Just the right things to know about Shares
What are ‘Shares’? Shares are units of ownership interest in a company that provides for an equal distribution of any profits, if any are declared, in the form of dividends. This blog typically is going to walk you through the stuff that is Just the right things to know about Shares.
Two major types of shares are
(1) Ordinary shares (common stock), which entitle the shareholder to share in the earnings of the company as and when they occur, and to vote at the company’s annual general meetings and other official meetings.
(2) Preference shares (preferred stock) which entitle the shareholder to a fixed periodic income (interest) but generally do not give him or her voting rights.
Different Kind of shares
- Equity share
Equity shares will get dividend and repayment of capital after meeting the claims of preference shareholders. There will be no fixed rate of dividend to be paid to the equity shareholders and this rate may vary from year to year. This rate of dividend is determined by directors and in case of larger profits, it may even be more than the rate attached to preference shares. Such shareholders may go without any dividend if no profit is made. The investors of equity shareholder are the risk taker. Equity shareholder has stake in the company and control in terms of voting power in their hand, they can change the decision of the management if they think that the decision will not give benefit to them in long term.
- Preference share
Preference shares, more commonly referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, the shareholders with preferred stock are entitled to be paid from company assets first. Most preference shares have a fixed dividend, while common stocks generally do not. Preferred stock shareholders also typically do not hold any voting rights, although under some agreements these rights may revert to shareholders that have not received their dividend. Preferred shares have less potential to appreciate in price than common stock.
Some preferred stock is convertible, means it can be exchanged for a given number of common shares under certain circumstances. The board of directors might vote to convert the stock, the investor might have the option to convert, or the stock might have a specified date at which it automatically converts. Whether this is advantageous to the investor depends on the market price of the common stock. Preference shareholder enjoys the preferential rights as to dividend and repayment of capital in the event of winding up of the company over the equity shares are called preference shares. The holder of preference shares will get a fixed rate of dividend.
There are four types of preference shares:
(a) Cumulative Preference Share
If the company does no earn an adequate profit in any year, dividends on preference shares may not be paid for that year. But if the preference shares are cumulative such unpaid dividends on these shares go on accumulating and become payable out of the profits of the company, in subsequent years. Only after such arrears have been paid off, any dividend can be paid to the holder of quality shares. Thus a cumulative preference shareholder is sure to receive the dividend on his shares for all the years out of the earnings of the company.
(b) Non-cumulative Preference Shares
The holders of non-cumulative preference share no doubt will get a preferential right in getting a fixed dividend it is distributed to quality shareholders. The fixed dividend is to be paid only out of the divisible profits but if in a particular year there is no profit as to distribute it among the shareholders, the non-cumulative preference shareholders, will not get any dividend for that year and they cannot claim it in the next year during which period there might be profits. If it is not paid, it cannot be carried forward. These shares will be treated on the same footing as other preference shareholders as regards the payment of capital is concerned.
(c) Redeemable Preference Shares
Capital raised by issuing shares, is not to be repaid to the shareholders (except buyback of shares in certain conditions) but capital raised through the issue of redeemable preference shares is to be paid back to the company to such shareholders after the expiry of a stipulated period, whether the company is wound up or not. A company cannot issue any preference shares which are irredeemable or redeemable after the expiry of a period of 10 years from the date of its issue. It means a company can issue redeemable preference share which is redeemable within 10 years from the date of their issue.
(d) Participating or Non-participating Preference Shares
The preference shares which are entitled to a share in the surplus profit of the company in addition to the fixed rate of preference dividend are known as participating preference shares. After the payment of the dividend, a part of surplus is distributed as dividend among the quality shareholders at a particulate rate. The balance may be shared both by equity shareholders at a particular rate. The balance may be shared both by equity and participating preference shares. Thus participating preference shareholders obtain the return on their capital in two forms (i) fixed dividend (ii) share in excess of profits. Those preference shares which do not carry the right of share in excess profits are known as non-participating preference shares.
- Bonus share
Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are company’s accumulated earnings which are not given out in the form of dividends but are converted into free shares.
The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of a number of shares held to the number of shares outstanding. Companies issue bonus shares to encourage retail participation and increase their equity base. When the price per share of a company is high, it becomes difficult for new investors to buy shares of that particular company. Increase in the number of shares reduces the price per share. But the overall capital remains the same even if bonus shares are declared. A bonus issue is usually based upon the number of shares that shareholders already own. Bonus shares are issued:-
- to capitalize a part of the company’s retained earnings
- for conversion of its share premium account, or
- distribution of treasury shares.
- Sweat Equity share
Sweat equity shares refer to equity shares given to the company’s employees on favorable terms, in recognition of their work. It is one of the modes of making share-based payments to employees of the company. The issue of sweat equity allows the company to retain the employees by rewarding them for their services. Sweat equity rewards the beneficiaries by giving them incentives in lieu of their contribution towards the development of the company. Further, it enables greater employee stake and interest in the growth of an organization as it encourages the employees to contribute more towards the company in which they feel they have a stake.
- Employee stock option
An employee stock option (ESO) is a stock option granted to specified employees of a company. ESOs offer the options holder the right to buy a certain amount of company shares at a predetermined price for a specific period of time. An employee stock option is slightly different from an exchange-traded option because it is not traded between investors on an exchange.
Ways to issue shares:
Some of the major methods of issuing corporate securities are as follows:
- Public Issue or Initial Public Offer (IPO):
Under this method, the company issues a prospectus to the public inviting offers for a subscription. The investors who are interested in the securities apply for the securities they are willing to buy. Advertisements are also issued in the leading newspapers. Under the Company Act, it is obligatory for a public limited company to issue a prospectus or file a statement in lieu of prospectus with the Registrar of Companies.
Once subscriptions are received, the company makes allotment of securities keeping in view the prescribed requirements. The prospectus must be drafted and issued in accordance with the provisions of the Companies Act and the guidelines of SEBI. Otherwise, it may lead to civil and criminal liabilities.
Public issue or direct selling of securities is the most common method of selling new issues of securities. This method enables a company to raise funds from a large number of investors widely scattered throughout the country. This method ensures a wider distribution of securities thereby leading to diffusion of ownership and avoids concentration of economic power in a few hands.
However, this method is quite cumbersome involving a large number of administrative problems. Moreover, this method does not guarantee the raising of adequate funds unless the issue is underwritten. In short, this method is suitable for reputed companies which want to raise large capital and can bear the large costs of a public issue.
- Private Placement:
In this method, the issuing company sells its securities privately to one or more institutional brokers who in turn sell them to their clients and associates. This method is quite convenient and economical. Moreover, the company gets the money quickly and there is no risk of non-receipt of minimum subscription.
The private placement, however, suffers from certain drawbacks. The financial institution may insist on a huge discount or other conditions for the private purchase of securities. Secondly, it may not sell the securities in the market but keep them with it.
This deprives the public a chance to purchase securities of a flourishing company and there may be a concentration of the company’s ownership in a few hands. The private placement is very suitable for small issues, particularly during a depression.
- Offer for Sale:
Under this method, the issuing company allots or agrees to allow the security to an issue house at an agreed price. The issuing house or financial institution publishes a document called an ‘offer for sale’. It offers to the public shares or debentures for sale at a higher price. The application form is attached to the offer document. After receiving applications, the issue house renounces the allotment in favor of the applicants who become direct allottees of the shares or debentures.
This method saves the company from the cost and trouble of selling securities directly to the investing public. It ensures that the whole issue is sold and stamp duty payable on the transfer of shares is saved. But the entire premium received is retained by the offerer and not the issuing company.
- Sale through Intermediaries:
In this method, a company appoints intermediaries like stock brokers, commercial banks, and financial institutions to assist in finding the market for the new securities on a commission basis. The company supplies blank application forms to each intermediary who affixes his seal on them and distributes it among prospective investors. Each intermediary gets the commission on a number of security applications bearing his seal. However, intermediaries do not guarantee the sale of securities.
This method is useful when a company has already offered 49 percent of the issue to the general public which is essential for a listing of securities. The pace of sale of securities may be very slow and there is uncertainty about the sale of a whole lot of securities offered through intermediaries. But this method saves the administrative problems and expenses involved in direct selling of securities to the public.
- Sale to Inside Coterie:
A company may resort to subscription by promoters and directors. This method helps to save the expenses of a public issue. Generally, a percentage of the new issue of securities is reserved for subscription by the inside coterie who can in this way share the future prosperity of the company.
- Sale through Managing Brokers:
Sale of securities through managing brokers is becoming popular particularly among new companies. Managing brokers advise companies about the proper timing and terms of the issue of securities. They assist companies in pre-issue publicity, drafting and issue of the prospectus and getting stock exchange listing. They also enlist the support and cooperation of share brokers.
- Privileged Subscriptions:
When an existing company wants to issue further securities, it is required to offer them to existing shareholders on prorate basis. This is known as ‘Rights Issue’. Sale of shares by rights issues is simpler and cheaper as compared to sale through the prospectus.
But the existing shareholders will subscribe to the new issues only when the past performance and future prospects of the company are good. An existing company may also issue Bonus Shares free of charge to the existing shareholders by capitalizing its reserves and surplus.