Equity Shares: Definition, Advantages, and Disadvantages (2024)

What are equity shares?

Equity shares are a key source of long-term financing for companies, issued to the general public and non-redeemable. Shareholders of equity shares have voting rights, share in profits, and can claim assets, providing them with a stake in the company's success.

Equity shares, also known as common shares or ordinary shares, represent a form of ownership in a company. When an individual or entity holds equity shares in a company, they become partial owners, sharing in the ownership capital of the business. These shares confer various rights and privileges to the shareholders, and they play a crucial role in the financial structure of a company.

Types of equity shares available

1. Bonus shares:
   Bonus shares are additional shares distributed to existing shareholders without any additional cost. This is often a result of the company's accumulated profits or reserves.
2. Right shares:
   Right shares give existing shareholders the privilege to purchase additional shares before they are offered to the public. This provides an opportunity for current investors to maintain or increase their ownership in the company.
3. Sweat equity shares:
   Sweat equity shares are issued to employees or directors as a form of compensation for their contributions to the company's growth. This is a way for companies to retain and reward key individuals.
4. Voting and non-voting shares:
   Voting shares grant shareholders the right to participate in the decision-making process of the company, such as electing the board of directors. Non-voting shares, on the other hand, do not confer such rights but still offer a share in the company's profits.
5. Authorised share capital:
   This represents the maximum number of shares a company can issue as per its memorandum of association. It sets the limit on the company's fundraising capacity.
6. Issued share capital:
   The portion of authorised shares that the company has actually issued to shareholders is known as issued share capital.
7. Subscribed share capital:
   Subscribed share capital is the part of issued share capital for which shareholders have made payments.
8. Paid up capital:
   This is the amount of money that shareholders have paid for the shares they subscribed to. It represents the actual capital available to the company for its operations.

Features of equity shares

1. Ownership stake: Equity shares signify ownership in a company. Shareholders who hold these shares are considered partial owners of the business, and the extent of their ownership is proportionate to the number of equity shares they hold relative to the total outstanding shares.
2. Voting rights: Equity shareholders typically have the right to vote on certain matters related to the company's management and decision-making. Common issues subject to shareholder votes include the election of the board of directors, approval of significant corporate actions, and changes to the company's charter.
3. Dividend income: Equity shareholders are entitled to a share the company’s profit in the form of dividends. However, the payment of dividends is at the discretion of the company's board of directors, and not all companies distribute dividends regularly.
4. Capital gains: The value of equity shares can fluctuate based on market conditions, the company's performance, and other economic factors. Shareholders have the opportunity to benefit from capital gains by selling their shares at a higher price than the purchase price.
5. Residual claim: In the event of liquidation or winding up of the company, equity shareholders have a residual claim on the company's assets. After all debts and obligations have been settled, any remaining assets are distributed among the equity shareholders.
6. Limited liability: One of the advantages of holding equity shares is that shareholders' liability is generally limited to the amount invested in the shares. Unlike some other forms of investments, shareholders are not personally responsible for the company's debts.
7. Risk and return: Equity shares are considered riskier than certain fixed-income securities, such as bonds, because their value is subject to market fluctuations. However, they also offer the potential for higher returns, especially in the form of capital appreciation.
8. Transferability: Equity shares are often traded on stock exchanges, providing liquidity to shareholders. Investors can buy or sell these shares in the secondary market, making them more liquid compared to some other forms of investments.

Additional read: Shares vs Debentures

Why should you invest in equity shares?

1. Capital gain, income, and dividend: Investing in equity shares offers the potential for capital appreciation, regular income through dividends, and the possibility of earning from the sale of shares at a higher market price.
2. Limited liability: Shareholders' liability is limited to the amount invested in the shares. In the case of financial distress or bankruptcy, the personal assets of shareholders are not at risk.
3. Exercise control: Equity shareholders have the right to participate in crucial decisions by voting during annual general meetings. This gives them a say in the company's policies and major undertakings.
4. Bonus shares: Companies may issue bonus shares as a gesture of sharing profits with existing shareholders. This enhances the shareholder's wealth without any additional investment.
5. Liquidity: Equity shares are traded on stock exchanges, providing liquidity to investors. They can easily buy or sell shares based on market conditions.
6. Stock split: Companies sometimes opt for stock splits to make shares more affordable for small investors. This does not impact the overall valuation but increases the number of shares outstanding.

What are the risks associated with equity investment?

While equity shares offer significant advantages, they are not without risks. Market fluctuations, economic downturns, and company-specific issues can impact the value of equity shares. It is crucial for investors to be aware of these risks:

• Market risk: The value of equity shares is influenced by market dynamics. Economic conditions, interest rates, and geopolitical events can lead to fluctuations in share prices.
• Company-specific risks: The performance of a company, its management decisions, and industry trends can affect the value of its shares. Poor financial performance or governance issues can lead to a decline in share prices.
• Liquidity risk: While equity shares are generally liquid, there can be instances where trading volumes are low, making it challenging to buy or sell shares at desired prices.
• Currency risk: For investors in international markets, fluctuations in exchange rates can impact the returns on equity investments.

Alternative investment options

While equity shares are a popular investment choice, diversification is key to a well-rounded portfolio. Some alternative investment options include:

• Bonds: Fixed-income securities that provide regular interest payments and return of principal at maturity.
• Mutual funds: Investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities.
• Real estate: Investment in physical properties for rental income or capital appreciation.
• Precious metals: Gold, silver, and other precious metals are often considered safe-haven assets and can serve as a hedge against inflation.

Additional read: What is SEBI

Conclusion

In conclusion, shares play a pivotal role in the world of finance, serving as a means for individuals to participate in the ownership and profits of companies. Understanding the various types of equity shares, their features, and the associated risks are crucial for investors. While equity shares offer numerous advantages such as capital gain, limited liability, and control over decision-making, it is essential to diversify one's investment portfolio to mitigate risks. Whether it's through bonds, mutual funds, real estate, or other alternative investments, a well-balanced approach is key to building a resilient and profitable investment portfolio.