Share, as defined in the Companies Act 2013, is the measure of a shareholder’s interest in a company’s assets. In other words, shares represent a shareholder’s stake of ownership of a company.
Public limited companies can raise capital for their business by issuing stocks. Apart from possessing ownership rights, these shares also carry an array of other entitlements. Some types of shares confer voting rights, right to dividends on priority, company’s surplus profits, share in the company’s losses, etc.
A common feature in all variants of shares is the right to dividend, which a company pays out of the profit.
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As per Section 43 of the Companies Act 2013, shares can be broadly classified into two types –
- Ordinary equity shares
- Preference shares
Both these types of shares vary in regards to share in profitability, voting rights, as well as a settlement of capital when a company is winding up or is being liquidated.
Ordinary or equity share is the commonest variant of stock that a public company issues to raise capital. Typically, holders of ordinary shares enjoy voting rights, can attend general and annual meetings of a company, and are also entitled to a company’s surplus profits.
In regards to voting rights, typically a single share denotes one vote, which might be concerning company policies or election of directors. However, companies can tweak the relation between the number of shares and vote count.
For instance, Tata Motors issued a special category named ‘A’ equity shares in 2008. By policy, 10 ‘A’ shares were equivalent to 1 vote; but, they received 5% more dividends than regular shares.
Ordinary shareholders also partake in the losses that a company suffers limited to their stake in a company. These entitlements are conferred upon equity shareholders because they hold a stake in a company’s ownership and represent its equity.
However, equity shareholders receive dividends when all other entitlements a company is bound to pay out of its profits are met. Therefore, such stakeholders do not receive any fixed amount of dividend or even a guarantee of dividend receipt.
That’s why, dividends are typically not the primary source of income from an equity share, but instead its price changes. Since equity shares are transferable, investors can reap monetary benefits by selling them at a premium and buying them at a discount in different types of share market.
When it comes to types of shares, ordinary shares involve classification based on two understandings. One is definition-based, and the other is feature-based.
The definition-based types of equity shares are –
- Authorised share capital
It denotes the total amount of capital that a company can raise by issuing stocks, as mentioned in the Memorandum of Association (MoA).
For instance, if a company’s MoA shows an authorised share capital of Rs.50 crore, then by law, such a company cannot issue shares whose outstanding value exceeds that amount.
However, that does not mean that a company cannot modify the authorised share capital in its MoA later on. But, to do so, an organisation needs to adhere to a set of formalities inter alia.
- Issued share capital
As the name suggests, issued share capital refers to the amount of capital a company raises by means of issuing stocks.
However, one shall note that issued share capital only represents the nominal value of all ordinary shares that a company has issued.
For instance, if the nominal value of a company’s stock is Rs. 10 and it has issued 50 lakh shares in the market, then its issued capital stands at Rs. 5 crores.
- Subscribed capital and paid-up capital
It refers to a percentage of issued capital to which investors have subscribed. It can happen that investors do not purchase all the shares that a company issues.
On the other hand, paid-up capital is the amount that investors have actually paid against their shareholdings. Thus, it directly relates to the amount of capital a company raises by issuing shares.
Feature-based types of shares are –
- Voting shares and non-voting shares
As the name suggests, entities holding these voting shares are entitled to cast their vote in matters concerning a company’s policies or election of directors. Typically most ordinary shares are voting shares.
In the case of non-voting shares, it might entail differential voting rights or none at all. An example of differential voting rights is mentioned above, where Tata Motors issued ‘A’ shares in 2008.
- Sweat equity shares
Companies can issue shares to its employees and directors as a means of compensation, usually when they perform excellently. By means of sweat equity shares, companies retain efficient employees by giving them a stake in the ownership.
- Right shares
Among the many types of stocks, a company issues this variant to its existing shareholders. In a stricter sense, companies proffer existing stakeholders the right to purchase such shares before it is open for trade to external investors.
- Bonus shares
Companies issue bonus shares in lieu of monetary compensation for dividends. Therefore, existing shareholders are only entitled to bonus shares. Organisations can also issue bonus shares for converting a portion of retained earnings into equity shares.
Preference shares carry special rights or preferential treatments, especially in regards to dividend receipt and capital reimbursement when an organization is winding up. In other words, preference shareholders receive dividends on the highest priority, and also companies return their capital before ordinary shareholders when undergoing liquidation.
Moreover, preference shareholders enjoy the guarantee of a fixed dividend, which ordinary shareholders do not. Thence, investors looking for low-risk investment options can choose to purchase preference shares of a company.
However, typically, preference shareholders cannot partake in an organisation’s profits beyond their fixed entitlement. Therefore, if a company raises its dividend rate in correspondence with its net income, preference shareholders cannot enjoy that raise, but only ordinary shareholders can.
Plus, preference shares usually do not carry voting rights. For these reasons, preference shares are usually not a popular choice among investors.
Nevertheless, types of stocks under preference shares are –
- Redeemable and irredeemable preference shares
In the case of redeemable types of shares, the issuing company and such shareholders agree that the company can redeem or buy-back those shares at a later period, either after the lapse of a certain time or on a future date. Redeemable shares vary based on who can exercise the buy-back provision – the shareholder or the organisation. An irredeemable share is, therefore, the exact opposite of a redeemable stock.
- Convertible and non-convertible preference shares
Another way types of shares can be categorised based on whether they carry the provision of conversion or not. To that effect, holders of convertible preference stocks can convert their holdings to equity shares upon meeting specific conditions. Conversely, holders of non-convertible preference shares are not entitled to that provision.
- Participating and non-participating preference shares
Holders of participating preference shares have the right to partake in a company’s profits once a company allots dividends to ordinary shareholders. Therefore, when a company’s net income is substantially high, such shareholders stand to receive a part of such profits. On the other hand, holders of non-participating shares are only entitled to a fixed dividend payment. The latter is a commoner variant.
- Cumulative and non-cumulative preference shares
If a company does not provide dividends for preference shares in a particular year, such dividend entitlement is carried forward to the following year if it is a cumulative stock. Conversely, in the case of non-cumulative preference shares, the dividend amount is not carried forward if an organisation does not pay dividends in a specific year.