EQUITY SHARES Equity shares also known as Ordinary shares. Equity shares represent the ownership position in a company. The shareholders of equity shares are the legal owner of the company. Equity shares are the source of the permanent capital since they do not have a maturity date. shareholders are entitled for dividend. The amount or rate of dividend is not fixed: the company’s board of directors decides it. An ordinary share is known as variable income security
Authorized Share Capital represents the maximum amount of capital, which a company can raise from shareholders. The portion of the authorized share capital, which has been offered to shareholders, is called Issued Share Capital. Subscribed Share Capital represents that part of the issued share capital, which has been accepted by shareholders. The amount of subscribed share capital actually paid up by shareholders to the company is called Paid-Up Share Capital. The company’s earnings, which have not been distributed to shareholders and have been retained in the business, are called Reserves and Surplus.
Features of Equity Shares1. Maturity: Equity shares provide permanent capital to the company and cannot be redeemed during the life time of the company2. Claims on Income: Equity shareholders have a residual claim on the income of a company. They have a claim on income left after paying dividend to preference shareholders.
3. Claim on Assets: Ordinary shareholders have a residual claim on the company’s assets in the case of liquidation.4. Right to control: Ordinary shareholders have the legal power to elect directors on the board. Ordinary shareholders are able to control management of the company through their voting rights and right to maintain proportionate ownership.
5. Voting rights: Ordinary shareholders are required to vote for election of directors and change in the memorandum of association. An ordinary share holder has votes equal to the number of shares held by him. Shareholders may vote in person or by proxy. A proxy gives a designated person right to vote on behalf of a shareholder at the company’s annual general meeting.
6. Pre-emptive Right: The law grants shareholders the right to purchase new shares in the same proportion as their current ownership.7. Limited Liability: Ordinary shareholders are the true owners of the company, but their liability is limited to the amount of their investment in shares.
Advantages of equity shares Advantages to company:1. Long-term and Permanent Capital2. No Fixed Burden on the companys resources3. Credit worthiness4. Risk Capital5. Dividend Policy
Advantages to Investors:1. More Income2. Right to Participate in the Control and Management3. Capital profits4. An Attraction of Persons having Limited Income
Disadvantages of equity shares Disadvantages to company1. Dilution in control2. Trading on equity not possible3. Over-capitalization4. No flexibility in capital structure5. High cost6. Speculation
Disadvantages to investors1. Uncertain and Irregular Income2. Capital loss During Depression Period3. Loss on Liquidation
RIGHT ISSUE OF EQUITY SHARES A rights issue is a way in which a company can sell new shares in order to raise capital. The law in India requires that the new ordinary shares must be first issued to the existing share holder.
Advantages of Right Issue1. It gives existing shareholders securities called "rights", which give the shareholders the right to purchase new shares at a discount to the market price.2. Issue involves less flotation cost as the company can avoid the underwriting commission.3. In the case of profitable companies, the issue is more likely to be successful since the subscription price is set much below the current market price.
Disadvantages Share holders who fail to exercise their rights may lose in terms of decline in their wealth. The value of each share will be diluted as a result of the increased number of shares issued. Another disadvantage is for those companies whose share holding is concentrated in the hands of financial institutions, because of the conversion of loan into equity. They would prefer public issue of shares rather than the right issue.
PREFERENCE SHARES Preference shares are a long term source of finance for a company. They are neither completely similar to equity nor equivalent to debt. The law treats them as shares but they have elements of both equity shares and debt. For this reason, they are also called ‘hybrid financing instruments’. These are also known as preferred stock, preferred shares, or only preferred in different part of the world.
Features of Preference Shares1. Fixed Dividends Preference shares have fixed dividends. Also preference dividends are not tax deductible.2. Preference over Equity Preference share dividend has to be paid before any dividend payment to ordinary equity shares & at the time of liquidation also, these shares would be paid before equity shares.3. No Share in Earnings Preference shareholders can not claim on the residual earnings and residual assets.
4. Fixed Maturity Like debt, preference shares also have fixed maturity date.5. Cumulative dividend It requires that all past unpaid preference dividend be paid before any ordinary dividends are paid.6. Dividend from PAT Preference share dividend is paid out of the profits left after all expenses and even taxes.
Advantages of Preference SharesAdvantages from Company point of view1. Fixed Return2. No Voting Right3. Flexibility in Capital Structure4. No Charge on Assets5. Widens Capital Market
Advantages from Investors point of view:1. Regular Fixed Income2. Preferential Rights3. Voting Right for Safety of Interest4. Lesser Capital Losses5. Fair Security
Disadvantages of Preference SharesDisadvantages for companies1. Higher Rate of Dividend2. Financial Burden3. Dilution of Claim over Assets4. Adverse effect on credit-worthiness5. Tax disadvantage
Disadvantages for Investors1. No Voting Right2. Fixed Income3. No claim over surplus4. No Guarantee of Assets
Classification of Preference Share1.Cumulative and Non-cumulative Preference shares In the case of Cumulative preference shares, dividend in arrears for the years in which company earned no profits or insufficient profits receives the dividend in the year in which company earns profits. But, If company does not have any profits in a year, no dividend will be paid to non-cumulative preference shareholders.
2. Redeemable and Irredeemable Preference Shares Redeemable preference shares can be redeemed on or after a fixed period after giving a proper notice of redemption to preference shareholders. while Irredeemable preference shares are those shares which cannot be redeemed during the lifetime of the company.3.Convertible and Non-convertible preference shares Preference shareholders are given a right to covert their holding into ordinary shares such shares are known as convertible preference shares. The holders of non- convertible preference shares have no such right of conversion.
4. Participating and Non-participating Preference Shares The holders of participating preference shares have a right to participate in the surplus profits of the company remained after paying dividend to the ordinary & preference shareholders at a fixed rate. The preference shares which do not have such right to participate in surplus profits, are known as non- participating preference shares.
DEBENTURES A debenture or a bond is long-term promissory note for raising loan capital. The firm promises to pay interest and principal as stipulated. The purchaser of debenture is called lender or debenture-holder. Although the money raised by the debentures becomes a part of the companys capital structure, it does not become share capital.
Features of Debentures1. Interest rate: The interest rate on a debenture is fixed and known. Debenture interest is tax deductible.2. Maturity: Debentures are issued for a specific period of time.3. Redemption: Debentures are mostly redeemable, they are generally redeemed on maturity.
4. Sinking fund: A sinking fund is cash set aside periodically for retiring debentures. Periodic retirement of debt through sinking fund reduces the amount required to redeem the remaining debt at maturity.5. Buy-back (call) provision: Buy-back provisions enable the company to redeem debenture at a specified price before the maturity date. Buy-back price may be more than par value.
6. Indenture or debenture trust deed: An indenture is a legal agreement between the company issuing debentures and the debenture trustee who represents the debenture holders. Trustee ensures that the company will fulfill the contractual obligations.7. Security: Debentures are either secured or unsecured. A secured debenture is secured by a lien on the company’s specific assets. When debentures are not protected by any security, they are known as unsecured debenture.
8. Yield The yield is related to its market price; Two types of yield: The current yield on a debenture is the ratio of the annual interest payment to the debenture’s market price. The yield-to-maturity takes into account the payments of interest and principal, over the life of the debenture.9. Claims on assets and income Debenture holders have a claim on the company’s earning, prior to that of the shareholders.
Types of Debentures1. Non-convertible debentures (NCDs): NCDs are pure debentures without a feature of conversion. They are repayable on maturity. The investor is entitled for interest and repayment of principal.2. Fully-convertible debentures (FCDs): FCDs are converted into shares as per the terms of the issue, with regard to the price and time of conversion.3. Partly-convertible debenture (PCDs): The investor has advantages of both convertible and non-convertible debenture blended into single debenture.
Advantages of Debentures1. Less costly2. No ownership dilution3. Fixed payment of interest4. Reduced real obligation
Term Loans: Term loans are obtained directly from the banks and financial institutions for long term debt. They are obtained for financing large expansion. Modernization or diversification projects. It has a maturity of more than one year.
Features:1. Maturity: Financial institutions provide loan for a period of 6 to 10 years. This is the period during which the company will not needs to make any payment.2. direct negotiation: A firm negotiates term loans for project finance directly with a bank or institutions.3. security: The assets acquired using term loan funds secure them. This is called primary security. If Current assets are secured then it is called secondary security.
4. Restrictive covenants: FI add a number of restrictive covenants on loan from lenders. The borrowing firm has generally to keep the lender informed by furnishing financial statements and other information periodically. The covenants may be categorized as follows:1. Asset-related covenants2. Liability-related covenants3. Cash flow-related covenants4. Control-related covenants
5. Convertibility:6.Repayment schedule: It specifies the time schedule for paying interest and principal. It is also known as loan amortization schedule. It requires to repay the principal in equal installment and pay interest on the unpaid loan. Thus, interest payment will decline over the years and total loan payment will not be equal in each period.