What Exactly Are Shares in a business?
Wondering what are shares, and how they are different from stocks? When a company wants to raise capital for either expanding its business or for operational requirements, it has two options: either borrowing money or issuing stocks that provide part-ownership of the company to investors. Shares are the smallest denomination of a company’s stocks, indicating a portion of ownership of the company.
Equity ownership interests in a corporation are represented by shares, which are financial assets that provide for an equal distribution of any residual profits, if any are declared, in the form of dividends to all stockholders of the corporation. If the value of the company increases, shareholders may also benefit from capital gains.
A company’s equity stock is represented by shares, which are divided into two types: ordinary stock and preferred stock, which are traded on a stock exchange. Thus, the terms “shares” and “stock” are frequently used interchangeably in the financial industry.
IMPORTANT TAKEAWAYS
- Shares indicate equity ownership in a firm or financial asset, and they are owned by investors who exchange capital for these units in exchange for their capital.
- Common shares provide voting rights as well as the possibility of financial gains from price increase and dividends.
- Despite the fact that preferred shares do not provide price appreciation, they can be redeemed at a favorable price and pay regular dividends.
- The shares of most corporations are exchanged on stock exchanges, but only the shares of publicly traded companies are available for purchase.
Understanding Shares in a business
When forming a business, owners have the option of issuing either ordinary stock or preferred stock to potential investors. Stockholders receive equity shares from companies in exchange for capital, which is then utilized to expand and operate the company.
When compared to debt capital, which is obtained through a loan or bond issue, equity capital has no legal obligation to be repaid to investors, and stock dividends, while they may be paid as a distribution of profits, do not accrue interest. Almost all businesses, from small partnerships and limited liability organizations to large multinational corporations, issue some form of stock.
The founders or partners of privately held corporations or partnerships own the stock in the corporation or partnership. Shares in small companies are sold to outside investors in the primary market as they increase in size. Friends and family members may be among the first to invest, followed by angel and venture capital (VC) investors.
It is possible that the company will seek more equity financing by selling shares to the public on the secondary market through an initial share offering if its business continues to grow (IPO). Following an initial public offering (IPO), a company’s stock is said to be publicly traded and to have been listed on a stock exchange.
The majority of businesses issue common stock. The shareholders’ residual claim on the company and its profits, as well as the possibility of investment development through both capital gains and dividends, are provided by these arrangements.
Common shares are also accompanied by voting rights, allowing shareholders to have greater control over the company. 1 Shareholders of record in a corporation have the ability to vote on certain corporate acts, elect members to the board of directors, and approve the issuance of new securities or the payment of dividends, among other things.
Furthermore, certain common stock is accompanied with preemptive rights, which ensure that shareholders have the opportunity to purchase additional shares while maintaining their percentage of ownership when the firm issues new stock.
Preferred shares, on the other hand, often do not provide much in the way of market appreciation or voting rights in the company. However, because this sort of stock often has established payment conditions, as well as a dividend that is paid out on a regular basis, it is less risky than ordinary stock.
Because preferred stock takes precedence over ordinary stock in the event that a company goes bankrupt and is compelled to repay its creditors, preferred stockholders receive payment before regular stockholders but after bondholders. As a result of preferred shareholders’ preference in repayment in the event of a bankruptcy, they are less risky than common shareholders.
Physical paper stock certificates have been phased out in favor of computerized recordation of stock shares in the stock market. The Securities and Exchange Commission (SEC) regulates the issuance and distribution of shares in both the public and private markets, while the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) regulate the trading of shares on the secondary market.
Stock represents the owners’ residual claim on the corporation’s assets, which remains after all obligations and debts have been satisfied.
Types Of Shares
- Equity shares
- Preference shares
Equity Shares Meaning
These are also known as ordinary shares, and it comprises the bulk of the shares being issued by a particular company. Equity shares are transferable and traded actively by investors in stock markets. As an equity shareholder, you are not only entitled to voting rights on company issues, but also have the right to receive dividends. However, the dividends – issued from the profits of the company – are not fixed. You must also note that equity shareholders are subject to the maximum risk – owing to market volatility and other factors affecting stock markets – as per their amount of investment. The types of shares in this category can be classified on the basis of:
- Share capital
- Definition
- Returns
Classification Of Equity Shares On The Basis Of Share Capital
Equity financing or share capital is the amount raised by a particular company by issuing shares. A company can increase its share capital by additional Initial Public Offerings (IPOs). Here is a look at the classification of equity shares on the basis of share capital:
- Authorised Share Capital: Every company, in its Memorandum of Associations, requires to prescribe the maximum amount of capital that can be raised by issuing equity shares. The limit, however, can be increased by paying additional fees and after completion of certain legal procedures.
- Issued Share Capital: This implies the specified portion of the company’s capital, which has been offered to investors through issuance of equity shares. For example, if the nominal value of one stock is Rs 200 and the company issues 20,000 equity shares, the issued share capital will be Rs 40 lakh.
- Subscribed Share Capital: The portion of the issued capital, which has been subscribed by investors is known as subscribed share capital.
- Paid-Up Capital: The amount of money paid by investors for holding the company’s stocks is known as paid-up capital. As investors pay the entire amount at once, subscribed and paid-up capital refer to the same amount.
Classification Of Equity Shares On The Basis Of Definition
Here is a look at the equity share classification on the basis of definition:
- Bonus Shares: Bonus share definition implies those additional stocks which are issued to existing shareholders free-of-cost, or as a bonus.
- Rights Shares: Right shares meaning is that a company can provide new shares to its existing shareholders – at a particular price and within a specific time-period – before being offered for trading in stock markets.
- Sweat Equity Shares: If as an employee of the company, you have made a significant contribution, the company can reward you by issuing sweat equity shares.
- Voting And Non-Voting Shares: Although the majority of shares carry voting rights, the company can make an exception and issue differential or zero voting rights to shareholders.
Classification Of Equity Shares On The Basis Of Returns
On the basis of returns, here is a look at the types of shares:
- Dividend Shares: A company can choose to pay dividends in the form of issuing new shares, on a pro-rata basis.
- Growth Shares: These types of shares are associated with companies that have extraordinary growth rates. While such companies might not provide dividends, the value of their stocks increase rapidly, thereby providing capital gains to investors.
- Value Shares: These types of shares are traded in stock markets at prices lower than their intrinsic value. Investors can expect the prices to appreciate over a period of time, thus providing them with a better share price.
Preference Shares Meaning
These are among the next types of shares issued by a company. Preferential shareholders receive preference in receiving profits of a company as compared to ordinary shareholders. Also, in the event of liquidation of a particular company, the preferential shareholders are paid off before ordinary shareholders. Here is a look at the different types of shares in this category:
- Cumulative And Non-Cumulative Preference Shares Meaning: In the case of cumulative preference shares, if a particular company doesn’t declare an annual dividend, the benefit is carried forward to the next financial year. Non-cumulative preference shares don’t provide for receiving outstanding dividends benefits.
- Participating/Non-Participating Preference Share Definition: Participating preference shares allow shareholders to receive surplus profits, after payment of dividends by the company. This is over and above the receipt of dividends. Non-participating preference shares carry no such benefits, apart from the regular receipt of dividends.
- Convertible/Non-Convertible Preference Shares Meaning: Convertible preference shares can be converted into equity shares, after meeting the requisite stipulations by the company’s Article of Association (AoA), while non-convertible preference shares carry no such benefits.
- Redeemable/Irredeemable Preference Share Definition: A company can repurchase or claim redeemable preference share at a fixed price and time. These types of shares are sans any maturity date. Irredeemable preference shares, on the other hand, have no such conditions.
