Equity Shares

The capital of a company is divided into shares.

Each share forms a unit of ownership of a company and is offered for sale so as to raise capital for the company.

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The holders of shares are called shareholders.

Shares are of two types- ordinary or equity shares and preference shares

 

What are ordinary/equity shares?

  • They are the legal owners of the company.
  • Ordinary shares are source of permanent capital since they don’t have maturity date.
  • Shareholders are entitled to receive dividends by the company.
  • The amount or rate of dividend is not fixed. It is decided by the company’s board of directors.
  • Ordinary share is also known as a variable income security.

What are the features of equity shares?

Claim on income

Ordinary shareholders have a residual ownership claim.

Residual income is earnings available after paying expenses, interest charges, taxes, preference dividend, if any.

This residual income is either directly distributed to shareholders in the form of dividends or indirectly in the form of retained earnings which are reinvested in the business.

Retained earnings help in growth of the company, which is beneficial for the shareholders.

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Claim on assets

On liquidation of the company, dues are paid to debt holders, preference shareholders and the remaining is paid to ordinary shareholders.

 

Right to control

Ordinary shareholders have the legal power to elect directors on board.

Board of directors approve major policies of the company and appoint managers to carry out day to day operations.

Thus, ordinary shareholders can control the management of company by choosing board of directors.

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Voting rights

Ordinary shareholders have the right to vote on major decisions of the company eg. Change in memorandum of association, election of board of directors, etc.

An ordinary shareholder has votes equal to the number of shares held by him.

 

Limited liability

Liability of ordinary shareholders is limited to the amount of their investment in shares. In case of liquidation or any financial problem, ordinary shareholders are not liable to pay.

What are the advantages of equity shares?

Shareholders’ Point of View

  • Liquidity and easily traded in capital market
  • Higher dividends when company has increased profit
  • Voting rights to control management of the company
  • Appreciation in the value of shares when company performs well

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Company’s Point of View:

  • Least repayment liability
  • Permanent source of capital
  • No obligation to pay dividend

What are the disadvantages of equity shares?

Shareholders’ Point of View:

  • Uncertainty of receiving dividend
  • Fluctuations in value of shares
  • Issue of fresh shares reduces the earnings of existing shareholders

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Company’s Point of View:

  • High cost to source equity shares as compared to other sources of finance
  • Payment of dividend is not tax deductible

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Types of debentures

Debentures can be classified on the basis of:

  1. Transferability/ Registration

 

  • Registered Debentures- Name, address, and other holding details are registered with the issuing company.

The amount of registered debentures is payable only to those debenture holders whose name is mentioned in the register of the company.

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If the debenture is transferred by the holder, it is necessary to inform the issuing company for updating its records.

  • Unregistered/ Bearer Debentures- these debentures are not recorded in a register of the company.

Bearer debentures can be transferred by mere delivery to the new holder.

The interest and principal are paid to the person who produces the coupons attached to the debenture certificate.

  1. Security

 

  • Secured/ Mortgage Debentures- these debentures are secured by a charge on the asset or set of assets of the company.

The holders of secured debentures can recover the principal and unpaid interest amount out of the assets mortgaged by the company.

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These debentures are further classified into– first and second mortgaged debentures.

 

At the time of liquidation of the company, first mortgaged debentures have the first charge over the assets of the company whereas second mortgaged debentures have secondary charge.

  • Unsecured/ Simple Debentures- these debentures are not secured by any asset and are issued solely on the credibility of the company.

  1. Redemption

 

  • Redeemable Debentures- these debentures are issued for a fixed period. The principal amount is repaid to the holders on the specified date.

  • Non-redeemable/ Perpetual Debentures- these debentures do not have any date of redemption.

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These debentures are redeemed either when the company chooses to pay back or at the time of liquidation.

The company may pay back to reduce its liability and notifies the debenture holder by issuing due notice for it.

  1. Convertibility

  • Convertible Debentures- these debentures can be converted, fully or partly, into shares after a specified period of time.

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      Convertible debentures are further classified into:

  • Fully convertible debentures can be completely converted into equity shares.
  • Partly convertible debentures have two parts- Convertible part which is converted into shares as per the agreement. Non-convertible part is repaid after the expiry of the agreed period.

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  • Non-convertible Debentures- these debentures do not have the feature of conversion and are repaid on maturity.

 

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Debentures

What is a debenture?

Debenture is one of the financial securities traded in capital markets.

It is defined as a long-term promissory note for raising loan capital where the company promises to pay interest and principal as stipulated.

Who can issue debentures?

Debenture can be issued by both corporations and governments.

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An alternative form of debenture is a bond, mostly issued by public sector companies.

What are the features of debentures?

  1. Debenture is a form of loan capital for the company.

  1. The purchaser of debenture is called debenture holder. So, a debenture holder is a creditor of the company.

  1. The par value of a debenture is the face value mentioned on the debenture certificate.

  1. The interest rate on a debenture is fixed and known at the time of purchase. Interest is a percentage of this par value.

  1. The legal agreement between company and debenture holder is called indenture or debenture trust deed. It includes the specific terms of the agreement, description of debenture, rights of debentures holder, etc.

  1. Debenture can either be secured or unsecured. Secured debenture is secured by lien on the company’s specific asset. However, unsecured debenture is not protected by any security.

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  1. The credit rating of debenture indicates the degree of its safety. Credit ratings are provided by Credit Rating and Information Services of India (CRISIL) and few other rating companies like CARE and ICRA in India.

  1. Companies issue debenture in different denominations. But, public sector companies issue bonds in the denomination of Rs. 1000.

  1. Debenture is issued for a specific period of time.

  1. The maturity of debenture is the time period until the company returns the par value to debenture holder and terminates the debenture. Usually, a debenture is redeemed after 7 to 10 years of payment.

What are the advantages of debentures?

  • Fixed and stable interest income.
  • Definite maturity period
  • Ease of trading and liquidity

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  • Comparatively safer investment as debenture holder has specific or a floating charge on the secured asset of the company
  • Preferential right of payment at the time of liquidation of the company
  • Interest is protected as per indenture provisions and SEBI guidelines

What are the disadvantages of debentures?

  • No voting rights
  • Returns limited to the extent of interest, irrespective to higher or lower earnings of the company
  • No share in profits

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  • Debenture holder is only creditor to the company, has no ownership of company
  • Interest on debentures is fully taxable

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Understanding Capital market

Capital market facilitates buying and selling of financial securities such as shares, bonds or debentures.

Capital market channels savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, government and individuals.

Stock-Market

It has two mutually supporting and indivisible segments: the primary market and the secondary market.

Intermediaries such as investment bankers, merchant bankers, stock brokers, etc. play an important role in trading of securities in both the markets.

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Primary market

In the primary market companies issue new securities to raise funds. Hence, this market is also known as the new issues market.

New or listed companies make public issue of shares which implies that the securities are sold to public including all individuals and institutional investors.

Public issue by new companies for the first time is called the initial public offering (IPO).

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In this market, companies interact directly with investors.

 

Secondary market

The secondary market deals with second-hand securities ie. securities which have already been issued by companies that are listed in stock exchange.

These securities are listed and traded in the stock exchange. Hence this market is also known as the stock market.

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In this market, investors interact with themselves.

Secondary market may also include over the counter (OTC) market and derivatives market.

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The secondary market determines the price and risk of the securities issued.

This is helpful for both listed companies and investors to act in primary market.

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The operations of primary and secondary markets in India are regulated by Security Exchange Board of India (SEBI).

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