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What is Issue of Shares? Types of Shares, Advantages and Disadvantages

Sayeba Naushad
Published: December 21, 2022

Meaning of Issue of Shares

Share capital is capital obtained through the issuance of shares. A company’s capital is divided into small units called shares. Each share has a nominal value. For example, a company can issue 2,00,000 shares of Rs. 10 each for a total of Rs. 20,00,000. The person who holds the shares is referred to as the shareholder. 

A company typically issues two types of shares Equity and Preference shares. The money raised by issuing equity shares is referred to as Equity share capital, whereas money raised by issuing preference shares is referred to as Preference share capital.

Types of Shares

1. Equity Shares: A company’s most important source of long-term capital is equity shares. Because equity shares represent a company’s ownership, the capital raised through the issuance of such shares is known as ownership capital or owner’s funds. A company must have equity share capital in order to be established.

Equity shareholders are paid on the basis of the company’s earnings rather than a fixed dividend. They are known as “residual owners” since they receive what remains after all other claims on the company’s income and assets have been satisfied. They gain from the reward while also bearing the risk of ownership. Their liability is limited to the amount of capital they invested in the company.

Merits of Equity Shares :

  • Equity shares are appropriate for investors who are willing to take on risk in exchange for higher returns.
  • The payment of dividends to equity shareholders is optional. As a result, the company bears no burden in this regard.
  • Equity capital is permanent capital because it is repaid only when a company is liquidated. It provides a buffer for creditors in the event of a company’s insolvency because it is listed last on the list of claims.
  • Equity capital provides the company with creditworthiness and confidence in potential loan providers.
  • Funds can be raised through an equity issue without placing a charge on the company’s current assets. If necessary, a company may freely mortgage its assets in exchange to obtain financing.
  • The voting rights of equity shareholders ensure democratic control over the company’s management.

Demerits of Equity Shares :

  • Due to the fluctuating returns on equity shares, investors looking to find a consistent income may not prefer equity shares.
  • The cost of equity shares is typically higher than the cost of raising funds from other sources.
  • The voting rights and profits of current equity shareholders are diluted when new equity shares are issued.
  • Raising money through the issuance of equity shares involves more formalities and delays in the legal process.

2. Preference Shares: Preference share capital is the capital acquired through the issuance of preferred shares. There are two ways in which preference shareholders are in a better position than equity shareholders :

  1. receiving a fixed rate of dividend before any dividend is paid to equity shareholders out of the company’s net profits.
  2. receiving their capital at the time of the company’s liquidation after the debts of its creditors have been settled.

In comparison to equity shareholders, preference shareholders have a preferential claim to dividends and capital repayment. Preference shares are similar to debentures in that they have a fixed rate of return. Furthermore, As the dividend is paid only at the discretion of the directors and only from profit after tax, these are similar to equity shares in that context. As a result, preference shares share some characteristics of both equity and debentures.

Merits of Preference Shares:

  • Preference shares provide reasonably consistent income in the form of a fixed rate of return and investment safety.
  • Preference shares are useful for investors seeking a fixed rate of return with low risk.
  • It has no effect on equity shareholders’ control over management because preference shareholders do not have voting rights.
  • Paying a fixed dividend rate to preference shares may enable a company to declare higher dividend rates to equity shareholders in good times.
  • In the event of a company’s liquidation, preference shareholders have a preferential repayment right over equity shareholders.
  • Preference capital does not impose any kind of charge on a company’s assets.

Demerits of Preference Share:

  • Preference shares are not suitable for investors who are willing to take risks in exchange for higher returns.
  • Preference capital dilutes equity shareholders’ claims towards the company’s assets.
  • The dividend rate on preference shares is generally higher than the interest rate on debentures.
  • As the dividend on these shares is only paid when the company makes a profit, there is no guaranteed return for investors. As a result, these shares may not be very appealing to investors.
  • The dividend is not deductible as an expense from profits. As a result, there is no tax savings, as in the case of interest on loans.

Types of Preference Shares

Preference Shares are of the following types:

  1. Cumulative and Non-Cumulative: Cumulative preference shares are those that have the right to accumulate unpaid dividends in future years if they are not paid during the current year. On the other hand, dividends on non-cumulative shares are not accumulated if they are not paid in a given year.
  2. Participating and Non-Participating: Participating preference shares are preference shares that have the right to participate in the additional surplus of a company’s shares after a dividend at a certain rate has been paid on equity shares. Non-participating preferences are those who do not have the right to participate in the company’s profits.
  3. Convertible and Non-Convertible: Convertible preference shares are preference shares that can be converted into equity shares within a certain time frame. Non-convertible shares are those that cannot be converted into equity shares.