Financial instruments with financial value issued by a company to support its business and growth are called securities. They represent various ownership options, creditor connections, and prospective future income. Securities are essentially the intermediary between companies in need of money and investors looking for lucrative opportunities.
Companies issue several kinds of securities, including equity shares, preference shares, debentures, and bonds, which come with several characteristics, rewards, and dangers. Equity securities have voting rights; debt instruments are loans that have to be returned with interest.
What is a Share?
A share represents a unit of ownership in a company. When one buys shares in a corporation, they become the shareholders, meaning they are owners of that company and have a claim on its assets and profits.
Each share gives the owner various rights, such as voting in meetings, dividends that result from the profits of the company, and appreciation of share value over time. The price of a share depends on the performance of the company, market dynamics, and general economic conditions.
In India, share trading is carried out through recognized stock exchanges, such as the Bombay Stock Exchange and the National Stock Exchange. These exchanges facilitate buying and selling through a Demat and trading account.
Owning a share essentially means the ownership of a tiny part of a company, thereby making the investor capable of participating in the growth and profits of the company, making decisions, and benefiting from its long-term wealth accumulation capabilities.
Types of Shares
In India, various types of shares can be issued by a company to strike a balance between ownership, control, and financial stability. A good understanding of each share type will enable investors to make good choices and corporations to handle capital within the legal framework.
Broad Classification of Shares
According to Section 43 of the Companies Act 2013, there are two different types of share capital that a company limited by shares can issue:
1. Equity Shares
Equity shares, also known as ordinary shares, are the real owners of an organisation. Owners of such shares are considered the true owners and bear the ultimate risk or reward due to the performance of the company.
The main features of equity shares are:
- Voting rights at general meetings.
- The dividend is not fixed and forms the leftover profit amount after payment to the company.
- Equity shareholders receive money in case of liquidation only when preference shareholders and other liabilities are repaid.
- They have a say in decisions and the election of the board of directors.
- If the company performs well, then capital appreciation is seen.
Subtypes of Equity Shares:
- Equity shares with voting rights give the shareholder a right to vote in key business decisions regarding the appointment of directors, mergers, etc., and policy changes.
- Equity shares with Differential Rights allow different voting and dividend rights. For example, a shareholder can have higher dividends and less or no voting powers. It is advantageous in cases where the founders want to keep control but raise funds.
2. Preference Shares
Preference shares are a type of share that grants their owners a priority claim on dividends as well as capital return, ahead of equity shareholders. However, they generally carry limited or no voting rights.
Key Features of Preference Shares:
- Fixed rate of dividend, which is payable before equity dividends.
- Priority of return of capital upon liquidation.
- Generally non-voting except on matters directly affecting their rights.
- Suitable for investors seeking stable returns rather than ownership control.
Sub-Types of Preference Shares:
- Cumulative Preference Shares: Unpaid dividends accumulate and must be paid in future years before any equity dividend is distributed.
- Non-Cumulative Preference Shares: In the event of its failure to declare a dividend in any given year, the right lapses; dividends cannot be carried forward without being paid.
- Redeemable Preference Shares: These shares can be bought back by the company after a specific period or on fulfilment of certain conditions. Most preference shares in India today are redeemable.
- Irredeemable Preference Shares: These cannot be redeemed during the lifetime of the company. However, as per the Companies Act, 2013, irredeemable preference shares cannot be issued in India anymore.
- Convertible Preference Shares: Can be subsequently converted into equity shares after a specified period or on the happening of certain conditions at the time of their issue.
- Non-Convertible Preference Shares: Cannot be converted into equity shares and continue as preference shares until redemption.
- Participating Preference Shares: Permit holders to participate further in profits beyond their fixed dividend, often along with the equity shareholders.
- Non-Participating Preference Shares: Entitled only to a fixed dividend, without any participation in the surplus profits.
Other Types of Shares
In addition to equity and preference shares, companies may classify shares for certain purposes or internal governance:
- Bonus Shares: Current shareholders are provided with additional shares free of cost, which are sourced from accumulated profits or reserves. Bonus shares increase the total outstanding shares but not the value of the capital, hence rewarding shareholders without requiring any cash outlay.
- Right Shares: Current shareholders now have an opportunity to purchase shares at a price lower than their current holdings in order to maintain their ownership while at the same time giving the company additional capital.
- Sweat Equity Shares: It is issued to the directors or employees as consideration for their services, like developing intellectual property, technical expertise, or adding value to the company, at a concession or even against non-cash compensation.
- Employee Stock Option (ESOP): These are not actual shares at the time of issue, but give the employees a right to purchase shares of the company at a predetermined price at some point in the future. ESOPs align employee interests with company performance and retention-related goals.
Importance of Classification of Share Types
- Investment Flexibility: This allows investors to select shares based on their risk appetite and expectations of income.
- Capital Structure Management: Helps organizations manage risk and ensure stability.
- Attracting Investments: There are different share classes serving different investor groups, some for growth-oriented and others for income-seeking investors.
- Maintaining Control: Founders can generate funds by issuing shares with different voting rights, thus retaining their control.
- Legal Compliance: Correct categorisation of shares ensures that Sections 43 and 55 of the Companies Act, 2013, are met, along with the requirements of SEBI with regard to publicly listed companies.
Benefits of Investing in Shares
Investing in stocks is commonly referred to as equity investing; it has many benefits for people seeking to create wealth over the long term, be financially independent, and hedge against inflation.
- Wealth creation: A stock investment gives an individual a share in the achievements and profitability of a company. Well-chosen stocks, over time, can grow considerably in value to help investors amass long-term wealth and attain critical financial goals such as retirement, education, or home ownership.
- Historically, equities have given higher returns compared to fixed deposits, bonds, and gold. Though there are short-term fluctuations, the long-term potential for capital gains positions stocks as one of the most rewarding investment avenues.
- Dividend Income: Dividends are a common way for companies to distribute profits among their owners or shareholders. These quarterly distributions offer investors a reliable source of passive income, which can be reinvested in order to generate additional returns through compounding.
- Liquidity: Shares of companies listed on stock exchanges like NSE and BSE have huge liquidity. At any given time, an investor can sell or buy shares, and thus the investor can get cash from their investment whenever needed.
- Ownership and Voting Rights: Investors who purchase shares become part-owners of the company. With this ownership usually comes a right to vote on major corporate matters or to have access to information on the performance of the company.
- Inflation Hedge: Equities usually outperform inflation due to the long-term effect. With the general rise in prices, companies normally increase the prices of their products, which means increased revenues and profits, leading to benefits to the shareholders in terms of improved stock prices and dividends.
- Portfolio diversification: Diversifying investment across sectors and industries is one way of spreading risk. Even if one sector faces a slump, gains from other sectors balance the portfolio for stability and steady growth.
- Capital Gains and Bonus Issues: Besides dividends, the investor benefits from capital appreciation and corporate actions like bonus shares, rights issues, and stock splits that enhance the overall value of the investment.
- Flexibility and Accessibility: Online trading platforms make it easy and convenient to invest. Even a beginner can create a diversified portfolio with small amounts.
- Tax Benefits: Since long-term capital gains on shares held for over a year are taxed at a rate lower than that of other sources of income, this provides an added financial benefit.
Conclusion
Grasping the different kinds of shares is of great importance for investors and companies alike, as this enables them to make prudent financial and investment decisions. Shares are not just representations of ownership in a company but also determine the extent to which control, rights, and benefits are given to shareholders. Accordingly, while equity shares allow voting rights and increased returns in the form of dividends and capital appreciation, preference shares provide greater stability with fixed income from dividends and priority during profit distribution or liquidation. Each class of share plays a particular function in the capital structure of a company for the varied expectations of its investors, whether their objectives are growth, regular income, or risk reduction.
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