What is Equity Share Capital? Learn its Meaning, Types, Risks, Features & Formula
Investors looking to grow their wealth and expand their portfolio often turn to equity share capital. With returns generated close to 14-15% CAGR (compound annual growth rate) in the last 15 years, investing in equity capital markets is more profitable than other asset classes.
Investing in equities involves buying shares of publicly traded companies, which are traded on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). To learn more about equity share capital, read on to discover the definition of equity share, the types of equity share capital, and much more in this blog.
What is Equity Share Capital?
Equity share capital refers to the amount of money a company raises by issuing equity shares to investors. This capital forms a critical part of the company’s financial foundation. Equity share capital encompasses all funds contributed by shareholders in exchange for ownership shares.
Additionally, companies can raise funds by issuing equity shares in two ways: privately or, if listed on the stock exchange, through an Initial Public Offering (IPO). After investing through an IPO, investors can benefit from their investment by receiving dividends, attaining voting rights, and enjoying potential appreciation in value as the company grows.
What are Equities?
Equities, also known as stocks, represent ownership in a company. Equity refers to classes of shares that are equities, own a portion of the company and are entitled to a share of its profits/losses. Equities are traded on stock exchanges, and their value fluctuates based on the company’s performance, market conditions, and investor sentiment. Investing in equities carries both the potential for capital appreciation and the risk of loss, making it a dynamic and essential component of financial markets.
What is an Equity Share?
Equity shares are known as a unit of ownership in a company. If you own equity shares, you are an equity shareholder. You are entitled to a portion of the company’s profits through dividends and are liable for any losses. Your stake in the company is proportional to the number of shares you hold. Equity shares can be bought, sold, and traded on stock exchanges. As a shareholder, you can receive dividends and vote on various company matters.
Example of Equity Share Capital
Consider a company, XYZ Ltd., which issues 1,000,000 shares at Rs. 10 each. The total equity share capital would be:
Equity Share Capital = Number of Shares×Price per Share
Equity Share Capital = 1,000,000×10 = Rs. 10,000,000
This example of equity illustrates how companies raise substantial funds through equity share capital.
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- House of Tata smallcase: This smallcase, managed by Windmill Capital, is a collection of companies that are part of the Tata group. It is suitable for investors seeking exposure to a diversified group of legacy companies.
- IT Tracker smallcase: Managed by Windmill Capital, this smallcase comprises IT & ITeS and online services companies, allowing investors to track and invest efficiently in the information technology sector.
- Disclosures for House of Tata and IT Tracker smallcases.
Types of Equity Share Capital
There are several different categories of share capital that investors can choose from. Let’s have a look at some of these types of share capital:
- Authorised Share Capital: Authorised share capital is the maximum amount of stock a company can legally issue to shareholders. It limits the number of shares the company can offer and is known as “nominal” or “registered” capital.
- Issued Share Capital: Issued share capital is the portion of authorised capital that has been allocated and sold to investors. It represents the shares for which the company has received payment.
- Subscribed Share Capital: The part of issued share capital that investors have agreed to buy and for which they have subscribed.
- Right Shares: Right shares are offered to existing shareholders in proportion to their current holdings, allowing them to maintain their ownership percentage. These shares are usually offered at a discount to the market price.
- Sweat Equity Shares: Sweat equity shares are issued to employees or directors at a discount or for non-cash consideration as a reward for their contributions. These shares serve as an incentive to retain key personnel.
- Paid-Up Capital: Paid-up capital is the portion of issued capital that shareholders have fully paid for. It indicates the total amount of money the company has received from shareholders in exchange for shares.
- Bonus Shares: Bonus shares are additional shares given to existing shareholders at no extra cost, based on the number of shares they already own. These are issued from the company’s accumulated earnings or reserves.
Why Do Companies Issue Equity Share Capital?
Companies issue equity share capital for several reasons:
- Raising Funds: To finance business expansion, research and development, or to pay off debt.
- Improving Liquidity: By increasing the number of shareholders and spreading ownership.
- Strengthening Capital Base: To enhance the company’s capital structure and financial stability.
A company may issue equity shares to attract long-term investors who are willing to take on more risk for potentially higher returns.
Features of Equity Share Capital
Equity share capital, also known as ordinary share capital, represents the ownership interest of the shareholders in a company. The features of equity share capital include:
- Ownership Rights: Equity shareholders can participate in the company’s management by electing directors and voting on important decisions.
- Dividend Rights: Equity shareholders are entitled to receive dividends as declared by the company occasionally. The payment of dividends is discretionary and subject to the availability of profits.
- Residual Claim on Assets: In the event of the company’s winding up, equity shareholders have the right to receive the company’s residual assets after all other settled obligations.
- Voting Rights: Equity shareholders have the right to vote on matters that affect the company, such as the election of directors, approval of financial statements, and major corporate actions.
- Transferability of Shares: Equity shares are freely transferable, subject to the provisions of the company’s articles of association and applicable laws.
- No Fixed Obligation to Pay Dividends: Unlike debt instruments, equity shares do not create a fixed obligation on the company to pay dividends. The payment of dividends is subject to the discretion of the company’s board of directors.
- Permanent Capital: Equity share capital represents permanent capital for the company, as there is no obligation to repay the amount raised through the issuance of equity shares.
Advantages of Equity Share Capital
Equity share capital is a popular form of raising business capital and has many advantages. Below, we have mentioned some of them:
- Permanent Capital: A company’s equity share capital constitutes its permanent capital, and unlike debt financing, it does not require repayment. It stabilises the company’s capital structure and reduces financial risk.
- Cost-Effective Source of Finance: Compared to debt financing, equity share capital is a more cost-effective source of finance. This reduces the company’s financial burden and allows it to allocate more funds towards its growth and expansion.
- No Obligation to Pay Dividends: Unlike debt financing, there is no obligation to pay dividends to equity shareholders. This provides flexibility to the company in terms of dividend payments based on the company’s financial performance.
- Attracts Long-Term Investors: Equity capital share attracts long-term investors interested in the company’s growth and success. This provides stability to the company’s shareholder base and reduces the risk of sudden changes in ownership.
Disadvantages of Equity Share Capital
Equity share capital is an important source of funding for companies, but it also comes with its risks. Two common risks associated are:
- Insufficient Capital Generation: One of the risks associated with equity share capital is inadequate capital generation. This may result in the company’s inability to meet its funding requirements. This can happen due to market conditions, economic downturns, or poor management decisions.
- High Liabilities: Another risk associated with equity share capital is the possibility of high liabilities. Equity shareholders have residual claims on the company’s assets. This means that they are the last to be paid in the event of liquidation. If the company’s liabilities exceed its assets, equity shareholders can suffer losses.
To Wrap It Up…
Equity share capital is a vital component of a company’s financial strategy, offering a means to raise funds and improve liquidity without incurring debt. However, it comes with its own set of challenges, such as potential dilution of control and market volatility. Understanding the equity share capital meaning, its types, and its implications can help investors and companies make informed decisions. While equity share capital comes with its own risks, various solutions are available to mitigate these risks, and one such solution is offered by smallcase.
Frequently Asked Questions About Equity Share Capital
Yes. Equity share capital, or share capital, refers to the funds a company raises by issuing shares. This money, provided by owners and investors, is used to develop or expand the company’s operations.
Equity share capital is calculated by multiplying the number of issued shares by the face value of each share. It represents the total value of shareholders’ equity in a company. The formula for calculating equity share capital is:
Equity Share Capital = Number of Shares×Price per Share
Equity capital is also known as residual capital.
Equity share capital is risk capital because your returns correlate directly to the company’s performance. For example, if the company performs well for the quarter and books profit, it will lead to an increase in the valuation of the company. And if that happens, it will be reflected in your investment. On the contrary, if the company loses money, which will eventually lead to depreciation in the valuation of a company, the value of your investment will also decrease
Total equity and long-term debt are a company’s primary sources of long-term capital. It is calculated by subtracting total liabilities from total assets, giving a rough estimate of the company’s break-up value.
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