Share Capital: Meaning & its Features

Share Capital: Meaning & its Features

Share capital is the financial base of the company, and it means money that an organization raises from issuing shares to various different investors who become part-owners. It is one of the key differentiations within the capital structure of a company and sets it apart from a debt-financed firm. Common shares give ownership and voting rights but no guaranteed dividends, while preference shares emphasize dividends and distribution on assets with usually no voting power.

It determines the financial health and valuation of a company since share capital is based on authorized, issued, subscribed, and paid-up shares. Share capital is one of the most important sources of funding operations, growth, and expansion. In addition, it plays a vital role in the total risk and share distribution of ownership of a firm.

Features of Share Capital

1. Ownership Stake

Share Capital Represents Ownership Interest of Shareholders in a Company: By buying shares, an individual or entity is buying proportionate ownership in the company.

Proportionate Ownership: The extent of proportional ownership of any shareholder will depend upon the number of shares held by such a shareholder. If a company issues 1,000 shares and a person owns 100 shares, he owns 10% of the company.

2. Limited Liability

Protection of Shareholders: The liability of shareholders is restricted only to their invested amount in the company. That is, when the company goes through some financial crisis and falls into financial trouble, shareholders are not personally liable for the company's debt or liabilities beyond their investment.

Encouragement of Investment: It encourages investment, as it restricts the amount of potential loss to the amount one invests in shares.

3. Permanent Capital

No Repayment Obligation: Share capital is permanent capital, as unlike debt, it need not be repaid. The company retains this capital throughout its life subject to liquidation or buying back of the shares.

Long-Term Investment: When the shareholders invest their capital, they know that it will stay with the company if they do not sell the shares.

4. Types of Shares

Equity Shares (Common Stock): Equity shares are the fundamental form of ownership in any company. The equity shareholders are endowed with voting rights, entitlement to dividends, and returns on liquidation, although only after all debts and other obligations have been paid.

Preference Shares: Such shares normally carry a fixed dividend, and are given preferential treatment as compared to equity shares regarding the payment of dividends and during liquidation. However, preference shareholders normally do not have any voting rights.

Hybrid Securities: Some shares may combine features of both equity and preference shares, for example, convertible preference shares that may be convertible into equity shares subject to certain conditions.

5. Entitlement to Dividend

Profit Distribution: Dividend is the portion of profits distributed by a company to its shareholders. It is declared by the board of directors mentioning the quantum and declaration timing.

Variable Payments: In the case of equity shareholders, dividends are not fixed and may vary depending on the profitability of the company. Preference shareholders get a fixed dividend that needs to be paid before anything is paid to the equity shareholder.

Cumulative and Non-Cumulative: Some preference shares are cumulative, meaning that in case of a dividend miss, it accrues and has to be paid out before any dividends are paid to equity shareholders. Non-cumulative shares do not have this feature.

6. Voting Rights

Say in Corporate Decisions: Equity shareholders normally have the right to vote on major corporate decisions, which includes the election of directors, mergers, and changes to the corporate charter.

Proportional Voting: The votes are normally proportional to the number of shares held. The more the shares, the more the votes.

Class-Based Voting: Sometimes, companies can have a few classes of shares with different voting rights. For instance, one class may have more votes per share than the other.

7. Residual Claim

Liquidation Hierarchy: Shareholders are residual claimants to the firm's assets only after all other debts, liabilities, and obligations are paid.

Order of Payment: Preference shareholders are paid before equity shareholders. Equity shareholders receive the residual assets after all other claims of creditors and shareholders are satisfied.

Risk and Return: Since equity shareholders are the last ones in line, in good times, there is the likelihood of earning greater returns.

8. Transferability

Ease in Buying and Selling: As a rule, shares are transferable. Stockholders can buy or sell their shares in stock markets. This liquidity is an important attribute since it offers an exit opportunity to investors.

Market Value: The prices at which shares are bought and sold are determined by market conditions, reflecting the perceived value of the company.

Private vs. Public Companies: This refers to the ease of share transfer in a public company through stock exchanges. In a private company, share transfer could be restricted and may require approval from the board or other shareholders.

9. Regulation and Compliance

Legal Framework: The issuance and management of share capital are regulated by corporate laws, securities regulations, and the company's own articles of incorporation. Such laws make sure there is transparency, investor protection, and market integrity.

Disclosure Requirements: A company shall give full disclosure of the share capital detail in statements of finances and reports sent to regulators or shareholders.

Compliance with Stock Exchanges: The public limited companies must comply with the rules and regulations of the stock exchange where their shares are listed. This includes making timely disclosure of material information and compliance with corporate governance standards.

10. Flexibility

Raising Additional Capital: The company may issue more shares to raise additional capital subject to it obtaining the approval from the shareholders as required and subject to legal limits also. This may be by way of rights issues, public issues, or private placement.

Buybacks: Companies may buy back shares, thereby reducing the number of outstanding shares. Consequently, this may cause an increase in the value of remaining outstanding shares, mostly in events of capital return to shareholders.

Stock Splits and Reverse Splits: Companies could issue stock splits, whereby the number of outstanding shares increases and the price per share drops, or reverse splits, whereby the number of shares drops and the price per share rises; either has no effect on the total value of the share capital.

These features go on to define share capital in a company in such a way that, on one hand, it offers opportunities to and protection for the shareholders, and on the other hand, financial security regarding operational and growth finance.

Advantage of raising share capital

1.No Repayment Obligation

Permanent Funding: Unlike loans or bonds, share capital, once raised, need not be repaid to the shareholders. This is long-term funding available to the company to be used indefinitely for the business and its expansion.

No Interest Payments: Unlike debt, there are no regular interest payments one needs to make against share capital, thus reducing the company's ongoing financial obligations and saving cash flow for other uses.

2.Improved Financial Stability :.

A strong balance sheet is correlated with an increase in share capital, which helps to beef up the equity base of the firm. One attains financial stability; less dependence results on debt. This can result in an improved credit rating of the firm and lay the ground for raising further finance whenever it is required.

Lower Financial Risk: Raising capital by issuing equity rather than debt reduces the financial risk of the company. It does not have the burden of repaying the principal amount and interest when times are bad or profits are low.

3.Attracting Investment

Equities have a potential for appreciation, which is one of the main reasons shareholders seek to buy shares of a company. Stock prices appreciate in response to the company's good performance and, therefore, the investor has substantial returns. Shareholders also stand to reap off dividends in case of the company's profitability. In return, such dividend opportunities may attract diverse investors.

4.Improving Company Repute

Establishing Market Confidence: Any successful share capital raising, particularly via a public offer, acts as a booster to the company's reputation in the market. It indicates confidence in its future prospects and can bring in greater visibility and credibility. Improved Perception in the Public Eye: A robust equity base and successful capital raising activities allow an organization to take a positive view of the perceptions of customers, partners, and other stakeholders. Greater Flexibility in Financial Management

No Restrictive Covenants: Fundamentally, raising share capital is not followed by restrictive covenants restricting the company from spending its funds for specified purposes. This provides management with greater flexibility for strategic initiatives and business decisions.

Ability to Fund Growth: Now, having more available capital, the company might embark on new projects or cover new markets with all the projects and without being restricted by debt.

5. Liquidity for Existing Shareholders

Exit Options: An increase in share capital, particularly when it involves a public offering, gives existing shareholders the opportunity for liquidity—meaning that they can sell their shares on the open market if they so desire.

Wealth Realization: Founders and early investors are able to liquidate their investments—in part or full—when share capital is raised and make large returns on investments.

6. Ability to attract and retain talent

Staff Share Schemes: Raising share capital can facilitate the adoption of employee share schemes, which are excellent ways of attracting the best talent and ensuring that it remains within the business. These schemes easily align employees' interest with that of the company since the workers have a stake in the business.

Disadvantages of Raising Share Capital

1. Dilution of Ownership

Decreased Control: As new shares are issued, the ownership percentage of the existing shareholders is diluted. This includes founders and early investors. This route can mean decreased control over a company or strategic direction.

Possible Conflicts: The dilution might create tension amongst the shareholders—specifically, in a case where new investors have substantial influence, or when the original shareholders feel that they're losing their previous control.

2. Dividend Obligations

Pressure to Pay Dividends: Though the declaration of dividends is not compulsory, the shareholders may expect regular payouts, especially if the business is profitable. This exerts pressure to distribute profits and not reinvest them in the business for growth purposes.

Impact on Retained Earnings: Dividend payment reduces the retained earnings that could have been utilized by the company for expansion, research, and development or repayment of debt.

3. Costly and Time-Consuming Process

High Costs: Share capital, particularly through an IPO, is very expensive. The costs include underwriting fees, legal and accounting fees, regulatory compliance expenses, and marketing expenses.

Lengthy Process: The process of raising capital in the public market is pretty long and requires a good amount of planning and preparation. This can take a lot of management time away from the day-to-day running of the business and strategic planning.

4. Increased Scrutiny and Regulation

Public Disclosure Requirements: A public raising of share capital brings the company into the rigor of regulatory supervision and the associated requirements for regular financial and operational information disclosures, which increase the administrative burden and costs.

Accountability to Shareholders: The company is now more accountable to a wide shareholding base and has added pressure to perform in respect of short-term financial goals set by shareholders.

5. Market Pressure

Volatility in Share Price: Once the shares begin to be traded on the open market, the business remains at the mercy of the volatility of the market. High fluctuations in the share price may hamper the image or reputation of the company, which can have implications for further capital raisings.

Short-Term Focus: Due to pressure from shareholders and analysts, the companies that have gone public may put stress on the short-term performance at the cost of long-term strategic goals. This could result in short-term decisions at the cost of sustainable growth.