Equity Shares: Definition, Features, Types, Merits and Demerits

Purchasing company stocks or equity is a popular investment strategy among individuals due to the considerable amount of returns it promises to offer. When an investor purchases equity shares, he/she/they becomes a fractional owner of the company. Investing in common stocks ususally bestows upon the investor the right to vote in the annual general meetings of the firm and participate in its decision-making activities. 

Equity shares are primarily distributed to retail and institutional investors as a medium to   mobilise capital for the expansion of the issuer’s business. Business organisations source the majority of their capital after getting listed on stock exchanges through this mechanism. 

Let us understand how equity shares work, their types, benefits and risks. 

What Are Equity Shares?

Equity shares represent ownership and act as long-term financing options for organisations looking to raise capital. Investors become fractional owners of the companies which they invest in on account of this. Additionally, these member shareholders possess voting rights, share profits and claim assets in the organisation. 

Equity shares are also known as ordinary shares, common shares or common stock, as they offer an investment opportunity to the general public. They are non-redeemable in nature, and an investor can only redeem them when the company gets closed. The value of equity shares can be expressed in various terms such as par value, book value, face value and so on.

What Are the Features of Equity Shares or Equity Share Capital?

The primary features of equity shares or equity share capital are as follows:

1. Permanent in nature: Equity shares issued by a company are non-redeemable and permanent in nature. They  can be redeemed only when the company decides to close its business. 
2. Potentially higher returns: Although equity shares are volatile and possess high-risk factors, the returns they offer can be very high. If an investor has the potential to accommodate more significant risks, he/she can earn a massive corpus from equity investment. This outcome is however conditional on how the issuer mobilised funds and generated profit.  
3. Transferable and offers dividend pay-out: The ownership of an equity share is transferable between investors, and in addition to earning a return on account of capital appreciation, equity investors can also benefit from dividends paid to them by equity issuers. This is however subject to the issuer’s decision with respect to distribution of company’s funds. It is a common practice for companies to not indulge in dividend payouts at times of financial distress.  
4. Management and voting rights: Equity shareholders are eligible for voting rights and can indirectly take part at a degree proportional to their stake in the company’s management. Equity shareholders in contrast to other providers of capital might also have access to excess profits generated by the issuer.

What Are the Different Types of Equity Shares?

The different types of equity shares are as follows:

1. Ordinary shares or issued shares

Ordinary shares are issued by a company with a motive to generate capital that can meet long-term expenses incurred by their business. They offer associated benefits to an investor like the right to participate in management meetings and other operations. Investors holding a majority of such shares gain substantial voting rights and can thereby exercise significant control over various aspects of a company’s operations. 

2. Preference equity shares

Preference equity shares include a payment guarantee of cumulative dividends paid before distribution of returns (if any) to the ordinary shareholders. Preference shareholders have  little to no voting rights. They can gain from stipulated profits, including bonus returns, if they have participating capacity. If these preference equity shares are classified as non-participating, the shareholders cannot avail of such benefits.

3. Bonus shares

Bonus shares are issued to the investors in place of cash dividend when a business generates profit and/or splits their  stocks. These shares do not increase the total market capitalisation value of a company. 

4. Rights shares

A company offers rights shares to existing stockholders at a discounted price. This enables investors to grow their  stake and preserve proprietary rights. Organisation usually offers rights shares for a limited time until the underlying extraordinary financial requirements are adequately met.

5. Sweat equity shares

Sweat equity shares are allocated to outstanding executives or workers of a business organisation. These are given as a reward for excellent work and may also provide property rights of an organisation to the entitled investors. 

6. Authorised shares

Authorised shares is  the term used to define the maximum number of shares  an organisation can issue. The value of these shares can change at any time.

7. Subscribed shares

Subscribed share is the portion of the issued share capital that an investor accepts and agrees upon investing. 

8. Paid up shares

Paid up shares are a section of the subscribed share capital that an investor provides. This is the money that an organisation actually invests in the company’s operation.

What Are the Merits Involved in Purchasing Equity Shares?

The merits or advantages involved in purchasing equity shares are as follows:

• Potential to earn a high reward

Although equity shares entails an array of high risk factors, they usually come with a greater return potential. In addition to earning via capital appreciation on account of rise in share price, when a company earns profit, its investors might get cash or kind dividends pay-outs. 

• Provides creditworthiness

When an investor owns equity shares of a firm, it can act as collateral on various loans as per requirement. These shares reflect the creditworthiness of a firm and can help the shareholder get quick approval of loans.

• Investment is highly liquid

A crucial factor which an investor should take into account before investing in any financial instrument is liquidity. This liquidity is the ease with which an investor can convert an investment into cash.

In this regard, equity shares are highly liquid and can easily be sold in the capital market. Thus, in case of an emergency, an investor can liquidate equity shares with greater ease.

• Diversification of investment portfolio

Diversification offers exposure to equities of various sectors and helps create a balanced portfolio for the investor in terms of risk and return. Investors can diversify their portfolios by investing across equities from various sectors or industries.

• An easy and efficient way of investment

Any individual can easily invest in the equity market by availing the services of a stockbroker. All an investor requires to invest in equity of any company of his/her choice is a Demat account. A Demat account enables an efficient and easy way of trading equity instruments .

What Are the Demerits of Buying Equity Shares?

The demerits or disadvantages which limit an investor from buying equity shares are as follows:

1. If the company undergoes liquidation, equity investors are not entitled to get back their investment. The priority will be given to preference shareholders and creditors, and only after that equity shareholders will be paid.  
2. Share prices of listed companies might fluctuate due to a number of factors. Therefore, it becomes a risky investment and may not suit the appetite of conservative investors.
3. The preference shareholders will receive priority in dividend payment. 
4. Investments in equity shares require a lot of planning and in depth knowledge about functioning of the respective industry and market as a whole. It may not be ideal for new and inexperienced investors.  

What Is the Difference Between Equity Shares and Preference Shares?

The differences between equity shares and preference shares is discussed below: 

Final Word

Investing in the equity share market requires a lot of time and effort from the investor’s end. It is recommended never to make any investment decision without having complete knowledge of the fundamentals and finances of the company of choice. Once an investor gains enough experience and knowledge, he/she can build a considerable corpus through equity market investment. 

Frequently Asked Questions