What Is Equity Share Capital?
Every company requires substantial working capital to keep their business smooth and running. Such capital proves effective at times when the company is faced with financial restrictions to keep its regular operations active. More than often, companies use their equity shares to raise the required capital known as equity share capital. The capital a company raises by offering shares is known as equity share capital or share capital. It is the money that company owners and investors direct towards a company's capital and use to develop or expand the operations of their venture. Equity shares represent ownership stake in a company, and individuals who hold equity shares are said to hold fractional ownership of the company, entitling them to earn returns in the form of dividends and capital appreciation.
What Are Equity Shares?
To understand equity share capital, individuals need to familiarize themselves with the meaning of equity shares. Equity shares, also known as ordinary shares, represent ownership stake in a company. Shares sold by a company function as a source of investment for the company as well. Individuals who hold equity shares are said to hold fractional ownership of a company.
Ownership Rights
Equity shareholders have fractional ownership of the company, entitling them to voting rights in company decisions and a share of company profits through dividends.
Dividend Entitlement
Equity shareholders are entitled to earn returns in the form of dividends, which are distributed from company profits based on the number of shares held.
Capital Appreciation
Equity shares offer potential for capital appreciation as the company grows and its share price increases in the stock market, providing additional returns beyond dividends.
Residual Claim
In case of company liquidation, equity shareholders have residual claim on company assets after all debts and obligations are paid to creditors and preference shareholders.
Why Do Companies Issue Equity Shares?
A company tends to invite the general public to acquire its shares as a means to earn fractional ownership of the same. Through such ownership, shareholders are entitled to earn returns in the form of dividends. Usually, a large privately-owned company issues shares to trade publicly in a stock exchange. However, capital generation is the primary reason why both small and large companies issue shares to the general public in the first place.
Capital Generation
The equity share capital raised through equity shares issued is used for developing the business venture of the company, funding expansion projects, and meeting working capital requirements.
Creditworthiness
A large capital base helps companies enhance their creditworthiness in the market, making it easier to obtain loans and other forms of financing from financial institutions.
Public Trading
Large privately-owned companies issue shares to trade publicly in stock exchanges, providing liquidity to existing shareholders and enabling public participation in company growth.
Types of Equity Share Capital
Several types of equity shares help companies generate equity share capital. The following highlights different classifications of equity share capital based on various criteria.
| Type | Description | Characteristics |
|---|---|---|
| Authorized Share Capital | Maximum capital a company is authorized to raise | Specified in company's Memorandum of Association, can be increased with shareholder approval |
| Issued Share Capital | Shares actually issued to investors | Cannot exceed authorized capital, represents shares offered to public or existing shareholders |
| Subscribed Share Capital | Shares subscribed by investors | Portion of issued capital that investors have agreed to purchase, may be less than issued capital |
| Paid-up Share Capital | Amount actually paid by investors | Portion of subscribed capital for which payment has been received, represents actual funds available to company |
Risks Associated with Equity Share Capital
The drawbacks of equity shares tend to magnify the risks that are associated with equity share capital. Companies and investors should be aware of these risks when dealing with equity share capital.
Failure to Generate Capital
If the shares issued by a company do not match the investors' requirements or expectations, they would not be willing to invest in them. If there are no buyers in the stock market, the company will fail to generate equity share capital.
Limited Capital Generation
There are numerous equity share options available in the stock exchange market for investors to choose from. The availability of multiple investment options often limits the chance of generating sufficient equity share capital and makes endeavors issuing shares ineffective.
Unmanageable Shareholder Base
When companies issue a huge number of shares at low face value, they run the chance of gaining a larger number of investors than they bargained for. Having a large shareholder base proves effective only when the number of shareholders is within a manageable limit.
Increased Liability Burden
When the number of shareholders becomes unmanageable, it adds to the company's liability burden as they have to pay a greater bulk of returns as dividends than they had bargained for. An increased liability burden defeats the purpose of raising equity share capital.
Final Thoughts
Equity share capital is a crucial component of a company's financial structure, providing permanent capital for business operations and expansion. Companies make new shares available for the public via Initial Public Offering (IPO) through the Book Building Process. To keep a better track of equity share investments, shareholders can create an equity share capital account and maintain the ledger for such transactions. Companies who offer equity shares should also maintain an equity share capital account to monitor the growth of their equity share capital. While equity share capital offers numerous benefits, companies must carefully plan their share issuance to avoid risks such as unmanageable shareholder bases and increased liability burdens. Proper management of equity share capital is essential for sustainable business growth and maintaining healthy investor relations.