Equity Share Capital is a key concept in the stock market, and understanding it is essential for every investor, whether you’re new or experienced. This article provides a comprehensive exploration of equity share capital, including its definition, examples, types, benefits, and limitations. We’ll also compare equity share capital with securities premium and discuss how issuing shares affects equity share capital. Let’s explore the concept of equity share capital and gain valuable insights.
What is Equity Share Capital?
Before understanding the concept of Equity Share Capital you must know what equity shares are, equity shares also known as common stock, represent the smallest unit of ownership in a company. A company’s ownership is divided into these equity shares, so when you purchase equity shares, you are buying ownership (a stake) in the company proportional to your investment. Companies issue equity shares to raise additional capital for various purposes, such as expanding operations, funding new projects, or reducing debt. This method of raising funds allows companies to obtain financing without taking on debt and its associated interest obligations while sharing both ownership and risk with shareholders.
Equity Share Capital refers to the funds a company raises through the issuance of equity shares. It is calculated by multiplying the total number of outstanding shares by their face value. When a company issues shares at a price higher than their face value, the additional amount received is called the premium.
For example, if a company conducts an IPO and issues 100,000 shares with an issue price of ₹100 each, while the face value is ₹10, the total funds raised amount to ₹1 crore. Out of this, ₹10 lakh represents the equity share capital (100,000 shares x ₹10 face value), and the remaining ₹90 lakh is the premium (100,000 shares x ₹90 premium).
The primary purpose of equity share capital is to provide long-term financing that does not require repayment, unlike loans and bonds. This capital supports various business activities, including growth initiatives and operational needs. By contributing to a company’s financial stability, equity share capital plays a crucial role in funding expansion and maintaining overall financial health without increasing debt.
Real World Example - Hindalco Industries
Let’s take Hindalco Industries Ltd. as an example to understand the concept of Equity Share Capital:
To calculate the Equity Share Capital of Hindalco Industries Ltd., we need the face value (or nominal value) and the total number of outstanding shares.
Equity Share Capital = Face Value × Total Number of Outstanding Shares
Face Value: Also known as nominal value, is the initial value assigned to a company’s share when it is issued. You can find it by dividing the total equity share capital by the number of shares that have been issued. The face value of Hindalco Industries Ltd. is ₹1 per share.
Total Number of Outstanding Shares: This refers to the total number of common shares that have been issued by the company and are currently held by investors. Hindalco Industries Ltd. has 2,221,098,266 (222 crore) outstanding shares.
Equity Share Capital = ₹1 × 2,221,098,266 = ₹2,221,098,266
Equity Share Capital = ₹ 222.10 crore
Note: You can find information about a company’s face value and total number of outstanding shares in its financial statements—specifically the balance sheet. This information is usually available on the company’s website, stock exchange websites, and stock broker platforms.
Types of Equity Share Capital
Equity share capital can be categorized into various types based on different factors. Here are the main types:
- Authorized Capital: It is the maximum amount of equity share capital that a company is allowed to issue, as specified in its corporate charter or articles of association. This limit is set to ensure that the company does not exceed its planned capital structure and helps maintain control over the issuance of new shares.
- Issued Capital: This refers to the part of the total authorized capital that the company has actually issued to shareholders.
- Subscribed Capital: It is the total amount that shareholders have agreed to invest in the company. However, this amount might not yet be fully paid or received.
- Paid-Up Capital: This is the portion of subscribed capital that shareholders have actually paid. It represents the money received by the company in exchange for the shares issued.
- Bonus Shares: These are additional shares issued to existing shareholders free of charge, based on the number of shares they already own. Bonus shares increase the number of shares in circulation but do not change the total value of equity share capital.
- Rights Shares: These are shares offered to existing shareholders at a discounted price, typically in proportion to their existing holdings.
- Sweat Equity Shares: These are shares issued to employees or directors as a substitute for cash payment or as a reward for their work, especially if the company can’t pay them in cash. They are often used to incentivize and retain key talent.
Benefits & Limitations
Benefits:
- Not to Repay: Unlike debt, share capital does not require repayment. This means the company does not have to worry about making regular interest payments or repaying the principal amount, which helps reduce financial pressure and provides greater flexibility for growth and investment.
- No Interest: Share capital is the money a company raises from investors by offering them ownership (shares) in the company. Since it involves issuing shares rather than borrowing money, there are no interest payments required.
- Shared Risk: By issuing equity shares, the company spreads the financial risk among its shareholders. This approach is advantageous for the company, particularly during uncertain economic times.
Limitations:
- Ownership dilution: Issuing new shares can dilute the ownership percentage of existing shareholders, which may reduce their control and affect their voting power.
- Cost of equity: Raising money through equity is often more expensive than borrowing because investors expect a bigger return on their investment. This higher expected return makes equity cost more than taking out a loan.
- Complexity and Regulatory Compliance: Raising equity capital involves regulatory requirements, disclosure obligations, and potential complexities in the issuance process. Following these regulations can be both time-consuming and expensive.
Equity Share Capital Vs. Securities Premium
Equity Share Capital
- Meaning: When a company issues its shares, it usually issues them above the face value, the total amount of face value of all the issued shares referred to as equity share capital or shareholder’s capital, and is transferred to the share capital account.
- Usage: A company utilizes this fund for various purposes such as business expansion, acquiring assets, funding research and development, reducing debt, or supporting overall operational growth.
- Presentation in Financial Statements: Equity share capital is presented under the shareholders’ equity section in the balance sheet. It represents the total value of shares issued based on their face or nominal value.
- Example: If a company issues 1 crore shares at a price of ₹50 each, with a face value of ₹5 per share, the equity share capital account will be credited with ₹5 crore.
Securities Premium
- Meaning: Securities premium refers to the amount received by a company over and above the face value of the shares issued. This excess amount is recorded separately from the share capital in a share premium account.
- Usage: It can be used for purposes specified by company law, such as writing off preliminary expenses, issuing bonus shares, or redeeming preference shares. It cannot be used for dividend payments.
- Presentation in Financial Statements: Securities premium appears under the reserves and surplus section of the balance sheet, typically labeled as “Securities Premium” or “Share Premium”.
- Example: Using the same example, if a company issues 1 crore shares at ₹50 each, with ₹5 crore transferred to the equity share capital account (representing the face value of ₹5 per share), the amount exceeding the face value is considered the premium. Therefore, ₹45 crore will be transferred to the share premium account.
How Issuing Shares Impacts Equity Share Capital
Issuing shares can impact a company’s equity share capital in several ways:
- Increase in Equity Share Capital: When a company issues new shares through a fresh issue, it raises additional capital, increasing the total equity share capital as the face value of all the new shares is added to the existing equity share capital. However, if the shares are issued through an offer for sale, no new capital is raised, as OFS involves existing shareholders selling their shares to the new investors, which reduces their stake in the company
- Dilution of existing shares: Issuing new shares can dilute the ownership percentage of existing shareholders. Although the company’s total value may grow, the individual ownership percentage of existing shareholders decreases because their stakes are diluted by the issuance of new shares.
- Impact on share price: Issuing new shares can influence the company’s share price. If the market perceives the issuance as a positive move (such as funding growth or reducing debt), the share price may rise. Conversely, if the market views it as a sign of financial weakness, the share price might fall.
- Changes in financial ratios: The issuance of shares impacts various financial ratios, such as earnings per share (EPS) and return on equity (ROE). With more shares outstanding, EPS may decrease, though this could be offset by increased revenue and profits from the new capital. ROE might also be affected depending on how the raised capital is utilized.
Conclusion
Share capital is a key part of corporate finance, essential for a company’s growth and financial health. When companies issue equity shares, they can raise funds needed for expansion and new projects without having to repay the money. Issuing equity shares means the company is giving ownership in return for the funds, helping them grow and invest strategically. Whether you are a new investor or experienced, understanding share capital can help you see how companies raise money and manage their finances. We hope you enjoyed this exploration of share capital and gained valuable insights into its significance and impact.
FAQs
Q1. Does the issuance of shares through an Offer for Sale (OFS) result in an increase in equity share capital?
A1. No, the issuance of shares through an Offer for Sale (OFS) does not increase share capital. An OFS involves the sale of existing shares held by promoters or other shareholders to the public, resulting in a transfer of ownership rather than an increase in capital. While it can dilute the stake of the selling shareholders.
Q2. How does a company utilize the funds raised from equity share capital?
A2. A company typically uses the funds raised from share capital for various purposes, including financing business expansion, investing in research and development, acquiring assets, reducing debt, and supporting overall operational growth.
Q3. How is the value of equity share capital determined?
A3. The value of share capital is determined by multiplying the number of issued shares by their face value / nominal value.
Q4. Does the total number of shares used to determine equity share capital include preference shares?
A4. No, the total number of shares used to determine share capital doesn’t include preference shares. Equity share capital specifically refers to the funds raised through the issuance of equity shares.
Q5. Can dividends be paid out of equity share capital?
A5. No, a company cannot use share capital directly to pay dividends. Dividends are paid out of a company’s profits or retained earnings, not from the capital invested by shareholders.
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