A company has two primary sources of capital to consider when seeking funding. It can raise money through equity, i.e. issuing shares, or it can raise money through debt, in which case it needs to borrow funds from investors through a wide range of debt instruments like debentures. In this case, the company gives investors a portion of the company in return for their funding. There are various kinds of shares, including equity shares and preference shares. We hope to better fully comprehend equity shares in this article.
What are Equity Shares?
An equity share also called an ordinary share, is a form of partial ownership that carries the greatest amount of entrepreneurial risk for a trading concern. These shareholders can cast ballots in any organisation. A company that needs the long-term type of financing seeking capital such as equity shares. Each equity share is a fractional ownership interest in the company. The public is given the opportunity to invest in equity shares, also known as ordinary shares or common stock.
The Objective of Equity Shares
The primary goal of the businesses issuing equity shares is to raise money for expansion and organisational growth. Equity shareholders are entitled to a portion of the company’s profits.
The company’s face value or book value determines the majority of an equity share’s value. A company’s stock price will increase as more people buy its shares, and it drives up share prices. On the other hand, the share prices would stagnate if a growing number of people started selling off their shares.
The basics of supply and demand determine the price of a company’s shares. When the shares begin trading on the exchange, the demand and supply will be higher.
How Do Equity Shares Work?
Equity shares function on the concept of demand and supply in the market. Basic economics states that the price of a good or service will go up with an increase in demand for the same, and vice versa. The same applies to equity shares, which means:
- If more number of people are selling the shares of a company, then the price of that stock will go down
- If more people are buying the stock of a company, then the price of that particular stock will go up
People buy or sell equities based on their understanding of the market. The investments are made by making assumptions regarding the future of a company:
- If the investors think that a company has a bright future, then they will purchase more of that stock. This will result in an increase in the price of that equity
- If the investors think that the company is not going to do well in the coming years, they will start selling shares of that company. This will result in the price of the share going down
Types of Equity Shares
Ordinary Shares
A company will issue these shares to raise money for long-term costs. In these situations, investors receive a portion of the company based on the number of shares they own. Shareholders with regular voting rights may vote.
Preference Equity Shares
Investors will receive a cumulative dividend when purchasing preference equity shares before common shareholders. The membership and voting rights of common shareholders are not available to preference shareholders.
Bonus Shares
Equity shares that a company issues from its retained profits are known as bonus shares. In simple words, a business issues bonus shares of its profits. The market capitalisation of the company doesn’t rise as a result, though.
Rights Shares
Rights shares are intended for the company’s premium investors. It means that such holders have a significant equity stake. Companies provide discounted rights issues. The goal is to raise money to cover the company’s financial requirements.
Sweat Equity
Directors and company employees both own shares of sweat equity. These shares are offered to employees as a component of their remuneration or at a discounted rate in exchange for additional benefits, excellent work, or other noteworthy accomplishments.
Employee Stock Options (ESOPs)
Under an ESOP’s terms, employees are allowed to buy the stock at a fixed price later as part of a company’s incentive and retention strategy. These shares are given to both employees and executives who assert their option for an ESOP grant.
Features of Equity Shares
The following are some of the characteristics of equity shares which makes them one of the most sought after investment tools today:
- Usually, the equity shares issued by companies carry a voting right to take part in the major decisions of the company. Shareholders have the right to choose individuals to look after the day to day business of the company. Appointing efficient leaders help in increasing the annual turnover of a company, thereby increasing the average dividend each shareholder receives
- The equity shares issued by an organization are non-redeemable and permanent in nature. These shares cannot be returned unless the company has decided to discontinue operations
- Holders of equity shares are liable to receive additional profits generated in a financial year. Any person having a considerable investment in the company will also experience an increase in personal wealth
- Equity shares are transferable in nature. Even though these shares are non-redeemable in nature, they can be transferred very easily. These shares can be transferred from one investor to the other
- There are many companies that pay out dividends with respect to the number of shares issued. The amount paid out in dividends depends on the profit made by a company and the fund availability of a company
- Even though they are one of the most sought after investment tools in the market, they are highly volatile. The risk factor associated with these shares is high, thus ensuring a greater return on investment. So an experienced investor with affinity for risk trading can build a very strong portfolio with these shares
Benefits of Investing in Equity Shares
The following are some of the benefits to investors who invest in equity shares:
Higher Return on Investment
As we’ve established earlier, equity shares are high risk investment options. As is the rule of the market, the higher the risk factor, the higher the returns potential. This is also a wise investment option as any shareholder also benefits from dividends and profit made by the company.
Voting Rights
When an investor purchases equity shares of a company, they also claim a stake in the ownership of the company. Which means that the investor also gets a voting right in the decision making process of the company. The higher the number of equity shares, the more they have power in an organization.
Lack of Legal Obligations
Any equity shareholder of a company is not liable to be involved in the legal obligations of a company. The company operates as a separate legal entity from the investor. So in case the company is involved in any legal issues, the stakeholder is not responsible for it in any way.
Diverse Portfolio
By investing in equity shares, an investor can create a large and diverse investment portfolio. By diversifying your portfolio by investing in equity shares of different sectors, you can receive increased dividend payments. This creates a well balanced portfolio offering stable returns for a long time.
Easy and Efficient
Investing in equity shares is fairly simple than it sounds. An investor can easily invest in the share market with the help of a financial advisor or stockbroker. An individual can also open a Demat account and invest in the equities of companies of their choice.
Difference between Equity Shares and Preference Shares
The following are the main distinctions between preference shares and equity shares.
| Difference in | Equity Shares | Bonus Shares |
| Meaning | Equity shares signify a company’s ownership. | Shareholders with a preference have a claim to the company’s assets and profits. |
| Dividend Pay-out | Dividends to equity shareholders are paid only after dividends to preference shareholders. | The priority for dividend payments goes to preference shareholders. |
| Bonus Shares | Equity shareholders may receive bonus shares in exchange for their current holdings. | No bonus shares are issued to preference shareholders in exchange for their holdings. |
| Dividend Rate | Varies depending on the earnings | It is fixed |
| Redemption | Shares of equity cannot be redeemed. | Shares of preference may be redeemed. |
| Capitalization | High capitalization chances | Low capitalization chances |
| Convertibility | Shares of equity cannot be converted. | Equity shares may be converted from preference shares. |
Demerits of Investing in Equity Shares
Even though investing in equity shares has a number of benefits, you shouldn’t always expect a positive return from your investments. There is still a great chance that you might also incur a great loss while investing in the equity market. The shareholder may also face loss if the company fails to register a profit during a fiscal year. Some of the risks associated with investing in the equity market are as follows:
Dividend Payments are not Prioritised
Equity shareholders receive dividend payments when a company makes a profit. The equity shareholders have the last claim to these profits. The dividends are first distributed among bond holders and then among preference shareholders. The remaining amount is then distributed among the equity holders. Which means that if the amount of profit is low, then the majority of it will be given to bond holders. This leaves a very low amount to be distributed among equity shareholders.
Market Risks
As discussed before, the profit returns from equity investment is subject to the changes in the market. Bond holders on the other hand, face no market risks regardless of the price of the stock. This means that investing in the equity market does not guarantee assured returns. If the performance of the company is poor, it can lead to a drop in the share price of that company. This in turn will lead to shareholders selling their investments at a loss.
How to Buy Equity Shares?
If you wish to invest in the equity market, you require the following three main accounts:
- Demat Account: This account is required to hold all the shares in the holder’s name
- Trading Account: This account is required to place, buy, and sell shares
- Linked Bank Account
The following is how you can invest in the equity market:
Through IPOs
An IPO is a public listing announced when a company is launching its shares for the first time. An interested investor can buy these shares through their netbanking account. They can also place a bid for the company’s securities through stock exchanges.
Stock Market
If you are not able to purchase shares through an IPO, you can purchase them once they are listed on stock exchanges.
Why Should You Invest in Equity Shares?
Equity funds have proven to be a potentially profitable choice for investors due to their many advantages. Below are some of the numerous advantages of mutual funds that make them a beneficial investment option for investors.
Diversification: Diversification is provided by equity funds in numerous ways. One, they make multiple stock investments; two, they make sector investments; and three, they invest in additional asset classes. You can own stock in businesses with various capitalizations and in all industries as an investor.
Wealth Creation: Most investment types produce higher returns than equity funds. They can provide returns that outpace inflation, enabling investors to build up a healthy corpus in the future. Investors who want to generate capital over the long term should put money into equity funds. They do carry some risk, but if you retain them for a longer time, they can recover.
Risk Mitigation: Due to diversification, in which the help finance corpus is distributed equally among several stocks, the related profits and the risks are also spread out. One stock’s performance may improve when the other does not. Similar to how one sector may compromise the portfolio if another is declining, reducing the total loss sustained. Since the investor isn’t reliant on a single stock or industry, they significantly reduce the stock- and sector-specific risk.
Cost-Efficient: Due to the low minimum investment amount and the ability to become a shareholder in numerous companies, equity funds are cost-effective. Otherwise, buying stock in every company might have been expensive. As a result, it offers cost savings by enabling you to invest in more companies than you would have done separately. Additionally, as the size
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Frequently Asked Questions (FAQ)
Q1. What is meant by equity shares?
Equity shares, also called common shares, are a source of long-term financing for companies looking to raise funds.
Q2. What are the benefits of equity shares?
There are lots of benefits of equity shares, some of which are dividend income, exercise control, and of course, the potential for gaining profit.
Q3. How do I buy equity shares?
You can buy equity shares by opening a Demat account or getting in touch with a stock exchange broker.
Q4. Why do companies issue equity shares?
Companies issue equity shares to raise capital for their company.
Q5. Who can issue equity shares?
Any company can issue their share to the public if it is a Limited Company. In the case of a private limited company, they can give shares to their friends and family members.
