Equity share is a primary source of finance for any company giving investors rights to vote, share profits, and claim on assets. Various types of equity share capital are authorized, issued, subscribed, paid-up, rights, bonus, sweat equity, etc. The expression of the value of equity shares is in terms of the face value or par value, issue price, book value, market value, intrinsic value, stock market value, etc.
In the world of finance and investment management, ‘equity share’ is a big word, and we frequently use it in every following discussion. We call it stock, ordinary share, or shares; all are the same. Explaining equity shares on a page or a bunch of pages is very difficult. Let us still try to define it in as a summarized manner as possible.
Usually, a company is started with equity finance as its first source of capital from the owners or promoters of that company (founder’s stock). After a certain level of growth, there is a requirement for more capital for further growth. The company then finds an investor in the form of friends, relatives, venture capitalists, mutual funds, or any such small group of investors and issues new equity shares to these investors.
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A point comes where the company reaches a very high level and requires enormous capital investment for business growth. An Initial Public Offer (IPO) is the offer of shares that the company makes to the general public for the first time. And Follow on Public Offer (FPO) are more such offers in the future to the public. Other than these, there are various other sources of equity financing.
Equity Shares
They fall under the long-term sources of finance– category because, legally, they are irredeemable. For an investor, these shares are a certificate of ownership in the company by virtue of which investors are entitled to share the net profits and have a residual claim over the company’s assets in the event of liquidation. Investors have voting rights in the company, and their liability to the company is limited to the amount of issue price of the equity stock.
Types of Equity Shares
There are various classes of shares (equity) dependent on multiple things. Let’s discuss them.
In the company’s financial statements, we place the equity shares on the liability side of the balance sheet. Their classification into various categories is as follows:
Authorized Share Capital
It is the maximum amount of capital that a company can issue. The companies can increase it from time to time. For that, we need to comply with some formalities and pay some fees to the legal bodies.
Issued Share Capital
It is part of the authorized capital that the company offers to investors.
Subscribed Share Capital
An investor accepts and agrees upon that part of the issued capital.
Paid Up Capital
It is the part of the subscribed capital that the investors pay. Normally, all companies accept complete money in one shot and therefore issued, subscribed, and paid capital becomes the same. Conceptually, paid-up capital is the amount of money a company invests in the business. It is also known as contributed capital.
Apart from the above, other types of shares (equity) also exist.
Rights Shares
Right shares are those that a company issues to its existing shareholders. The company issues such kinds of shares to protect the ownership rights of the existing investors.
Bonus Shares
When the company issues shares to its shareholders in the form of a dividend, we shall call them bonus shares. There are various advantages and disadvantages of bonus shares like dividend, capital gain, limited liability, high risk, fluctuation in the market, etc.
Sweat Equity Share
Sweat equity shares are issued to exceptional employees or directors of the company for their exceptional job in terms of providing know-how or intellectual property rights to the company.
Treasury Stock
Treasury stock means the share that the company has bought back.
Various Prices of Equity Shares
Par or Face Value
Par or face value is the value of shares that we record in the books of accounts. It is also termed the legal capital in the books of accounts of the company.
Issue Price
This price is the price that a company offers to investors. Normally, the issue price and face value of a share are the same in the case of new companies.
Share/Security Premium and Share at Discount
When the issuance of shares is at a price higher than face value, we shall call this excess amount to be premium. On the contrary, when the issuance of shares is at a price lower than face value, we shall call this deficit amount a discount.
Book Value
The calculation of the book value will be:
Paid-up Capital + Reserves and Surplus – Any Loss / The total number of equity shares of the company
This is the balance sheet value of shares. This is an important value in the case of Mergers and Acquisitions.
Market Value
In the case of companies listed on stock exchanges, the market value of the equity share is the price at which they are currently sold in the market. The other term for it is stock market value. It may happen that stock market value and value as per fundamental principles differ. Because there are a number of sentiments that affect the stock market value.
Fundamental Value
The number of times the fundamental value of the security is calculated for the purpose of the Merger or valuation. Its calculation is as per (i) Dividend Discount Model (ii) Price Earning Ratio Method (iii) Earning Capitalization Method (iii) Chop Shop method.
Investing and Financing Angle of Equity Shares
When talking about equity shares, there are two angles. One investor angle wherein the investor invests in equity shares and the second financing angle where a company accepts the finance in the form of equity. There are pros and cons of both of these as described below.
Financing Angle: Benefits and Disadvantages of Equity Finance
Investor Angle: Benefits and Disadvantages of Equity Shares Investment
Frequently Asked Questions (FAQs)
Equity in stocks is a long-term source of finance for any company, where the investors get shares as a certification of ownership in the company. These investors are entitled to the voting right, share in the net profits and residual claim on the assets of the company at the time of liquation of the company
Authorized share capital.
Issued share capital.
Subscribed share capital.
Paid-up capital.
Right shares.
Bonus shares.
Sweat equity shares.
Rights shares or right issue refers to the shares issued to the existing shareholders. These shares protect the ownership rights of the existing investors.
Quiz on Equity Share and its Types
This quiz will help you to take a quick test of what you have read here.
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Nice Article. Here is some information about Stockholder’s equity.
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Business angels are wealthy individuals who invest in high growth businesses in return for a share in the business.
Between Equity and Debenture which one is the cheapest source of long-term finance
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