Topics Covered in this article
Meaning of Shares
In order to establish or expand any business, the company needs money or capital. To generate such capital the company issues the rights of the company in small and finite units also known as, shares which can be purchased by the people as per their wish. Shares are the smallest unit of a company’s total capital. Section 2(84) of the Companies Act, 2013 (the ‘Act’) defines the term ‘Shares’ as ‘a share means a share in the share capital of a company including stocks.’ A share represents the ownership of a company which is given to people in exchange for money. A person who purchases the shares of the company is called a ‘shareholder’. Shareholders are also known as the partial owners of the company as they get certain rights, liabilities and interests after purchasing the shares. They receive a part of the profit earned by the company, if there are any, in the form of ‘dividend.’
Illustration: A person ‘X’ purchased 50 shares of a company namely, ‘ABC ltd.’ at the rate of Rs. 5 per share. Here, ‘X’ is the shareholder who has acquired a partial ownership of the company and in return the company generated the capital of 250 (50×5) rupees.
A company prefers to generate funds by issuing shares rather than taking debts because debt financing involves payment of a fixed sum of interest even when the company has suffered losses in the given financial year. On the other hand, a dividend on shares is paid only when the company has earned profits. Greater profits results in greater dividends and that is the rule. The company must also consider the cost of the capital as a factor before deciding the method of raising such capital.
Another reason for a company to opt for share issue for generating funds over raising a debt can be when the shares of the company are inflated and are likely to generate more capital at lower cost.
Nature of Shares
In India, shares are considered as goods which are movable property and can be transferred from one person to another. Section 44 provides that a share is a tangible property and can be transferred from one shareholder to another shareholder if the Article of Association of the company permits to do so.
According to Lord M.R. Greene, any movable property of a man is of two kinds:
- Choose in possession
- Choose in action
A Choose in Possession gives the absolute possession of the property and therefore the property holder has the complete control over the said property, whereas, Choose in Action gives the property holder the legal rights over the property but does not give its immediate possession. Shares are a choose in action property that is, the share holder does not have the immediate possession of the shares but have a legal right over it which can be enforced through legal actions.
Once the shares of a company is transferred in the name of the shareholder, the shareholder gets a share certificate which is considered as a proof that such person holds the shares of a particular company. Therefore, shares must not be considered as goods in its traditional sense as they cannot be transferred like other movable goods are transferred.
Transferability of shares also depends upon the type of company. In a case, it was observed that the Companies Act, 2013 establishes a clear distinction between the transferability of shares in a private company as well as in a public company. The transfer of shares of a private company is limited and such limitation is provided in the Article of Association of the company, whereas the transfer of shares of a public limited company are not restricted.
Section 45 states that every share with a share capital must have a distinguished number.
For example- If a person is holding a share then the physical share certificate will show that the owner is holding the share of this particular share number.
But if the shareholder trades in shares through a Demat account then such share certificate stating the share numbers is not required and the shares are debited and credited through that account only.
Share Capital- Meaning and Types
The capital or funds raised by the company by issuing its shares to the people is known as share capital. A share is the smallest unit of the share capital which is issued at its face value.
For example: A company issues 20,000 shares of Rs. 50 each. The total share capital generated is of Rs. 10,00,000 (20,000×50). The Memorandum of Association of every ‘Limited’ company must state the amount of share capital which the company is authorized to issue during its lifetime.
At times, when the company is expanding and making good profits, the price of the share is inflated and therefore the share is issued at a higher price generating more capital for the company. But when the company is going through losses and the company decides to issue more shares to generate capital for its day-to-day functioning then the shares can even be issued at a lower or deflated price.
The share capital of a company is represented in the Shareholder’s funds column along with Reserves and Surplus under the head ‘Equity and Liabilities.’
To generate funds through share capital, the company needs to strictly comply with the provisions of the Companies Act, 2013. There are a number of share markets in India where the shares can be listed for ‘new issue’ or ‘primary issue,’ NSE and BSE being the most popular ones.
Types of Share Capital
Primarily, there are two types of share capital- Preference Share Capital and Equity Share Capital.
Preference Share Capital
As the name suggests, preference share capital is the capital generated by issuing preference shares. Now, what is a Preference Share ? Preference shares are those shares which hold a certain preference when it comes to the distribution of profit by the company to the shareholders and therefore the capital raised by issuing the preference share is known as ‘Preference Share Capital.’ The Preference Share Capital carries preferential rights. For example- The company gives a fixed rate of interest to the preference shareholders. But the Preference shareholders do not get exclusive rights or interest in the company and they don’t have any decision making power. Also, they don’t have any voting rights in the company.
At the time of winding up of the company, the preference shareholders also known as ‘Preferred stock’ are given a priority over the equity shareholders and they are paid from the assets of the company after all the debts are settled.
To sum up it can be said that a preference share is actually a hybrid of an equity share and a debt as it has the characteristics of both the securities.
It must be noted, that if the company is suffering from a loss then in that case payment of interest to the preference shareholders is not at all necessary. The decision to pay the preference shareholders vests completely with the management of the company.
Illustration: A company ‘Super Ltd’ issues 5000 preference shares at the rate of Rs. 10 per share. The total preference share capital generated by the company will be 5000×10 i.e., Rs. 50,000.
Features of Preference Share Capital
- A Preference share capital generates a long term capital for the company unlike debts which have to be repaid after a certain period of time.
- The interest paid on the preference share capital is not tax deductible.
- Generating capital through preference shares does not involve granting company’s rights or decision making powers to the shareholders.
- The interest to be paid on the preference share capital is lesser as compared to the dividend paid on the equity share capital.
- There is no legal obligation to pay interest on the preference share capital when the company is unable to generate adequate profits.
Preference shares are further categorized on the basis of their characteristics. In India, there are nine types of preference shares through which capital can be generated.
- Cumulative Preference Shares
Cumulative Preference shares are the shares in which the interest is paid by the company cumulatively in a given financial year if the company was unable to pay it in the previous years due to certain losses.
Illustration: Suppose a company namely, ‘Alpha Ltd.’ has issued 5000 cumulative preference shares to its shareholders at rate of Rs. 50 per share. Due to the Covid pandemic, the company suffered losses and therefore was unable to pay to its shareholders any interest in the financial year 2020-2021. So when the company’s business revived in the succeeding year, the company cumulatively paid its shareholders the interest of that particular year along with the interest of the year 2020-2021.
- Non Cumulative Preference Shares
As the name implies, the non- cumulative preference shares are the shares in which the shareholders are paid the interest for that particular financial year and not for any other year.
- Redeemable Preference Shares
Preference shares that are redeemed by the company which issued it are known as Redeemable Preference shares. These shares have a maturity date and on that particular date the shares are returned back to the company at a predetermined price.
Illustration: A company namely, ‘Beeta Ltd.’ issued 1000 redeemable preference shares at the rate of Rs. 500 per share. The shares were issued with a maturity date that is let’s say 20.07.2021. On that particular day the shareholders will cease to be the shareholders of the company and the ownership of those 1000 shares will go back to the company and in return the shareholders will get a fixed amount per share.
- Irredeemable Preference Shares
Irredeemable preference shares are the shares which cannot be purchased by the issuing company again until the company is going through a liquidation process therefore they are called as irredeemable.
- Participating Preference Shares
The participating preference shares are the shares which give its holder’s certain added advantages along with the interest which is paid in the preference shares. These added advantages include:-
- Additional interest along with the regular interest if the company earns good profit after all the other shareholders are paid.
- They may also have voting and decision making rights in the company.
- A part of the net sale after the winding up of the company.
Illustration: Suppose a company ‘Crew Ltd.’ issues 50 Participating preference shares at the rate of Rs. 10 per share and the capital generated is Rs. 500. The company gives 5% interest on such shares which is considered as the regular interest. So after the company pays the regular interest to the preference shareholders and dividend to the equity shareholder’s, the participating preference shareholders will receive an additional interest from the remaining profit.
- Non Participating Preference Shares
Non participating preference shares are the shares which does hold any such advantage or rights which a Participating preference share holds.
- Convertible Preference Share
Convertible preference shares are the shares which can be converted to equity shares after a certain period of time and at a predetermined price as mentioned in the Memorandum of Association of the company.
- Non- Convertible Preference Share
The shares which cannot be converted into equity shares during the lifetime of the company are known as the Non- convertible preference shares.
- Adjustable- rate Preference Share
Adjustable- rate preference shares are those shares whose interest significantly depends upon the current market condition. A company issues adjustable- rate preference shares to avoid paying a fixed amount of interest to the shareholders which can sometimes create a burden on the company. The interest is directly linked to the rupee interest benchmark rate.
For example- a company ‘Delta Ltd.’ issues adjustable- rate preference shares for which the offered rate of interest is MCLR (Marginal Cost of Fund Based Lending Rate) of SBI along with an additional 7%.
There is usually a cap on the interest paid in order to protect the company from paying huge interests.
A company can generate Preference share capital through issuing any of the above- mentioned preference shares.
Equity Share Capital
Equity Share Capital is the capital generated by the company by issuing the Equity shares. Equity shares are the shares which grants the ownership of the company to its shareholders. Dividend is paid to the equity shareholders after the payment of interest to the lenders and preference share- holders. Such dividend is not fixed and is fluctuating as per the profits earned by the company. In case the company is not able to earn enough profits, dividend is not paid to the equity share-holders.
The share capital of Berger Paints only consists of Equity share capital that means they only issue equity shares and not preference shares.
Features of Equity Share Capital
- The dividend on the equity share capital is paid only when the company has enough profits to pay the same.
- By generating capital through equity shares, the company grants the ownership rights, voting rights and several other decision making rights to its shareholders.
- The capital is repaid at the time of winding up of the company.
- Tax is not paid on the dividend received by the shareholder.
A company always prefers generating capital through equity shares rather than through preference shares.
Following a thorough examination of shares and share capital, it is clear that generating capital is very important for any business. When such capital is generated though issuance of shares then it is known as share capital. Share capital can be generated either by issuing equity shares or by preference shares. If we look at it from the perspective of the company then generating equity share capital is considered to be a preferable option as it does not put a burden on the company for the payment of a preset dividend; whereas in preference shares, a company has to pay a predetermined interest even though the company is not earning good profits.
On the other hand, investing in preference shares is a better option for the people who do not want to take risks and want a steady income. If an investor is interested in acquiring the rights of the company and is ready to take risks they can surely go for investment in equity shares. Many times, even the company prefers issuing preference shares when they don’t want to give the rights of the company to the outsiders.
To conclude we can say that investment in the share market and more specifically in the equity shares comes with a lot of risks and can potentially result in losses. Therefore, it is important to consider all the aspects of the investment before making any decision.