced at ₹100, investors subscribe to 18 lakh shares (₹18 crore / ₹100 per share).
4. Paid-Up Capital: Out of the ₹18 crore subscribed by investors, they actually pay ₹15 crore. This paid amount is the paid-up capital. For example, if each share is priced at ₹100, the paid-up capital is 15 lakh shares (₹15 crore / ₹100 per share).
5. Right Shares: Suppose XYZ Ltd. decides to issue additional shares to existing shareholders to raise more funds while preserving their ownership percentage. These additional shares are known as right shares. For example, XYZ Ltd. offers 1 right share for every 10 shares held at a price of ₹90.
6. Sweat equity shares: As an appreciation for a job well done, XYZ Ltd. may issue shares to employees or directors at a discount or for consideration other than cash. These shares are known as sweat equity shares. For example, XYZ Ltd. issues 1 lakh shares to its employees at ₹50 per share.
7. Bonus Shares: XYZ Ltd. decides to issue additional shares to its existing shareholders in the form of a dividend, without any additional cost. These are bonus shares. For example, XYZ Ltd. issues 1 bonus share for every 5 shares held.

Advantages of Equity Share Capital

1. No repayment obligation: Imagine a tech startup that raises ₹10 crore through equity financing. Unlike a loan, this ₹10 crore does not need to be repaid, allowing the company to use the funds to develop new products and expand without worrying about regular repayments.
2. Dividend flexibility: In its first year, the company makes a profit and decides to distribute a portion of it as dividends. In the next year, due to market conditions, profits are lower, and the company chooses not to pay dividends. This flexibility helps manage cash flow according to the company's financial health.
3. Increased creditworthiness: With ₹10 crore in equity capital, the company appears financially stable and creditworthy to banks and lenders. As a result, when the company seeks a loan to purchase new equipment, lenders are more willing to provide financing at favourable terms.
4. Ownership and control: Shareholders of the company have voting rights that allow them to influence major company decisions, such as electing the board of directors or approving mergers. This aligns the interests of the management and the shareholders towards the long-term success of the company.
5. Growth and expansion: Using the ₹10 crore raised, the company launches new products, enters international markets, and hires additional staff. This capital enables the company to grow rapidly, increasing its market share and profitability.
6. Attracting Talent: The company issues sweat equity shares to key employees as a reward for their contributions. These shares motivate employees to stay with the company and work towards its success, as they now have a personal stake in the company's future.

Risks Associated with Equity Share Capital

1. Market volatility: After the IPO, the company's share price fluctuates due to market conditions, economic news, and quarterly earnings reports. Investors face the risk of their shares losing value in volatile markets.
2. Dividend uncertainty: Although the company paid dividends in the first year, in subsequent years of lower profitability, it may not distribute dividends. Investors relying on dividend income might face uncertainty.
3. Dilution of control: The company decides to issue more shares to raise additional funds for expansion. Existing shareholders, unless they purchase more shares, see their ownership percentage and influence over company decisions reduced.
4. Regulatory and compliance costs: To comply with regulatory requirements, the company incurs significant costs for legal fees, financial audits, and reporting. These costs can be substantial, especially for smaller companies.
5. Potential for hostile takeovers: If a large number of the company's shares are bought by a competitor or an investor, there is a risk of a hostile takeover, which can lead to changes in management and strategic direction that existing shareholders might not favour.

The Serious Truth You Should Know About Equity Share Capital

Equity share capital is vital for growth, offering shareholders a stake in a company's future. However, as the company expands and issues more shares, it's important to be aware of equity dilution. While this can slightly reduce your ownership percentage, it often means the company is growing and creating more value in the long run.

Conclusion

Equity share capital is crucial in a company's financial framework, providing essential funds for growth and expansion while offering shareholders a stake in the company's success.

To gain detailed insights and further your understanding of such concepts, visit the Sharekhan Knowledge Centre and explore our comprehensive resources related to finance and investments.