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There are different sources of financing for companies. Some are short-term, and some are long-term. One of the essential sources of long-term financing for companies is equity shares. The difference between equity shares and other forms of debt is that they are not redeemable. The general public can subscribe to equity shares through the stock exchange and sell them through the stock exchange.
When you buy equity shares, you become the owner or shareholder of the company. You are eligible for voting rights during the annual general meeting (AGM) when you own equity shares and enjoy a share of the company's profits.
Now that the meaning of equity shares is clear to you let's find out about the different types of equity shares available in the next section.
Different Types of Equity Shares
Here are the different types of equity shares that you can invest in:
These represent long-term debt, and a company issues ordinary equity shares to pay for the long-term expenses of the business. An individual investor with a certain percentage of equity shares controls the company's operations. Buying these shares gives you ownership of the company.
Unlike ordinary equity shares, owners of this category of shares have no voting or ownership rights. However, when you invest in preference shares, there is a cumulative dividend payment guarantee before the distribution of profits among ordinary shareholders.
There are two sub-categories of preference shares:
- Participating Preference Shares: As an owner of this category of equity shares, you will enjoy a share of the profits, including bonus shares
- Non-Participating Preference Shares: You don't get a share of profits or bonus shares in this category
Bonus shares are additional equity shares issued to existing shareholders to distribute profits. These shares are issued free of cost, and the market capitalization or the total number of shares x market price remains the same. For example, if a company decides to issue bonus shares in the ratio of 2:1, then if you hold 1000 shares, you are eligible for a bonus of 500 shares. The total number of shares goes up, and the market price per share goes down since there is no corresponding rise in the market price.
Unlike bonus shares, right shares are offered to a company's existing shareholders at a discounted rate. This is a limited-period offer, and rights shares are issued to help the company meet its expenses.
After knowing what equity shares are and their different types, let's know more about the features of these instruments.
Characteristics of Equity Shares
Here are some features of equity shares that make them a popular investment tool.
Equity shareholders have the right to decide how the company is operated, including electing the right people to run the company. A company that has efficient management delivers better revenues and higher dividends for its shareholders.
Additional Profits Through Bonus
Some are distributed to equity shareholders through bonus shares when the company makes higher profits. It increases the number of equity shares held by you without any additional investment. When the market price of the shares goes up, so does the value of your investment.
Even though equity shares have no maturity period, you can easily sell your shares in the secondary market. Suppose your company has performed well over the years, and you have held the shares and participated in both rights and bonus issues. In that case, you enjoy greater wealth creation due to capital appreciation.
We'll next find out the benefits of investing in equity shares:
What are the Benefits of Investing in Equity Shares
Long-term investing in equity shares provides the following benefits:
Equity shares provide multiple wealth-creation opportunities for you. The three sources of wealth creation are:
- Capital Appreciation: The value of your shares grow over time, and if the company issues bonus and the right shares, it adds to both capital appreciation and wealth creation
- Dividends: Depending on the company's performance, it issues dividends to its investors. This dividend adds to your regular income.
Protection From Inflation
Inflation erodes the value of money, and you need to invest in financial instruments that help you earn a higher post-tax return to beat inflation. Equity shares are such instruments that have a much higher annual growth rate compared to inflation, and this help to create real wealth.
Diversification of Portfolio
You can diversify your investment portfolio through different asset classes like debt and equity. While debt is less volatile compared to equity shares, it also offers lower returns. With the right choice of long-term and short-term debt (depending on interest rate movements) with equity, the average returns of your portfolio will go up.
Are Investments in Equity Shares Risky?
Here are the risks that come with equity shares:
- Equity shares are highly volatile in the short term
- During slow economic growth, profits are lower, and you may or may not get a dividend since all other liabilities are paid off first.
How to overcome the risks associated with equity shares:
- Invest for the long term since the fluctuations are lower during this period, and you can enjoy capital appreciation depending on the performance of the company
- Buy more units during periods of market volatility to enjoy the benefits of rupee cost averaging. The average cost of purchase comes down, and your profits go up.
Terms You Should Be Familiar With
As an investor in equity shares, you need to be aware of the following terms:
Authorized Share Capital: This is the maximum value of shares that an organization can issue.
Issued Share Capital: This he approved capital that a company can issue
Subscribed Share Capital: This is the portion of capital that investors subscribe
Paid-Up Capital: This is the part of the subscribed share capital that has been paid for.
Sweat Equity Share: This category of equity shares is issued to employees in exchange for know-how or IPR (intellectual property rights). The shares are issued at a discount to the market price.
Equity shares are an excellent wealth-creation tool for the long term. To benefit from equity, you need to stay invested for at least 10 years in a high-performing company.
What is the Difference Between ESOP and Sweat Equity Shares?
While the equity shares allotted under ESOP stay in a trust till the date of vesting, under sweat equity, employees are directly allotted shares. ESOP is issued to employees as a performance-based incentive, sweat equity is given to employees who contribute to IPR or trademark.
There is a lock-in period for sweat equity of at least 3 years, but there is no such lock-in period for ESOPs.
How are Equity Shares and Preference Shares Different?
Here are the differences between equity shares and preference shares:
|Preference Shares||Equity Shares|
|Dividend||Paid at a fixed rate||Keeps fluctuating|
|Voting Rights||No voting rights||Have voting rights|
|Management Decisions||Cannot participate in management decisions||Has the right to participate in management decision|
|Payment Preference||Preference shareholders are paid first||Paid after preference shareholders are paid|
What are Bull Markets and Bear Markets?
When economic conditions are strong, stock markets experience a 'bull phase', and during weak economic conditions, markets undergo a 'bear phase'. The price of equity shares go up during the bull phase and fall during the bear phase. If you have a company with a strong performance, buy units of this share during the 'bear phase' to gain big over the long term.
What are Bonus Shares?
When the company issues additional shares to existing shareholders at a certain ratio, these are known as bonus shares.