Equity shares are financial instruments to raise equity capital. The equity share capital is the backbone of any company’s financial structure. Equity capital represents ownership capital. Equity shareholders collectively own the company. They enjoy the reward of ownership and bear the risk of ownership. The equity share capital is also termed as the venture capital on account of the risk involved in it. The equity shareholders’ liability, unlike the liability of the owner in a proprietary concern and the partners in a partnership concern, is limited to their capital subscription and contribution.
In India, under the Companies Act 1956, shares which are not preference shares are called equity shares. The equity shareholders get dividend after the payment of dividend to the preference shareholders. Similarly, at the event of the winding up of the company, capital is returned to them after the return of capital to the preference shareholders. The equity shareholders enjoy a statutory right to vote in the general body meeting and thus exercise their voice in the management and affairs of the company. They have an unlimited interest in the company’s profit and assets. If the profit of the company is substantial, the equity shareholders may get good dividend; if not, there may be little or no dividend with reduced or nil profit. The equity shareholders return of income, i.e. dividend is of fluctuating character and its magnitude directly depends upon the amount of profit made by a company in a particular year.
Now a days equity capital is raised through global equity issues. Global depository receipts (GDRs), American depository receipts (ADRs), etc. are financial instruments used by Indian companies to overseas capital market to get equity capital.
Advantages of Equity Share Capital
- Equity share capital constitutes the ‘corpus’ of the company. It is the ‘heart’ to the business.
- It represents permanent capital. Hence, there is no problem of refunding the capital. It is repayable only in the event of company’s winding up and that too only after the claims of preference shareholders have been met in full.
- Equity share capital does not involve any fixed obligation for payment of dividend. Payment of dividend to equity shareholders depends on the availability of profit and the discretion of the Board of Directors.
- Equity shares do not create any charge on the assets of the company and the assets may be used as security for further financing.
- Equity capital is the risk-bearing capital, unlike debt capital which is risk-burdening.
- Equity share capital strengthens the credit worthiness and borrowing or debt capacity of the company. In general, other things being equal, the larger the equity base, the higher the ability of the company to secure debt capital.
- Equity capital market is now expanding and the global capital market can be accessed through international financial market instruments.
Disadvantages of Equity Shares Capial
- Cost of issue of equity shares is high as the limited group of risk-seeking investors need to be attracted and targeted. Equity shares attract only those classes of investors who can take risk. Conservative and cautious investors do not to subscribe for equity issues. So underwriting commission, brokerage costs and other issue expense are high for equity capital, raising up issue cost.
- The cost of servicing equity capital is generally higher than the cos’ issuing preference shares or debenture since on account of higher n the expectation of the equity shareholders is also high as compared preference shares or debentures.
- Equity dividend is payable from post-tax earnings. Unlike intent paid on debt capital, dividend is not deductible as an expense from, profit for taxation purposes. Hence cost of equity is high. Sometimes, dividend tax is paid, further rising cost of equity share capital.
- The issuing of equity capital causes dilution of control of the equity holders.
- In times of depression dividends on equity shares reach low be which leads to drastic full in their market values.
- Excessive reliance on financing through equity shares reduces the capacity of the company to trade on equity. The excessive use of equity shares is likely to result in over capitalization of the company.
Credit: Financial Management Concepts-MGU