Raising funds by issuing shares
(a) Equity or ordinary shares
A share which is not a preference share is an equity share. It means that if the shareholder is not entitled to a fixed dividend in preference to others or if there is not prior right for the capital to be repaid, the share capital will be treated as equity share capital.
In other words, equity shares participate in the profits of a company, after all, preferential rights have been satisfied. Equity shareholders are the virtual owners of the company. They get dividend after payment of all expenses and dividend to preference shareholders.
(b) Preference shares
Preference shares are those shares, which are entitled to a priority in the payment of dividends at a fixed rate, and sometimes also in the return of capital in the event of the winding up of the company. Preference shares can be divided into the following classes:
(i) Cumulative preference shares. The holders of this class of shares are entitled to all arrears. Suppose, a company has issued preference shares of $10 each carrying dividend at the rate of 10% and suppose dividend was not paid for 2017 and 2018. In 2019 profit is good. In that case dividend for the two years 2017 and 2018 will be payable in 2019.
(ii) Non-cumulative preference shares. In this case, arrears are not payable. In the above example in 2019 only the dividend for 2019 will be paid and not that for 2017 or 2018.
(iii) Redeemable preference shares. When preference shares are redeemable out of the profits by the creation of a “capital redemption reserve fund” or by new issue of shares or out of the sale proceeds of the property of the company, they are called redeemable preference shares.
(iv) Participating preference shares. When preference shares participate like equity shares in profit of a company in addition to their fixed profit, they are known as participating preference shares.
(v) Guaranteed preference shares. Guaranteed preference shares are the shares at which a fixed dividend is guaranteed by the vendors or some other party, if the profit in a particular year are insufficient to pay the dividend, the guarantors pay the amount. The company it self cannot give guarantee. The guarantee can be given by vendor of promoter.
Evaluation of Raising Funds by issuing Shares
Shareholders are virtually the owners of the company. They bear the ultimate risk of the company. These shareholders are the last to claim their dividend in the earning and resources of the enterprise. It is always in the interest of the company to procure its initial capital through issue of shares.
Advantages of Raising Funds by Issuing Shares
Following are some main advantages/merits of raising funds by issuing shares:
(i) Absence of fixed Liability. The company does not guarantee the rate of dividend on equity shares, so it has not fixed liability as in the case of debentures. In case of cumulative preference shares also dividends are not paid out of loss.
(ii) No charge on assets. Shares are issued without any security or charge on assets. In this way, the company procures funds without any charge on its assets or even pleading any security.
(iii) Preferred by adventurous investors. Rate of dividend is not guaranteed on equity shares. Dividend may be paid at a very high rate in case of sufficient profit. It is thus preferred by adventurous investors.
(iv) Preferred by companies of unsound position. When the company is financially unsound, equity shareholders bear the risk without asking for dividend.
(v) No repayment of liability. Funds raised by issuing of shares need not be refunded. The shareholders can not claim the refund, so the company does not have any liability for the repayment of share capital.
(vi) Building company financially sound. The company is not forced to pay dividend. The rate of dividend on equity shares is not even specified. In such a case, the company maintains sufficient reserve and builds itself financially sound.
(vii) Supply of long term fixed capital. The company receives long term fixed capital.
Disadvantages/Demerits of Raising Funds by Issuing Shares
The procurement of funds by issue of shares results in the following disadvantages.
(i) Danger of over-capitalization. As the funds are easily available any charge on the assets and also without any guarantee to the rate of dividend. In this case, there is a possibility of over-capitalization.
(ii) No investment by cautious investors. Cautious investors do not prefer to invest in equity shares, because return on these shares is not regular and guaranteed.
(iii) Danger of manipulation. The management of the company may declare dividend at higher and lower rates. It will cause fluctuation in the value of shares. There is always danger of manipulation.
(iv) Disadvantageous for company of sound financial position. A company of sound financial position will have to pay dividend at higher rates, even when loan at lower rates is available in the market.
(v) Uncertainty of dividend. The rate of dividend is not assumed and even not regular. Investors are thus uncertain about their earning.