Definition
Equity Share Capital is the share capital of a company that consists of its equity shares, as opposed to any form of non-equity shares, such as preference shares or debt instruments. Equity shares, also known as common shares, represent ownership in a company and entitle shareholders to a portion of the company’s profits through dividends and increases in stock value. Importantly, equity shareholders usually have voting rights, allowing them to participate in decisions crucial to the company’s future.
Examples
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Initial Public Offering (IPO): When a company goes public, it issues equity share capital to raise funds. For instance, if a company issues 1 million shares at $10 each, it creates $10 million in equity share capital.
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Follow-On Public Offering (FPO): If a company needs additional capital after an IPO, it might issue more equity shares. Suppose it needs to raise another $5 million and issues 500,000 shares at $10 each, this adds another $5 million to its equity share capital.
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Private Placement: A company might decide to raise funds by selling equity shares directly to a private investor or institution without a public offering, thus increasing its equity share capital.
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Bonus Issue: A company capitalizes on its reserves by issuing additional shares to existing shareholders without charge, effectively converting retained earnings into equity share capital.
Frequently Asked Questions
What is the difference between equity shares and preference shares?
Equity shares come with voting rights and a claim on residual profits in the form of dividends, but dividends are not guaranteed. Preference shares typically do not come with voting rights but offer fixed dividends and have priority over equity shares in the distribution of assets during liquidation.
How is equity share capital recorded on a company’s balance sheet?
Equity share capital is recorded under the shareholder’s equity section of a balance sheet. It includes both the nominal value of the issued shares and any additional paid-in capital (amount received above the nominal value).
Can equity share capital be negative?
No, equity share capital itself cannot be negative. However, a company’s overall shareholder’s equity can be negative if the accumulated losses and liabilities exceed the total equity share capital and retained earnings.
What are the advantages of issuing equity share capital?
Issuing equity share capital does not incur debt; thus, the company doesn’t have to pay interest or repay principal. This reduces financial risk and leverages investor capital to generate business growth.
What are the disadvantages of equity share capital?
Issuing additional shares dilutes existing shareholders’ ownership percentage and may lead to divided profits among a greater number of shares, potentially reducing individual shareholder returns.
How does equity share capital impact a company’s control structure?
Equity shareholders typically have voting rights, meaning they can influence corporate decisions including the election of the board of directors and major structural changes. Issuing additional shares can shift the control dynamics if new investors gain a substantial number of shares.
What is authorized share capital versus issued share capital?
Authorized share capital is the maximum capital that a company is allowed to issue as per its constitutional documents, whereas issued share capital is the portion of authorized share capital that has actually been issued to shareholders.
Can equity share capital be converted into another form?
Equity share capital itself cannot be directly converted into another form like debt. However, equity shareholders can sell their shares in the open market or the company may buy back shares, altering the capital structure indirectly.
How does equity share capital affect dividend distribution?
Dividends are typically paid out of profits and excess reserves. The more the equity share capital, the higher the total number of shares among which profits need to be distributed, potentially lowering per-share dividend amounts.
What is the role of equity share capital in company valuation?
Equity share capital, combined with the market price of shares, helps in determining the company’s market capitalization, which is a critical component in evaluating the company’s overall market value.
Related Terms
- Authorized Share Capital: The maximum amount of share capital that a company is authorized to issue by its charter.
- Issued Share Capital: The portion of authorized share capital that has been issued to shareholders.
- Outstanding Shares: The total shares that are currently held by all shareholders, including restricted shares and shares held by the public.
- Shareholder’s Equity: The residual interest in the assets of the entity after deducting liabilities.
Online References
- Investopedia: What Is Equity Capital?
- The Balance: Understanding Share Capital
- Corporate Finance Institute: Equity Shares
Suggested Books
- “Equity Asset Valuation” by Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, and John D. Stowe
- “The Intelligent Investor” by Benjamin Graham
- “Corporate Finance” by Stephen A. Ross, Randolph W. Westerfield, and Jeffrey Jaffe
- “Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company Inc.
Accounting Basics: “Equity Share Capital” Fundamentals Quiz
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