EQUITY
SHARES
They are the real owners of the
company. Full voting rights are
guaranteed to equity shareholders. They participate in the meetings of the
shareholders, elect directors and approve major changes in the policies and programmes
of the company. Equity shares are listed at the stock exchange and are freely
transferable.
The rate of dividend is not fixed. It
is decided by the board of directors on the basis of profits left after making
payments of preference shares dividend. Therefore, the investors bear the
maximum risk but may enjoy the maximum profits if the company’s performance is
good.
Advantages of Equity
Shares
A.) From the
company point of view
1. Permanent capital – The funds raised through issue of
equity shares is permanent capital for the company. It is not required to be
refunded during the lifetime of the company. This amount is mostly used to
generate fixed assets of the company.
2. No charge on assets – A company is not required to
mortgage or create a charge on the assets of the company for raising funds
through issue of equity shares.
3. No burden on profits – It is not obligatory on the part of
the company to pay dividend on equity shares in case the profits are not
sufficient or the company decides to retain profits for expansion or
modernisation.
4. Source of strength – Equity share capital reflects the
strength of the company because it is used for fixed assets and does not create
burden for its repayment or payment of dividend on regular basis.
5. Large funds – Equity shares have a small nominal
value (say Rs.10 per share). It encourages the investors to invest in equity
shares. There is no limit of number of members in a public company. Therefore,
a large number of persons invest in equity shares and the company will be in a
position to collect huge amount of money through equity shares.
B.) From the shareholder point of view
1. Voting rights – Equity shareholders have full voting
rights and participate in the meetings of shareholders. They elect directors
and approve major policy changes.
2. Higher dividend – The rate of dividend on equity
shares is not fixed. It depends upon profits, in case the earnings of the
company are good, the directors recommend high rate of dividend.
3. Capital appreciation – Equity shares are listed at the
stock exchange and the prices of shares go up in case the performance of the
company has been good and the market conditions are also favourable.
5. Bonus shares and Right shares – Bonus shares and Right shares are
issued only to the equity shareholders.
5. Tax benefits – The company gives tax-free dividend
to the equity shareholders.
Disadvantages of Equity Shares
A.) From the company point of view
1. Manipulation of control – The management of the company may be
manipulated by few shareholders to maintain the control of the company in their
own hands. Sometimes, they may not work in the interest of the company.
2. Overcapitalisation – The funds raised through equity
shares are not returned during the lifetime of the company. Sometimes, more
capital is raised than required which results in overcapitalisation. It reduces
earnings per share.
3. No trading on equity – If all the funds are raised through
equity shares, the company will not be able to take advantage of trading on
equity.
4. Costly – The cost of raising funds through
issue of equity shares is high. A lot of money is spend on underwriting
commission, brokerage and other expenses.
B.) From the shareholders point of view
1. High risk – Equity shareholders bear the
maximum risk. They are the last to get return on their investment, i.e.,
dividend and the capital when the company is closed.
2. Uncertainty of dividend – Dividend on equity shares is paid
only out of profits. In case, the profits are not sufficient, no dividend is
paid.
3. Concentration of power in few
hands – Some
shareholders keep the control of the company in their own hands by holding
majority shares. Therefore, small investors may remain at the mercy of such
shareholders.
4. Unhealthy speculation – The stock market fluctuates wildly
because of speculations by few operators. The management of the company may
also indulge into such activities which causes extensive loss to the innocent
investors.
PREFERENCE SHARES
These are those types of shares on
which a fixed rate of dividend is paid, and
1. Dividend
on preference shares is paid in priority to equity shares dividend, i.e., the
preference dividend is paid before dividend is paid on equity shares.
2. Return
of Capital: Preference share capital is paid back (returned) in priority to
equity share capital in the event of or at the time of winding up (closing of)
of the company.
Features/characteristics of Preference Shares
1.
A fixed rate of dividend is paid on preference shares.
2. The
preference shareholders have preference in getting the dividend. It is paid in
priority to equity share dividend.
3.
The preference share capital is returned in priority to equity share capital,
if the company is closed.
4.
Preference shareholders do not have voting rights and cannot take part in the
meetings of the shareholders.
5.
A company can issue different kinds of preference shares, like redeemable,
non-redeemable, commulative or non-commulative shares, etc.
Types of Preference shares
1. Cumulative
preference shares – These preference shares have a right to get dividend
out of the profits and in case the profits are insufficient, the dividend is to
be carried forward and paid out of the future profits.
Non-cumulative preference shares – Dividend on such shares is paid
only out of the current year’s profit and in case the profits are not
sufficient, no dividend is to be paid and the preference shareholders do not
have the right to get the ‘arrears’ (past unpaid amount) of dividend in the
future.
2.
Redeemable preference shares – Such shares are redeemed (paid back)
after a fixed period of time and the preference share capital is returned to
the shareholders.
Irredeemable preference shares – The amount raised from such shares
is not redeemed during the lifetime of the company and is to be paid back only
after the winding up of the company.
3.
Convertible preference shares – Those preference shares which are given
the right or option to get their shares converted into equity shares after a
fixed period of time, are known as convertible preference shares.
Non-convertible preference shares – Those preference shares which are
not convertible into equity shares, are known as non-convertible preference
shares.
4.
Participating preference shares – These are those preference shares on
which the investors have the right to participate in the surplus profits left
after paying all dividends (i.e., preference share dividend as well as dividend
on equity shares).
Non-participating preference shares – Only a fixed rate of dividend is
paid on these shares and there is no right to participate in the surplus
profits.
Advantages of preference shares
A.) From the point of view of the company
1. Appeal to cautious investors – A company is able to raise funds
from those investors, who want more security and stability or regularity in
their earnings as compared to equity shares.
2. No interference in management – Preference shareholders do not
have voting rights, therefore, the shareholders are not allowed to interfere in
the management and decisions of the company.
3. No charge on assets – A company is not required to
create a charge on the assets of the company. Therefore, the assets can be used
for raising loans in the future.
4. Trading on equity – The rate of dividend payable on
preference shares is fixed. When the earnings of the company are good, a higher
rate of dividend can be paid on equity shares.
5. No burden on profits – There is no obligation on the
company to pay dividend in case of insufficient profits or when there are
losses in the company.
6. Flexibility – A company can maintain flexibility
in its capital structure by issuing redeemable preference shares.
B.) From the point of view
of the investors (Preference shareholders)
1. Stable and regular dividend – There is a higher possibility of
getting stable and regular dividend because preference dividend is paid before
the equity share dividend.
2. Less risk – Preference shares are less risky
as compared to equity shares because there is no fluctuation in the prices of
shares and there is better security to their investment as compared to equity
shares.
3. Redemption – Most of the preference shares are
redeemable after a fixed period of time. Therefore, the investors can get back
their investment from the company.
4. Cummulative Dividend – In case of cummulative preference
shares, the dividend is carried forward and the arrears are paid out of the
future profits.
Disadvantages of Preference Share
A.) From the point of view of the company
1. Low appeal – Preference shares have a very low
appeal to the investors. A cautious investor prefers debentures than preference
shares.
2. Permanent burden – There is a permanent burden on the
company to pay dividend on cumulative preference shares
3. More legal formalities – A company has to follow a number
of legal formalities when preference shares are to be redeemed
4. Costly – The dividend on preference shares
cannot be treated as business expense, therefore, the company has to pay higher
rate of tax.
B.) From the point of view of the investors
1. No voting rights – Preference shareholders cannot
participate in the meetings of the shareholders.
2. No capital appreciation – Preference shares are not listed
at the stock exchange, therefore, there is no possibility of increase of
capital appreciation of preference shares.
3. No guarantee of dividend – Dividend on preference shares is
paid only out of profits. In case a company continues to suffer losses, no
dividend will be paid even on preference shares.
4. Fear of being shown the door – Preference shares are redeemable. A
company has the option to pay back the preference share capital in case it has
surplus funds.
