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The report stated that Reliance Jio raised Rs.1.52 crore by selling 33 percent of its share. This way they managed to cut down their net debt target for the whole year. A share represents ownership units in a company that individuals can buy and sell. As a company needs funds to boost its growth, they offer company shares to investors. Company shareholders are the investors who purchase these shares. By buying these shares, they get part ownership in the company.
The above-mentioned news is a great example of shares and their use. Reliance Jio required funds for the development of entry-level smartphones. Hence, they sold a few company shares to raise the required amount. This way, focusing on their growth and development, companies can issue different types of shares. Companies mostly issue equity and preference shares.
Now, let’s delve into the various types of shares. This article will discuss more about the different kinds of shares in detail.
Types of Shares in India
How many types of shares are there? What are the advantages and disadvantages of these types of shares in a company? Let’s find out!
Equity Shares
Companies in need of long-term financing issue equity shares. The public has the opportunity to invest in non-redeemable companies. Each equity share gives partial ownership in the company.
Equity shares come in different types and these include:
1. Ordinary Shares
Companies offer these shares to raise funds to cover long-term company expenses. Here, investors receive a fraction of company ownership based on the number of their shares. Shareholders with a large number of equity shares get voting rights and participate in decision-making.
2. Participating Preference Shares
The company must provide the stipulated amount of company profits to a shareholder owning a participating preference share. This is based on the company’s performance in the given financial year. Additionally, they also receive bonus return.
3. Bonus Shares
Companies issue bonus shares from their retained business earnings. In simple words, the company distributes the profits among its investors in the form of bonus shares. Thus, it does not increase the market capitalization of the company.
4. Rights Shares
These shares are exclusive to the premium investors. Companies issue shares at a discounted price encouraging the holders to increase their stakes. These types of shares in company law are for a stipulated time. Companies issue them to fulfill the financial requirements of the company.
Advantages of Equity Shares
The following are the benefits of equity shares:
1. Higher Return on Investment
Equity shares are the type of shares that involve a huge amount of entrepreneurial risk. The greater the risk factor, the higher the return potential. Here, the investor also enjoys the company’s profits and dividends.
2. Easy and Efficient
Investing in equity shares is an easy process. With the help of a financial advisor, a shareholder can invest in the stock market. Here, investors can easily buy or sell the stock without significantly impacting its market price.
3. Ownership Control
When an investor buys a company share, they also claim partial ownership of the company. The higher the number of equity shares, the greater the power they have within the organization.
Disadvantages of Equity Shares
Here are some drawbacks of equity shares
1. Company Performance Risks
Investors in equity shares have the last claim to the company profits. The company distributes dividends among bond and preference stakeholders first. Then, it distributes the remaining amount among equity shareholders.
This means, that in case the company performs poorly and the profit is low, equity shareholders will have to settle for less amount.
2. Market Risks
There is no guarantee of returns in equity shares. If a company shows poor performance, the market price of the company drops. Thus, shareholders have to sell their shares at a low price.
Preference Shares
Preference shares allow investors to receive dividends from the business before distributing them to equity shareholders. Simply put, if a company decides to pay out dividends, preference shareholders are first in line to receive them.
Companies issue these types of shares to raise capital for their growth. They constitute preference share capital. Therefore, if the company incurs a loss, preference shareholders will be the last to receive payment. However, they will still receive it before equity shareholders.
The following are the features of preference shares:
1. Fixed Dividend Rates
Preference shares enable investors to receive dividend payouts without fail. Other stakeholders may receive them later. Or even worse, they may not receive them at all.
2. Priority in Receiving Dividends
As mentioned earlier, when the company announces to pay out its dividends, preference shareholders receive them first.
3. Limited Voting Rights
Under special circumstances, they also have the right to vote. Generally, purchasing shares doesn’t give the right to participate in a company’s management. Thus, this only happens rarely.
Also read: How to Invest in Stock Market in India: Guide for Beginners
Advantages of Preference Shares
The benefits of preference shares are as follows:
1. Regular Income
Just like equity shares, preference shares also represent partial ownership in the company. However, unlike equity shareholders, preference shareholders receive a fixed dividend payout.
2. Low-risk Investment
If the firm is winding up under unfortunate circumstances, the preference stakeholders have higher claims in comparison to equity shareholders. Thus, the risk factor is low here.
3. Dividend Preference
When it comes to dividends, preference shareholders have the advantage of receiving them first. Any other shareholder enjoys the dividend benefits after them.
Disadvantages of Preference Shares
These are a few disadvantages of preference shares:
1. Lower Returns
Fixed dividends on preference shares become less attractive when a company earns a huge amount. They cannot take full advantage of the company’s prosperity.
2. Limited Capital Appreciation Potential
Capital appreciation is the increase in the market price of the investment. Preference shareholders only get to enjoy company profits before equity shareholders.
Convertible Shares
Convertible shares, usually preference shares, have the capability to be convert to equity shares. Usually, companies fix the price at which the share can be converted when issuing the share.
The different types of convertible shares include:
1. Mandatory
The investors are obliged to convert the shares on the due date.
2. Reverse
Here the company can make a choice. They can convert the share to equity at the predetermined conversion price on the due date. Or they can buy the share in cash.
3. Vanilla
The investor gets to decide whether to convert the share to equity or keep it till maturity.
Advantages of Convertible Shares
The following are the advantages of convertible shares:
1. Capital Appreciation Potential
Convertible shareholders receive a fixed rate of interest until the shares reach maturity. Additionally, they also benefit from an increase in the stock market value.
2. Decreased Market Risk
When compared to other stakeholders, they experience less risk. In case the company is winding up, they are given first preference in the liquidation process.
Disadvantages of Convertible Shares
These are the disadvantages of convertible shares:
1. Lower Returns
Compared to other preference shares, the dividend yield here is less. This is due to the inclusion of the additional feature which is the conversion right.
2. Complex Legal and Tax Implications
The convertible bond is issued under many terms and conditions. Understanding the income tax consequences depending on the complexity of these terms can be daunting.
Cumulative and Non-cumulative Shares
Non-cumulative shares are the ones with no accumulation of dividends. This is mostly because the non-cumulative shareholders are paid from the company’s net profits from the present year. So, in case the company met with a loss in a particular year, shareholders cannot claim the outstanding dividends from its future profits.
Cumulative shares allow the shareholder to receive dividends in arrears. For instance, the company is running at a loss and cannot pay dividends now. They are obliged to pay the cumulative dividends in the following year.
Advantages of Cumulative Shares
The following are the advantages:
1. Security
In the long term, investors are less likely to suffer from the market volatility. In case the company shows poor performance in a particular year, it will receive assured returns.
2. Ranked Higher than Equity Shares
They are preferred before the equity shareholders under the circumstances of liquidation.
Disadvantages of Cumulative Shares
Here are the disadvantages:
1. Stagnant Dividend Rates
Although they are named shareholders, cumulative shareholders do not benefit from the company profits. Even if the company earns well, its dividend rates remain the same.
2. No Voting Rights
They are considered subordinate to bondholders. So, they do not enjoy any voting rights.
Redeemable and Irredeemable Shares
Redeemable shares are the shares where companies can repurchase or claim the shares after a fixed period. The redemption price is predetermined. The company can buy the shares back at the predetermined price range at any time.
Irredeemable shares cannot be redeemed during the company’s active lifetime. The shareholders can initiate their claim to the assets only when the company decides to wind up.
Advantage of Redeemable Shares
There are various advantages of redeemable shares, the advantages of redeemable shares include:
1. Ability to Control Risk
The shares will be repurchased after a given time. Since the redemption rates are predetermined, investors do not have to worry about losses even if the company is showing poor performance.
Disadvantage of Redeemable Shares
The disadvantages of redeemable shares are as follows:
1. Capital Risk
The company will only repurchase the shares when the market value is favorable. Otherwise, investors will have to wait till maturity to benefit from the investment.
Exploring the Diverse World of Shares
Investing in shares is a great way for you to generate long-term wealth. Learning about the different types of shares and their pros and cons can help you better understand the stock market.
Make sure you have a clear understanding of how the stock market works. Then, wisely choose your industries and types of shares to invest in.
Innovative, low-investment ideas for the hidden entrepreneur in you! Explore our guide on Business Ideas.
Frequently Asked Questions (FAQs)
What are shares, and why are they important to investors?
Shares are units of ownership in a company that can be sold and bought. Investors can benefit from the profits and dividends of the company based on the shares they are investing in. The dividends can either be received as income can be reinvested to buy more shares. Based on the type of shares, investors also get voting rights.
What are the different types of equity shares?
The different types of equity shares include:
1. Ordinary shares – Here, investors receive a fraction of company ownership based on their investment amount.
2. Participating preference shares – Investors are entitled to a stipulated amount of company shares.
3. Bonus shares – The company allocates additional shares from its earnings to the shareholders.
4. Right shares – These shares are issued to encourage premium investors to increase their stake.
What are preference shares?
In preference shares, the shareholder is entitled to a fixed dividend. When a company decides to pay out dividends, it will receive them before equity shareholders. Another advantage is that if the company decides to wind up, preference shareholders can stake a higher claim on the business’s assets.
What are convertible shares?
Convertible shares are the type of shares where the preference shares can be converted to equity shares.
There are three types of convertible shares:
1. Mandatory – the shares automatically get converted to equity shares on or before the due date.
2. Reverse – the company can choose either to convert the shares on the due date or buy them in cash.
3. Vanilla- the investors get to decide whether to convert the bond or hold it till maturity.
What are cumulative and non-cumulative shares?
Cumulative shares enable investors to receive missed dividends in the form of arrears. On the other hand, the company doesn’t have to compensate non-cumulative shareholders for missed dividends. Cumulative shares are often preferred over non-cumulative shares as the investors will receive the dividends that they missed at a later time.
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