A company’s capital is divided into units known as shares. To raise funds, companies can issue the following types of shares: equity shares and preference shares.

Equity Shares (or Ordinary Shares)

Any share that is not a preference share is an equity share. This means that if the shareholder is not entitled to a fixed dividend in preference to others, or if there is no prior right for the capital to be repaid, the share capital will be treated as equity share capital.

In other words, equity shares participate in the profits of a company after all preferential rights have been satisfied. Equity shareholders are the effective owners of the company. They receive dividends after the payment of all expenses and dividends to preference shareholders.

Preference Shares

Preference shares are those shares that are prioritized in the payment of dividends at a fixed rate, and sometimes also in the return of capital in the event of the company’s closure.

Preference shares can be divided into the following classes:

Cumulative

Holders of these shares are entitled to all arrears. For example, suppose that a company issues preference shares valued at $10 per share, carrying dividends at the rate of 10%.

Further, suppose that a dividend was not paid for 2017 and 2018. In 2019, the firm’s profitability is good, and so the dividend for both 2017 and 2018 will be payable in 2019.

Non-cumulative

For non-cumulative preference shares, arrears are not payable. In the above example, in 2019, only the dividend for 2019 will be paid (i.e., not the accumulated dividends for 2017 or 2018).

Redeemable

When preference shares are redeemable out of the profits through the creation of a capital redemption reserve fund, through the issue of shares, or through the sale proceeds of the property of the company, they are called redeemable preference shares.

Participating

When preference shares participate like equity shares in the profit of a company, in addition to their fixed profit, they are known as participating preference shares.

Guaranteed

Guaranteed preference shares are shares for which a fixed dividend is guaranteed by the vendors or some other party. If the profit in a particular year is insufficient to pay the dividend, guarantors pay the amount.

The company itself cannot give a guarantee. The guarantee must be given by the vendor or promoter.

Evaluation of Raising Funds by Issuing Shares

Shareholders are effectively the owners of the company. They bear the firm’s ultimate risk. These shareholders are the last to claim their dividend in the earning and resources of the enterprise.

It is always in the interest of a company to procure its initial capital through the issue of shares.

Advantages of Raising Funds by Issuing Shares

The following are some of the main advantages associated with raising funds by issuing shares:
(i) Absence of fixed liability: The company does not guarantee the dividend rate on equity shares, and so there is no fixed liability as in the case of debentures. For cumulative preference shares, dividends are not paid out of losses.
(ii) No charge on assets: Shares are issued without any security or charge on assets. In this way, the company procures funds without any charge on its assets or even pleading any security.
(iii) Preferred by adventurous investors: The dividend rate is not guaranteed on equity shares. Dividends may be paid at a very high rate when profit is large. Therefore, it is preferred by adventurous investors.
(iv) Preferred by companies in an unsound financial position: When a company is financially unsound, equity shareholders bear the risk without asking for dividends.
(v) No repayment of liability: Funds raised by issuing shares need not be refunded. The shareholders cannot claim a refund, and so the company does not have any liability to repay share capital.
(vi) Promotes financial health: Companies are not forced to pay dividends. In fact, the dividend rate on equity shares is not even specified. As such, the company can maintain a sufficient reserve and build itself into a financially sound position.
(vii) Supply of long-term fixed capital: The company receives long-term fixed capital.

Disadvantages of Raising Funds by Issuing Shares

The procurement of funds by issuing shares results in the following disadvantages:
(i) Danger of overcapitalization: The funds are easily available, there is no charge on assets, and there is no guarantee regarding the dividend rate. As such, firms may suffer from overcapitalization after raising funds by issuing shares.
(ii) No investment by cautious investors: Cautious investors prefer not to invest in equity shares because the return on these shares is not regular or guaranteed.
(iii) Danger of manipulation: The management of the company can declare dividends at higher or lower rates, which will cause the value of shares to fluctuate. In this context, there is always the danger of manipulation.
(iv) Disadvantageous for companies in a sound financial position: Companies in a sound financial position will have to pay dividends at higher rates, even when loans at lower rates are available in the market.
(v) Dividend uncertainty: The rate of dividend is not assumed and not even regular. Investors, therefore, are uncertain about their potential earnings.

Frequently Asked Questions

What are the benefits of issuing shares?

Issuing shares is a way in which companies can raise capital for their business. As the shareholder is the owner of the company, they bear all its risks. These shareholders are paid last when it comes to dividing up profits and assets.

What is the difference between share price and share value?

The share price is the cost of a single share. The share value is the total worth of all outstanding shares.

What are some disadvantages to issuing shares?

Issuing shares may result in the company being overcapitalized which can be dangerous for a company's financial health. Additionally, overly issued shares may make it difficult for companies to pay dividends. As a result, cautious investors may not want to purchase Equity Shares because they are risky and do not offer a guaranteed return on investment.

What is the value of a company's share price?

The value of a company's share price can fluctuate depending upon many factors such as the state of the market, industry trends and even the company's operating performance.

What is the difference between price and value?

The price of an equity share is measured in terms of money while its value is measured in terms of assets, liabilities and owner's equity.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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