Owned Sources of Finance — Equity Shares, Preference Shares and Retained Earnings

Owned sources of finance are those contributed by, or belonging to, the owners of a company, and they form the base on which a company's entire capital structure is built. The three principal owned sources are equity shares, preference shares and retained earnings.

Equity shares represent the ownership capital of a company. A person who buys equity shares becomes a part-owner of the company and is entitled to a share of its profits in the form of dividend. Unlike a fixed obligation, the rate of dividend on equity shares is not fixed — it is decided by the board of directors each year depending on how much profit is available and how much the company wishes to retain for future use, which means equity shareholders may receive a high dividend in a good year and nothing at all in a poor year. Equity shareholders enjoy voting rights in the company's general meetings, giving them a voice in major decisions such as the appointment of directors. They also have a residual claim, meaning that if the company is wound up, they are paid only after every other claim — creditors, debenture holders and preference shareholders — has been settled in full, which makes equity capital the riskiest, but also potentially the most rewarding, form of investment in a company. From the company's point of view, equity capital is permanent capital that need never be repaid during the company's lifetime and carries no obligation to pay a fixed return, which makes it an excellent cushion against risk, though raising it dilutes ownership among a larger number of shareholders.

Preference shares occupy a middle position between equity shares and borrowed funds like debentures. Holders of preference shares are entitled to receive dividend at a fixed rate before any dividend is paid to equity shareholders, and hence enjoy a preferential right to dividend. They also enjoy a preferential right regarding the repayment of capital, meaning that if the company is wound up, preference shareholders are paid back their capital before equity shareholders, though after all creditors and debenture holders. In exchange for these preferences, preference shareholders generally do not enjoy voting rights, except in matters that directly affect their own interests or if their dividend remains unpaid for a specified period. Preference shares therefore give a company a way to raise capital that is treated as ownership funds for classification purposes, while still keeping the return to those investors capped at a known, fixed rate, which appeals to investors who want a more predictable income than an equity share can promise but slightly higher, and less secure, than what a debenture offers. …