Share capital is the money that a company raises by issuing common or preferred stock. When a company is first created, if its only asset is the cash invested by the shareholders, the balance sheet is balanced with money on the left and share capital on the right side. Share capital is different from the market value of the shares. Share capital represents how much money was used to buy shares, but the market value of the shares might mean that those shares would be worth much more if sold.
The share capital reported by a company includes only payments for purchases made directly from the company. The later sales and purchases of those shares and the rise or fall of their prices on the open market do not affect its share capital.
Types of Share capitals
There are five main types of share capitals:
1. Authorized Share Capital:
It is the total capital that a corporation accepts from its investors by issuing shares listed in the firm’s official documents. The company has the discretion to take the required steps necessary to increase the limit of authorized capital to issue more shares. Still, it is not allowed to issue shares that exceed the authorized capital limit in any case.
2. Issued Share Capital:
The portion of Authorized Share Capital issued to the public for subscription is known as Issued Share Capital. Simply, Issued Share Capital is the subset of the Authorized Share Capital.
3. Subscribed Capital:
The portion of issued capital that has been sold to the public is known as subscribed capital. The performance of a share issue depends on its subscribed capital. If this percentage (subscribed/issued capital) falls too low, that organization may have to sell another round of shares.
4. Called-Up Capital:
It is the amount of share capital that the shareholders owe and are yet to be paid. It is the part of the Subscribed Capital, which includes the amount paid by the shareholder.
5. Paid-Up Capital:
It is the portion of Called-up Capital paid by the shareholder. The paid-up capital shall always be less than or equal to the authorized share capital at any point in time. The company is not allowed to issue shares beyond the company’s authorized share capital.
Advantages of Share capital
Some advantages of share capitals include:
- Some companies will decide to increase their share capital as an alternative to taking out a loan. The advantage being there are no interest payments. Although dividends are often paid to shareholders, this depends on the business’s success, and there is generally no obligation to pay dividends.
- In general, a business that uses more equity than debt has a lower risk of bankruptcy. If a business suffers a setback and fails to make interest payments, its creditors can force it into bankruptcy. Equity investors have no such rights. They must wait out any potential downturns to benefit when a business prospers. For example, assume you finance your small business with equity and have a bad year. Investors might be disappointed, but their only option is to hope for improvement.
- Right Over Assets and Income: When you purchase the shares of a company, you get a part of the ownership in the company. This makes you the owner of the assets that the company owns. Also, investors can receive a share of the profits through dividends. They also stand to indirectly benefit when the company makes profits over time by increasing the share’s value.
- Liquidity: Liquidity is one of the main advantages of investing in share capital. Liquidity means the volume of shares that are traded on the stock exchange. When you purchase the shares of a company, you can easily sell them on the exchange. The availability of buyers to purchase your stocks during the market session make the equity market appealing. Therefore, whenever you need cash, you can easily sell your stocks on the exchange and get money credited into your bank account.
- Residual Claim: The equity shareholder has the right to make a residual claim on the assets and income of the company. This claim can be made on those assets or income that are left after paying all the stakeholders like debenture holders, lenders, etc. This advantage can become a significant aspect if a company goes under. This is because you can still claim something from the company and get some of your investment back instead of suffering complete loss.
Disadvantages of Share capital
Some risks and disadvantages of share capitals include:
- Dividend: The dividend which a shareholder receives is neither fixed nor controllable by an investor. The management of the company decides how much dividend should be given. If there is a loss, there is no question of dividend. If there is a profit, investors will not receive the dividend unless the Board of Directors proposes a dividend.
- Suppose there are multiple principal shareholders and a new significant shareholder buys up enough newly created shares. In that case, they may ally with an existing principal shareholder, changing the balance of power. In the end, a company that issues too many new shares can become vulnerable to takeover by a competitor.
- It dilutes control for the founders: The more shares issued, the more shareholders there are who own part of the business. This results in the founders having less control. To have a majority stake in the business, the founders must hold more than 50 percent of the shares.
- Although equity does not require interest payments, it typically has a greater overall cost than debt capital. Stockholders shoulder more risk from their perspective than creditors because they are last in line to get paid if the company goes bankrupt. Consequently, equity investors demand a higher rate of return on their investment. You typically must give up more stock for a lower price when raising equity to compensate investors for this risk.
- Returns on equities vary from one stock to another. Some stocks can give you returns, while some can run into losses. Therefore, you must be very selective to overcome such a situation and pick stocks only after research and analysis.
Keeping the above points in mind while investing in the stock market will help you take better decisions. Also, check the difference between Ordinary shares and Preference shares and which ones are more suited for you.