Last Updated on May 24, 2022 by Aradhana Gotur

Shares are a unit of ownership in a company. A company’s capital worth is divided into small units of a finite number and the company distributes this through issue of shares to investors. In simple terms, a share is a percentage of ownership in a company and it acts as a financial asset. A person, company or institution holding shares of a company is known as its shareholders.

What is meant by issue of shares?

Issue of shares refers to the process of shares of a company being distributed among entities who are willing to invest in the company. These entities could be individuals or corporate entities like partnership firms, LLP, private limited company or even public limited companies. Equity shares can be purchased from the stock exchange based on the price prevailing on the date of purchase. Non-equity shares are purchased in the over-the-counter market. The money raised by the company through issue of shares is called the share capital.

The example mentioned below can help better understand the concept of issue of shares:

ABC company having a share capital of Rs 10 lakh has divided the same into 10,000 shares of Rs 100 each. Thus, anyone who wants to buy a stake in ABC limited can purchase the shares at the price of Rs 100 each.

Types of shares

There are two types of shares a company can issue:

Equity shares

Equity shares are also known as ordinary shares. The majority of shares issued by companies are equity shares. Equity shares are transferable and are traded actively by investors in the stock market. As an equity shareholder, you are entitled to voting rights on various issues of the company and have the right to receive dividends. However, the dividend on these shares is not fixed and it may vary year to year depending on the company’s profit. There is a subclassification of these shares which are mentioned below:

  • Bonus shares: These are additional shares issued to existing shareholders free-of-cost, or as a bonus.
  • Rights shares: These are a fresh issue of shares a company provides to its existing shareholders, at a particular price and within a specific time period; before offering it in open markets for trading. 
  • Voting and non-voting shares: Although the majority of shares carry voting rights, the company can make an exception and issue differential or zero-voting rights to shareholders.
As an equity shareholder, you have the right to vote on the issues of the company and have the right to receive dividends. Click To Tweet

Preference shares

As the name suggests, this type of share gives certain preferential rights as compared to other types of shares. The main benefits that preference shareholders have are:

  • They get first preference when it comes to the payout of dividends, i.e., a share of the profit earned by the company
  • When the company winds up, preference shareholders have the first right in terms of getting repaid

There are subclassifications of these shares which are mentioned below:

  • Cumulative preference shares: Cumulative shareholders have the right to receive arrears on dividends before any dividend is paid to equity shareholders. For example, if the dividends on preference shares for the years 2017 and 2018 have not been paid due to market downturns, preferential shareholders are entitled to receive dividends for all preceding years in addition to the current year. 
  • Non-cumulative preference shares: Non-cumulative shareholders cannot claim any outstanding dividend. These shareholders only earn a dividend when the company earns profits. No dividends are paid for the previous years.
  • Convertible preference shares: As the name suggests, these shares are convertible. Convertible shareholders can convert their preference shares into equity shares at a specific period of time.

Equity v/s preference: Which one should investors buy?

Let’s look at a comparison between equity shares and preference shares:

Source of divisionEquity sharesPreference shares
BriefEquity share is the main source for raising funds, and they signify ownership of the company.Preference shares are the shares that guarantee shareholders fix the rate of dividend, and they are a lender of capital and not an owner.
Dividend RateEquity shareholders receive a dividend at a fluctuating rate and are paid after all liabilities payments.Preference shareholders receive dividend payments at a fixed rate and before equity shareholders.
Capital Payment/LiquidationIn the case of company insolvency, equity shareholder’s payment is settled or repaid at the end.In the case of company insolvency preference shareholder’s payment is repaid before the equity shareholders.
Voting AuthorityEquity shareholders have the right to vote on all matters of the company.Generally, preference shareholders do not carry the voting rights.
ConvertibilityEquity shares cannot be converted to preference shares.Some types of preference shares can be converted to equity shares.
RiskThe risk associated with equity shares is higher.The risk associated with preference share is lower in comparison to equity share.
InvestorsInvestors with a higher risk appetite invest in equity shares. Investors who want a stable return on their investment, invest in preference shares.

FAQs

What are shares?

Shares are a unit of ownership in a company. A company’s capital is divided into small equal units of a finite number. 

Who can purchase shares?

When a company issue shares, the same can be bought by any individual having a Demat account and any corporate who can buy and sell at its own individual capacity.

How are shares issued?

The shares are issued in a 3-step process. First, the prospectus is issued to the public at large, secondly, receipts are provided to the applicants and lastly, the shares are allocated amongst the investors.

Having shares of a company allows the holders a stake in the company and a share in the profits. Equity shares traded on the stock exchanges tend to have a higher risk-reward ratio. Preference shares, in comparison, give a fixed sum of money at the cost of minimal risk. You should analyze your risk appetite and then choose wisely before investing in either of these financial assets.