Equity Shares

Equity shares, also called ordinary shares, are the fundamental source of financing a company's business activities, and the Companies Act, 2013 defines them somewhat indirectly, as "those shares which are not preference shares." Working through what that negative definition actually means is instructive: equity shares carry no preferential right either to a fixed dividend or to the priority return of capital on winding up, so an equity shareholder's fortunes are tied entirely to how well the company actually performs.

Because every other class of claimant — creditors, debenture-holders, and preference shareholders — is paid first, whatever remains of the company's income and assets ultimately belongs to the equity shareholders; they are, in that sense, the company's residual claimants. This position cuts both ways. Equity shareholders carry no fixed commitment of dividend at all — the Board of Directors recommends a rate of dividend only out of profit actually earned, and in a loss-making year, or a year when the Board decides to plough profits back into the business instead, equity shareholders may receive nothing. Equally, if the company does exceptionally well, equity shareholders share fully and without any upper limit in that success, since there is no fixed ceiling on what they can be paid once every prior claim has been satisfied. It is precisely this exposure to both the upside and the downside of the company's fortunes that gives equity share capital its familiar description as "venture capital" or "risk capital," and equity shareholders are sometimes called the company's "shock absorbers" in a financial crisis, since a fall in the company's income shows up first as a fall in dividend and market value for them. …