The Companies Act has defined an equity share negatively as a share which is not a preference share. A preference share has been defined as a share which has two preferential rights. First, to payment of dividend in preference to other shareholders. Second, to return of capital in preference to other shareholders in case the company goes into liquidation.
Earlier an equity share was known as ordinary share. Equity share carries voting right and the management of the company vests in equity shareholders. Equity shareholders are the owners of the company. They have a chance to get unlimited amount of dividend in case the company earns good profit. However, they also run the risk of loosing their capital in case company is unable to earn profit or incurs losses continuously. Equity shareholders also have the benefit of capital appreciation as the value of such shares rises with the rising rate dividend declared by the company. In case the company does not pay good dividend, the value of such shares may fall below their face value or nominal value. Therefore, equity shares are very risky. For this reason equity shares capital is also known as ‘Risk capital’ or ‘Venture capital’.
Equity shares being very risky are subscribed (purchased) by such investors who are enterprising and want to take risk.
Merits of Equity Shares from the point of view of the company
- It provides long term capital which is repayable only when the company goes into liquidation.
- It provides ‘risk capital’ or ‘venture capital’.
- It does not impose any burden on the company as it is not obligatory to pay dividend.
- It does not create any charge on the assets of the company. As such the company can raise loans on the security of its assets.
Merits of Equity Shares from the point of view of the shareholders:
- It provides voting right to the shareholders who are the real owners of the company and manage the affairs of the company.
- They get higher return as they can share the surplus in case company earns good profit.
- Their investment is liquid as they can sell the shares.
- They can earn capital gains by selling their shares.
- They get income tax exemptions as dividend is ordinarily exempted from tax.
- They have a preferential right to buy shares in case company issues shares to raise further capital.
- They have a chance of getting bonus shares.
Limitations of Equity Shares from the point of view of the company
- It may lead to over-capitalisation as surplus funds cannot be returned. They would remain idle or under-utilised in the absence of investment opportunities.
- It may lead to speculation and insider trading in the shares of the company.
- Equity shareholders may adopt questionable means to gain control of management of the company.
- In case only equity shares are issued, the company may not be able to take the advantage of trading on equity, i.e., it cannot raise the rate of dividend on equity shares by issuing fixed interest bearing securities.
- Cost of raising capital by issuing shares in higher than raising funds through preference shares, debentures etc.
Limitations of equity Shares from the point of view of the equity shareholders
- It is very risky. The rate of return i.e., dividend is uncertain.
- They may suffer capital loss if the market value of a share goes down.
- They may not get their capital back if the company is wound up due to heavy losses as they are paid after the creditors, debenture-holders and preference shareholders have been paid.
- In practice they may not be able to exercise control over the management due to oligarchy of management. Moreover, they are not united as they are scattered throughout the country.
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