Issue of Shares

Meaning of share capital: The capital raised by issuing shares is called share capital. A company's capital is divided into small units called shares, each with a nominal (face) value. For example, a company can issue 1,00,000 shares of ₹10 each, for a total value of ₹10,00,000. The holder of a share is a shareholder.

A company normally issues two types of shares — equity shares and preference shares. Money raised from equity shares is equity share capital; money raised from preference shares is preference share capital.

(a) Equity Shares

Meaning: Equity shares are the most important source of long-term capital for a company. They represent the ownership of the company, so the capital they raise is called ownership capital / owner's funds; equity capital is a prerequisite to the creation of a company.

• Equity shareholders do not get a fixed dividend — they are paid on the basis of the company's earnings.
• They are called "residual owners" because they receive whatever is left after all other claims on income and assets have been settled.
• They enjoy the rewards and bear the risks of ownership, but their liability is limited to the capital they contributed.
• Through their right to vote, they can participate in the management of the company.

Merits

• Suitable for investors willing to assume risk for higher returns.
• No compulsion to pay dividend, so no burden on the company in this respect.
• Serve as permanent capital, repaid only at liquidation; standing last in the list of claims, they provide a cushion for creditors if the company is wound up.
• Provide creditworthiness and confidence to prospective lenders.
• Raised without creating any charge on assets, leaving the assets free to be mortgaged for future borrowing.
• Democratic control over management is ensured through voting rights.

Limitations

• Not preferred by income-seeking investors, since returns fluctuate.
• Costlier than raising funds through other sources.
• Issuing more equity dilutes the voting power and earnings of existing shareholders.
• Involves more formalities and procedural delays.

(b) Preference Shares

Meaning: Capital raised by issuing preference shares is preference share capital. Preference shareholders enjoy a preferential position over equity shareholders in two ways:

• (i) They receive a fixed rate of dividend out of net profits before any dividend is declared for equity shareholders.
• (ii) At liquidation, they receive their capital back after the creditors' claims are settled but before equity shareholders.

Preference shares have a hybrid character: they resemble debentures (fixed rate of return) and also equity shares (dividend is paid only at the directors' discretion and only out of profit after tax). Preference shareholders generally do not enjoy voting rights. A company can issue different types of preference shares (their varieties are explained in §8.4.8, Box B).

Merits

• Provide reasonably steady income (fixed return) and safety of investment.
• Useful for investors wanting a fixed return with comparatively low risk.
• Do not affect the control of equity shareholders (no voting rights for preference holders).
• Paying them a fixed dividend can let the company declare higher dividends to equity shareholders in good times. …