Sources of Corporate Finance | Equity Share and Preference Share

Secretarial Practice 12th Commerce notes | secretarial practice 12th commerce important questions

SOURCES OF OWNED CAPITAL

• The capital raised by the company with the help of shareholders (owners) is named owned capital or ownership capital. The shareholders purchase shares of the company and provide mandatory capital to the company. It's one type of owned capital.
• Retained earnings are another type of owned capital. It is also called ploughing back of profit. It's the reinvestment of profit in the business by the company itself. Retained earnings is an inside or internal source of finance.
• Owned capital is considered permanent capital because it is returned only at the time of winding up of the company.
• Owned capital provides an initial source of capital for a new company in the form of share capital. It is raised any time later to satisfy the extra or additional capital needs of a company. However, retained earnings cannot be an initial source of capital, but it can be a very important source of capital when a company runs its business profitably during its existence.
• Promoters decide the share capital required by a company. This amount of share capital is known as authorized capital. It is stated in the Capital clause of the Memorandum of Association of the company. Let us learn in detail the various sources of owned capital.

What is Shares? 

The term share is defined by Section 2 (84) of the Companies Act 2013, ‘Share means a share in the share capital of a company and includes stock’. ‘Share का मतलब किसी कंपनी की शेयर पूंजी में हिस्सा लेना होता है और इसमें Stock भी शामिल होता है’।

• A share could be a unit by which the share capital is split/divided. The total capital of the company is divided into small parts and every part is called a share and the value of every part/unit is known as face value. A share is a small unit of the capital of a company. It facilitates the general public to purchase the capital in smaller amounts.
• A person can buy any quantity of shares according to his wish. A person who buys shares of a company is called a shareholder or a member of that company.

Features of Shares :

1. Ownership: The owner of shares is known as a shareholder. It shows the ownership of a shareholder in the company.
2. Distinctive Number: Unless dematerialized, each share has a different number for identification. It is mentioned within the Share Certificate.
3. Evidence of title: A share certificate is issued by a company under its common seal. It is a document of title of ownership of shares. A share is not any visible thing. It is shown by share certificate or in the form of Demat share.
4. Value of a Share: Every share has a value expressed in terms of money. There may be:(a) Face value: This value is written on the share certificate and mentioned within the Memorandum of Association. (b) Issue price: It is the price at which the company sells its shares to the general public. (c) Market Value: This value of a share is decided by demand and supply forces within the share market.
5. Rights: A share gives certain rights to its holders such as the right to receive dividends, the right to examine statutory books, the right to attend shareholder's meetings, and the right to vote at such meetings, etc.
6. Income: A shareholder is entitled to get a share in the company's net profit. It is called a dividend.
7. Transferability: The shares of a public limited company are freely transferable in the manner provided within the Articles of Association.
8. Property of Shareholder: Share is the movable property of a shareholder.
9. Types of Shares: A company can issue two types of shares : (a) Equity shares. (b) Preference shares.

What is Equity Shares? Explain its features 

• Equity shares are called stock. Equity shares are the initial source of financing business activities. Equity shareholders own the company and bear the risk related to the ownership.
• Equity shareholders participate in their companies management. They're invited to attend general meetings. They're allowed to vote on all matters discussed at the general meeting. Equity shareholders elect the representatives of a company to manage the company. Thus Equity shareholders are real owners of the company. 
• Equity shareholders do not get any fixed dividends, dividends rely on companies' performance.  They're paid dividends declared by the Board of Directors. If there is no profit,  no dividends are payable. Similarly, with less profit, a lesser dividend is going to be paid. If the company is successful, equity shareholders enjoy great financial rewards and if the company fails, the risk falls mainly on shareholders. due to this position of equity share capital is called ‘venture capital’ or ‘risk capital’. The owners of equity shares are real risk bearers.
• Companies Act defines equity shares as ‘those shares which do not preference shares’.
• The above definition reveals that: a) The equity shares do not enjoy a preference for dividends. b) The equity shares do not get priority for repayment of capital at the time of winding up of the company.

Features of Equity Shares :

1. Permanent Capital: Equity shares are irredeemable shares. The amount received from equity shares is not refundable by the company during its lifetime. Equity shares become refundable only in the event of winding up of the company or the company decides to buy back shares. Thus equity share capital is long term and permanent capital of the company.
2. Fluctuating Dividend: The equity shares get dividends at a fluctuating rate because dividend depends on companies profit. If the company earns more profit, a high rate of dividend paid. similarly, if Companies earn lessor profit or loss, the Board of Directors may postpone the payment of dividends.  
3. Rights: Equity Shareholders enjoy certain rights: a) Right to vote, b) Right to share in profit, c) Right to inspect books, d) Right to transfer shares.
4. No preferential right: Equity shareholders do not enjoy preferential rights regards of payment of dividends. They are paid dividends only after the dividend on preference shares has been paid. Similarly,  at the time of winding up of the company, the equity shareholders are paid last and, if no surplus amount is available, equity shareholders will not get anything.
5. Controlling power: The equity shareholders enjoy control over the company. They are often described as ‘real masters’ of the company because they enjoy exclusive voting rights. The Act provides the right to cast vote in proportion to shareholding. They can participate in the management and affairs of the company. They elect their representatives called Directors for management of the company. 
6. Risk: The equity shareholders are the main risk-takers. They bear maximum risk in the company. They are described as ‘shock absorbers’ when a company has a financial crisis.
7. Residual claimant: Equity shareholders as owners are residual claimants to all earnings after expenses, taxes, etc. are paid. A residual claim means the last claim on the earnings of the company. Although equity shareholders come last, they have the advantage of receiving entire earnings that are leftover.
8. No charge on assets: The equity shares do not create any charge over the assets of the company.
9. Bonus Issue: Bonus shares are issued as a gift to equity shareholders. These shares are issued free of cost to existing equity shareholders. This benefit is available only to the equity shareholder.
10. Right Issue: When a company required more funds for expansion of the business and raises further capital by issue of shares, the existing equity shareholders may be given priority to get newly offered shares. This is called ‘Right Issue’. The shares are offered to equity shareholders first, in proportion to their existing shareholding.
11. Face Value: The face value of equity shares is low. It can be generally  10 per share or even  1 per share.
12. Market Value: The market value of equity shares fluctuates according to the demand and supply of these shares within the market. The demand and supply of equity shares depend on profits earned and dividends declared. 
13. Capital Appreciation: Share Capital appreciation takes place when the market value of shares increases in the share market. Profitability and prosperity of the company enhance the reputation of the company in the share market and it facilitates appreciation of the market value of equity shares.

What is Preference Shares? Explain its features

Preference shares have certain preferential rights different from equity shares. The shares which carry the preferential rights are known as preference shares:

a) A preferential right on payment of dividends during the lifetime of the company.

b) A preferential right on the return of capital at the time of winding up of the company.

• The preference shareholder has a prior right to receive a fixed rate of dividend equity shareholder. The rate of dividend is fixed at the time of issue.
• The preference shareholders are not the controllers but they are co-owners of the company. preference share purchase by investors who are interested in the safety of investment and who want fixed returns on investments.
• Normally preference shares do not carry any voting power. They have voting right only on matters of which affect their interest, like selling of undertaking or changing rights of preference shares, etc. or they get voting rights if the dividend remains unpaid.

Features of Preference Shares:

1. Preference for dividend: Preference shareholders have the first preference in companies annual net profit distribution. The dividend is paid to preference shareholders before equity shareholders.
2. Preference for repayment of capital: The Preference shareholders get the preference over equity shareholders at the time of winding up for repayment of the capital. this minimizes the risk of capital loss.
3. Fixed Return: Preference shares have a fixed-rate dividend. The rate of dividend is fixed at the time of issue. It may be in the form of a fixed sum or could be calculated at a fixed rate.
4. Nature of Capital: Preference shares do not provide permanent share capital. They are redeemed after a specific period of time. A company can not issue irredeemable preference shares. Preference capital is mostly raised at a later stage when the company gets established. These shares are issued to satisfy the requirement for extra capital of the company.
5. Market Value: The market value of preference shares does not change because the rate of dividend paid to preference shareholders at a fixed rate. The capital appreciation is considered to be low as compared with equity shares.
6. Voting rights: The preference shares do not have normal voting rights. They can vote only on matters affecting their interest.  They do not enjoy the right of control over the affairs of the company. 
7. Risk: Preference shareholders have less risk as they get preference for payment of dividend and repayment of capital at the time of business closer. 
8. Face Value: The face value of preference shares is comparatively more than the equity shares. They are normally issued at a face value of Rs. 100/-.
9. Rights or  Bonus  Issue:  Preference shareholders are not entitled to Rights issue or Bonus issues.
10. Nature of Investor: Preference shares attract an investor who is less risk-taker. Investors who interested in the safety of capital, and who want a fixed return on investment normally purchase preference shares.

Types of Preference Shares

1. Cumulative Preference Shares: It means, if the dividend is not paid in one or more years due to inadequate profits or bad performance of a company, then the unpaid dividend gets accumulated and paid when the company makes a profit. 
2. Non-cumulative Preference Shares: It means the dividend on shares can be paid only out of the profits of the current year. It is lost forever if the dividend is not paid in any year. The right to claim dividends will lapse if the company does not make a profit in that particular year. 
3. Participating Preference Shares: The preference shareholders are entitled to participate in surplus or excess profit other than the preferential dividend. This means preference shareholders participate in the remaining profit after the dividend has been paid to equity shareholders. 
4. Non-participating Preference Shares: The preference shares are considered to be non-participating if there is no clear provision in the Articles of Association. These shareholders are entitled to a fixed rate of dividend, prescribed at the time of issue.
5. Convertible Preference Shares: The preference shareholders have a right to convert their preference shares into equity shares. The conversion takes place within a certain fixed period.
6. Non-convertible Preference Shares: These shares cannot be converted into equity shares.
7. Redeemable Preference Shares: Shares that can be redeemed after a specific fixed period of time are called redeemable preference shares. 
8. Irredeemable Preference Shares: Shares that are not redeemable that are payable only at the time of winding up of the company are known as irredeemable preference shares. 

Sources of Borrowed Capital 

• Only owned capital is not sufficient to carry on all business activities of a joint-stock company. A company needs borrowed capital to supplement it’s owned capital.
• Every trading company is entitled to borrow money.  However, it is a standard practice to have an express provision in the Memorandum of Association, enabling a company to borrow money. The power to borrow money is normally exercised by the Board of Directors of the company.
•  A private company may exercise its borrowing powers immediately after incorporation. However, the public company cannot exercise its borrowing power until it secures a certificate of commencement of business.
• The capital could be borrowed for short, medium, or long term requirement. It is better to raise borrowed capital at a later stage for expansion and diversification of the business. This additional capital can be raised by A) issue of debentures B) Accepting deposits C) bonds D) Loans from commercial banks and financial institutions, etc. Interest is paid on borrowed capital. Borrowed capital is repayable after a certain period of time.

What is Debentures? Explain its features 

• Debentures are one of the principal sources of raising borrowed capital to satisfy long and medium-term financial needs. Over the years debentures have occupied an important position in the financial structure of the companies.
• The term debenture has come from the Latin word ‘debere’ which means to ‘owe’. Debenture means a document that either creates or acknowledges debt. 

Topham defines: “A debenture is a document given by a company as evidence of debt to the holder, usually arising out of loan, and most commonly secured by charge.” 
A debenture is an instrument issued in the form of a debenture certificate, under the common seal of the company.

 Features of Debenture

1. Promise: Debenture is a promise by the company that it owes a specified sum of money to the debenture holder.
2. Face Value: The face value of debenture normally carries a high denomination. It is for Rs. 100 or in multiples of Rs. 100.
3. Time of Repayment: Debentures are issued with the due date mentioned in the debenture certificate. The principal amount of debenture is repaid on the maturity date.
4. The priority of Repayment: Debentureholders have a priority in repayment of debenture capital over the other claimants of the company.
5. Assurance of Repayment: Debenture is a long term debt. They carry an assurance of repayment on the due date.
6. Interest: A fixed rate of interest is paid periodically in case of debentures. Payment of interest is a fixed liability of the company. It must be paid by the company no matter whether the company makes a profit or not.
7. Parties to Debentures: i)Company: This is the entity that borrows money. ii) Trustees: A company has to appoint a Debenture Trustee if it is offering Debentures to more than 500 people. The company makes an agreement with trustees, it is called Trust Deed. It contains the obligations of the company, rights of debenture holders, powers of Trustee, etc. iii) Debenture holders: These are the parties who provide loan and receive, ‘Debenture Certificate’ as evidence.
8. Authority to issue debentures: According to the Companies Act 2013, Section 179  (3), the Board of Directors has the power to issue debentures.
9. Status of Debentureholder: Debentureholder is a creditor of the company. Since debenture is a loan taken by a company, fixed-rate interest is paid at fixed intervals until the debenture is redeemed.
10. No Voting Right: According to Section 71 (2) of the Companies Act 2013, no company shall issue any debentures carrying any voting right. Debenture holders have no right to vote at a general meeting of the company.
11. Security: Debentures are generally secured by a fixed or fluctuating charge on the assets of the company. If a company is not in a position to make payment of interest or repayment of capital, the debenture holder can sell off the charged property of the company and recover their money.
12. Issuers: Debentures can be issued by both private companies and public limited companies.
13. Listing: Debentures must be listed with at least one recognized stock exchange.
14. Transferability: Debentures can be easily transferred, through the instrument of transfer.