In the financial world, the word equity share is most common.

We call it stock, ordinary share, or simply just shares. You might have the basic idea of what an equity share is as the definition is in the word itself.

But did you know that in reality, every shareholder is a part owner of the company?

Let us understand everything about these equity shares.

Equity Shares: Definition

For any company, equity shares is the main source of finance, giving investors the right to vote, share profit in the form of dividend and claim assets at the time of winding up.

The holders of equity shares are actually members of the company and have voting rights.

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In general, a company is started with equity finance as its first source of capital from the owners or promoters of that company.

As the company grows at a certain level, there is a requirement for more capital for further growth. The company then finds an investor in the form of friends, relatives, venture capitalists, mutual funds, or any such small group of investors and issues fresh equity shares to these investors.

Characteristics of Equity Shares

The main features of equity shares are:

  • They are permanent in nature.
  • Equity shareholders are the actual owners of the company and they bear the highest risk.
  • Equity shares are transferable in nature, i.e. ownership of equity shares can be transferred with or without consideration to other people.
  • Dividend payable to equity shareholders is an appropriation of profit earned by a company.
  • Equity shareholders do not get a fixed rate of dividend.
  • Holders of equity shares have the right to control the affairs of the company.
  • The liabilities of an equity shareholder is limited to the extent of his/her investment.

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Types of Equity Shares

There are various classes of equity shares dependent on various things. Let’s discuss them.

1. Sweat Equity Share

These kinds of equity shares are owned by the directors or employees of the company.

Sweat equity shares are issued at a discount or for consideration other than cash for their exceptional services towards the company.

2. Bonus Equity Share

In a general sense, bonus means getting something extra in addition to normal.

So in the same line, bonus shares are the type of shares issued free of cost, by a company to its existing shareholders.  The company provides bonus shares instead of a payable dividend.

As per SEBI guidelines, if a company has sufficient profits or reserves it can issue bonus shares to its existing shareholders in proportion to the number of equity shares held out of accumulated profits or reserves in order to capitalize the profit or reserves.

3. Right Equity Share

Right shares are those equity shares which a company issues to it’s existing shareholders. Any company issues such kind of right equity shares in order to protect the ownership rights of the existing investors.

Price of Equity Shares

Equity shares come with different prices at different places. Here are some of the important prices related to equity shares:

1. Par or Face Value

Par or face value is the value of equity shares which companies record in their books of accounts.

2. Issue Price

The issue price is the price which a company actually offers to the investors at the time of Initial Public Offering (IPO).

Normally, the issue price and face value of a share are the same in the case of new companies.

3. Share Premium and Share Discount Price

When the issuance of shares is at a price higher than face value, we call this excess amount to be share premium price.

Contrary to it, when the issuance of shares is at a price lower than face value, we shall call this deficit amount to be share discount price.

4. Book Value

The calculation for the book value of equity share is:

(Reserves and Surplus + Paid-up Capital – Any Loss) / (The total number of equity shares of the company)

This is the balance sheet value of shares. This is an important value in the case of mergers and acquisition of companies.

5. Market Value

In the case of a listed company on the stock exchanges, the market value of the share is the price at which they are currently traded in the market.

It is also called stock price or share price.

It may happen that stock price and value as per fundamental principles differ because there are a number of sentiments that affect the stock price.

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Advantages of Equity Shares

Various merits of equity shares are:

  • Equity shares are the foundation for the capital of a company. It stands last in the list of claims and also provides a cushion for creditors/investors.
  • Equity shares provide creditworthiness to the company and confidence to prospective loan providers.
  • Equity shares are preferred by investors who are willing to take a bigger risk for higher returns on investment.
  • Payment of dividend to the holders of equity shares is not compulsory, so there is no burden on the company as such.
  • Equity shares raise funds for a company without creating any charge on its assets.
  • Voting rights of holders of equity shares make them have democratic control over the management of the company.
  • From a shareholder’s point of view, the most important advantage of equity shares is that these are very liquid in nature and can be sold with ease in the capital market.

Disadvantages of Equity Shares

Many companies don’t prefer raising equity shares. Reason being:

  • Investors who prefer steady or fixed income may not prefer equity shares as these comes under high-risk investment instruments.
  • For a company, the cost of raising capital through equity shares is higher than the cost of raising funds through other sources.
  • The issue of additional equity shares dilutes the voting power and earning of existing equity shareholders which includes promoters.
  • Equity shares are time-consuming processes as they involve many formalities and procedural delays.

The Bottom Line

Studies and research have proved time and again, that equity shares are one of the best long-term investments in the financial market.

They tend to outperform low-risk investment instruments like government bonds, fixed deposits (FDs), corporate bonds, property and many other types of asset.

Equity share prices can go up as well as down, so buying these are not without risk, but over the long term, they can generate good returns.

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww