Shares are defined under Section 2(84) of the Companies Act, 2013, as share in the share capital of a company and includes stocks. Shares are issued by companies to raise capital from investors. This capital is intended to further development and growth of the business of the company. A share represents the interest of a shareholder in the company, and this interest is measured for the purpose of liability and dividend. It attaches various rights and liabilities to the shareholder.
Shares are considered a type of security. Security is defined under Section 2(80) of the Companies Act, and references to securities as defined under section 2(h) of the Securities Contracts Act, 1956. The shares of any member in a company is considered as movable property according to Section 44 of the Companies Act, 2013 and are considered to be transferable in the manner provided by the articles of the Company.
Section 45 of the Companies Act, mandates all companies to have a share which would ensure that the shares of the company is distinguished by a distinct number. However, if a share is held by a person who is entered as holder of beneficial interest in such share in the records of a depository, then the same would not be applicable to that extent.
Shares are issued in the following manner:
- In case of a private company, shares are issued through private placement, meaning they are issued to smaller groups of individuals.
- Alternatively, a public limited company floats a new class of shares in the open market through an Initial Public Offering (“IPO”) and later, these are traded on by individuals in the stock exchanges active in the country.
Types of Share Capital:
As per Section 43 of the Companies Act, 2013, the share capital of a given company limited by shares are of two types, (a) Equity Share, and (b) Preference Share.
Equity Share Capital:
Equity Share Capital with respect to any company limited by shares means all share capital which is not preference capital, and references the portion of the company’s capital which is raised in exchange for a share of ownership in the company. Equity shares come with voting rights, or with differential rights as to dividend, voting or otherwise, as prescribed from time to time.
Preference Share Capital:
Preference Share Capital, with respect to any company limited by shares means share capital having fixed rate of dividend and carry preferential rights over ordinary equity shares in sharing of profits and also claims over assets of the Company. Investors who buy preferential share capital are placed in higher priority where dividend declaration is concerned, and are the first to receive money at the time of winding up. Investing in preference share, does not give the investor a right to vote, unless the matter directly or indirectly affects them.
Preference share capital, as per Section 43 of the Companies Act, 2013, means that part of the issued share capital of the company which carries or would carry a preferential right in respect of the payment of dividend, as a predetermined amount or an amount calculated at a fixed rate, and maybe subject to income tax.
Further, in the case of winding up of the company or repayment of capital, there exists a preferential right to repayment of the amount of capital paid up or deemed to have been paid up, regardless of a preferential right to payment of any fixed premium or premium on any fixed which is specified in the memorandum or articles of the company.
There are different sub-types in preference shares:
Cumulative Preference Shares:
Cumulative Preference Shares give their shareholders the right to receive arrears on dividend before any dividend is paid to equity shareholders. For example, if the dividends on preference shares for the two years have not been paid due to market downturn, then preferential shareholders are entitled to receive dividend for those years in addition to the current one.
Non-cumulative preference shares:
Non-cumulative shares do not entitle their shareholders to claim any outstanding dividend. Such shareholders only earn a dividend once the company earns profits. No dividends are paid for the years of market downturn.
Convertible Preference shares:
Preference shares which are convertible are known as Convertible Preference Shares. Convertible Shareholders may convert their preference shares into equity shares after a specific period of time, provided that this conversion of shares is authorized by the Articles of Association of the company.
Types of Equity Shares based on Share Capital:
Based on Share Capital, Equity Shares can be classified as under : –
Authorized Share Capital:
Authorized Capital, also called nominal capital, is the maximum amount of capital which a company can raise to fund capital requirements through the issuance of equity shares. Each Company, through its Memorandum of Associations (“MoA”), requires to prescribe the maximum amount of capital that may be raised through the issuance of equity shares however, Companies cannot issue shares of the value more than the Authorized Capital.
Companies may increase the authorized share capital if required, through an Amendment via a resolution passed at a general meeting of the shareholders.
Issued Share Capital:
Issued Share Capital, refers to the portion of the Company’s Share Capital which is available for subscription to investors through the issuance of Equity Shares. Issued Share Capital is required to be within the limit of the Authorized Share Capital, and cannot be more than the Authorized Share Capital, as stated in the MoA. The Issued Share Capital can be either equal to or less than the Authorized Share Capital.
Since, a company does not have to issue all of its Authorized Share Capital at once, it may further issue Share Capital in the future, depending on its financing requirements.
Unissued Share Capital:
This is the portion of the Authorized Share Capital that has not been issued and is not available for subscription to investors. It is essentially the difference between the Authorized Share Capital and the Issued Share Capital.
Subscribed Share Capital:
Subscribed Share Capital is the Issued Share Capital which has been subscribed to by investors. Once investors have subscribed to the Issued Capital. Capital is increased when investors have subscribed to the shares of the Company. Subscribed Shares can only be equal to or less than the issued share capital.
Reserve Share Capital:
Reserve Share Capital is the Capital which is reserved for the purposes of liquidating or winding up. A company may establish Reserve Capital upon a 3/4th Majority vote in favour of this special resolution. The Articles of Association cannot be altered to avail Reserve Share Capital at any time once they have been constituted. Reserve Share Capital cannot be used to obtain collateral for loans either, and is subject to the winding up of the Company to be available.
Called-up Capital:
Called-up Capital is the investor’s payment upon subscription to the Issued Share Capital. Where, the capital paid by the investor is not paid in lumpsum, but rather, is paid in instalments. Therefore, called up capital is the portion of subscribed capital that the company demands the investor to pay upon subscription.
Paid- up Capital:
Paid-up Capital is the amount of money investors pay against its shareholdings in the Company. Where, Shareholders usually pay the entire amount at once, subscribed and paid-up capital are referred to the same.
Classification Of Equity Shares based on Definition
Based on its Definition, Equity Share Capital can be further classified as under: –
Employee Stock Option Plan:
The Employee Stock Option Plan (“ESOP”) is an employee benefit plan issued by the Company for its employees to encourage employee ownership in the Company. These Shares are available to the Employee and Directors of the Company, whereby the Employee or Director has the option to purchase these shares at a predetermined price. These Shares cannot however be equated to remuneration of the Employee or Director. ESOPs are an important to maintain liquidity, especially for start ups.
These shares can be issued in accordance with the Companies Act, alongwith the Companies (Share Capital and Debentures) Rules, 2014, which is applicable only to unlisted Companies. Listed Companies may issue such shares in accordance with Securities and Exchange Board of India Employee Stock Option Scheme Guidelines.
The Company shall issue ESOPs in accordance with Section 62(1) of the Companies Act, and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
Bonus Shares:
Bonus shares are fully paid-up share capital, which is issued to current shareholders in addition to their existing shares. The shareholders are exempt from paying for such shares, as they are provided at no cost. Once the Company has accumulated profit and wish to capitalize their reserve and surplus chase, Bonus shares are issued. Bonus shares are considered a good sign for the Company since it is issued to serve a large equity base while the net worth of the Company stays intact.
The Conditions laid down for issuing Bonus Shares are:
- Bonus Shares must be mentioned in the Articles of Association (“AoA”) of the Company, wherein Shareholders are mentioned to be eligible to receive Bonus Shares in the AoA. If this is not specified, then the AoA may be altered accordingly by a special majority.
- In order to issue Bonus Shares, the Board of Directors, along with higher management must pass a special resolution on the basis of profitability made by the Company. The Special Resolution may be passed on the basis of accumulated profit, and Bonus Shares are issued to all its Shareholders.
- The Company has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it. Further, the Company shall ensure that the Company has made timely payment of statutory dues of the employees such as contribution to provident fund, gratuity, bonus etc.
- Partly paid-shares, if outstanding on the date of allotment are made fully paid up by the Company.
- The Company shall ensure that the Authorized Share Capital is sufficient to issue Bonus Shares, else the Company shall increase Authorized Capital first.
- The Company shall ensure that the reserves created by revaluation of assets are not used for the issuance of Bonus Shares.
- The Company shall ensure that the bonus issue is not made in lieu of dividend.
Rights Shares: Right shares are those shares that a company can provide to its existing shareholders – at a particular price and within a specific period, giving such shareholders the right of pre-emption. Rights shares are issued to help raise capital but are not mandatory to be issued. Rights shares are issued in accordance with the Companies Act. The Company issuing Rights Shares shall have to comply with the following:
- Rights Shares are mentioned in the AoA of the Company.
- A notice to the shareholders regarding the Rights Shares has to be sent.
- This offer should be available for 15-30 days.
- The existing shareholders of the Company may renounce or accept this offer.
- Number of shares and price of such share has to be informed to the Shareholders.
Sweat Equity Shares:
Sweat Equity Shares are issued by the Company to its Directors (except Independent Directors) or employees of the Company at a discount for consideration other than capital. Sweat Equity Shares are issued for the purpose of contribution to the intellect of the Company, value addition to the employees, etc. In order to issue Sweat Equity Shares, the Company must follow these compliances:
Special Resolution must be passed by the members and the proposal of issuing such shares must come from the Board of Directors.
- Class of shares, Number of Shares, and to whom such shares may be issued.
- Price for such shares to be decided by the Board of Directors.
- The Company issuing such shares must have commenced business at least a year prior.
- Maximum shares which can be issued may be 15 percent of paid up share capital or 5 crores, whichever is higher.
- Notice to share holders prior to the issuance of sweat equity shares.
Voting and Non-Voting Shares:
Equity Shares generally give its Shareholder the right to vote. Section 47 of the Companies Act, determines the extent that the Shareholder holding Equity Share shall have in voting on matters of the Company. This means that Companies may issues Equity Shares which confer differential or no voting right at all to such Shareholders, subject to the Company being a private limited company and having such provisions under its AoA.
Classification Of Equity Shares based on Returns
Based on returns, Equity Shares are broadly categorized as follows:
Dividend Shares: When a Company earns a profit or surplus, it may pay a proportion of the profit as dividend to its Shareholders. Such companies which pay dividends are usually well-established with steady net incomes, and are an ideal investment avenue for risk-averse investors.
Growth Shares: Shares which are associated with companies that have extraordinary growth rates are referred to as Growth Shares. While such companies might not provide dividends, the value of their shares increase exponentially providing staggering capital gains to shareholders. Such types of shares are suitable for investors with high-risk aptitiude.
Value Shares: Shares which are traded at prices lower than their intrinsic value, are known as Value Shares. Investors may anticipate the prices of Value Shares to appreciate over some time, thus providing them with a better share price.
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