What is Share Capital? Types and Classes

A company requires funds to carry out its everyday operations, expand its business, scale up and develop or introduce new products or services. While there are several ways to obtain these funds, money raised by issuing share capital is one of the most common sources. 

In this article, we’ll take a closer look at what share capital is, the different classes and types of share capital and more. 

What is Share Capital?

In the broadest terms, the term share capital refers to the funds raised or obtained by a company by issuing shares to its investors. Each share represents a unit of ownership in the company. The investors, also known as shareholders, provide the funds required to run the business by subscribing or purchasing units of the company’s share capital. 

Since share capital is obtained as an investment and not as a loan, companies need not pay any interest on the funds raised. However, the investors who contribute to the company’s share capital have different levels of rights in running the business, depending on the type of share capital they hold. Some types of share capital carry voting rights, while others only offer the investors a right to the company’s profits in the form of dividends. 

Classes of Share Capital

Depending on their nature and the rights they offer investors, share capital can be classified as equity share capital and preference share capital. Let’s take a closer look at what each of these types of share capital classes entails. 

• Equity Share Capital

Equity share capital refers to the ordinary shares or common stock issued by a company to raise funds for its financial requirements. Each unit of this type of share capital indicates ownership in the company. Equity shareholders possess voting rights and are entitled to the company’s profits. However, the company is not obligated to pay any dividends to such shareholders. 

• Preference Share Capital

Preference share capital, also known as preferred capital or stock, offers some privileged rights to the shareholders. Like common stock, this type of capital also offers fixed dividends. In addition to this, preference shareholders gain priority over equity shareholders to receive dividends and funds in case of the company’s liquidation. On the flip side, preferred stock does not offer voting rights to shareholders. 

Types of Share Capital

Share capital can also be divided into different types depending on the stage or nature of the issue. Let’s take a closer look at the various types of share capital according to this method of classification. 

• Authorised Share Capital

Authorised share capital refers to the maximum amount of capital that a company is allowed to issue to its investors. This type of share capital is mentioned in the memorandum of association (MoA) of a company. If a company has already issued the maximum amount of share capital it is allowed to, the authorised capital can be increased if the company’s articles of association (AoA) permit the same.  

• Issued Share Capital

Issued share capital is the portion of a company’s authorised capital that has been issued to shareholders. This effectively reflects the amount of capital a company has attempted to raise. The issued share capital includes different classes of shares like equity shares and preference shares. The total value of the issued share capital is always less than or equal to the authorised capital. 

• Subscribed Share Capital

The subscribed share capital is the portion of a company’s issued capital that investors have subscribed to. This can be better understood by looking into the case of an Initial Public Offering (IPO), through which a company issues new shares. For instance, a company may issue 1,00,000 new shares, but investors may only subscribe to 80% of the issue (or 80,000 shares). 

• Called-Up Share Capital 

When investors subscribe to the shares issued by a company, they may be required to pay the price per share in full or in part. The amount of money that the company requires shareholders to pay at any point is known as the called-up share capital. This capital cannot exceed the amount of capital that investors have subscribed to. If the called-up share capital equals the subscribed share capital, it means all shares have been called for in full. 

• Paid-Up Share Capital

The paid-up share capital is the portion of the called-up share capital that investors have paid for. If any shareholders have not paid the called-up amount, the paid-up share capital will be less than the called-up capital. Once all the shareholders have paid the amount called up by the company for the shares that investors have subscribed to, the two figures become equal. 

Representation of Share Capital in the Balance Sheet

Irrespective of the type of share capital, it is not a loan to the company. Nevertheless, the capital raised by a company is still considered more of a liability than an asset because the company owes the shareholders various financial benefits. For this reason, the share capital of a company is shown on the liabilities side of the balance sheet rather than the assets side. 

It is included under a separate section titled ‘Shareholders’ Funds,’ along with other funds like reserves, surplus and any money received against shares. Within this section, the following types of share capital are distinctly represented in the balance sheet of a company. 

• Authorised share capital
• Issued share capital 
• Subscribed share capital 
• Called-up share capital 
• Paid-up share capital 

Advantages of Raising Share Capital

Raising funds by issuing share capital gives a company various advantages that may not be available with other sources of funding. Let’s take a closer look at the top benefits of issuing capital to raise funds. 

• Flexible Financing 

Unlike debt obligations, issuing share capital can be a more flexible avenue for companies. The business can determine the number and value of the shares being issued and the terms and conditions associated with each share. The maximum amount of share capital that can be raised is also often higher than the average borrowing capacity of businesses. 

• No Long-Term Obligations 

When a company opts for a loan, it results in long-term financial obligations that may last for 10 years or more. With share capital, however, a company need not worry about any such long-term obligations. The issue of paying interest on the amount raised is eliminated. Furthermore, companies are not even obligated to pay dividends on the equity shares they issue. 

• Favourable Investor Perception 

Raising funds by issuing more share capital may result in improved market visibility and reputation among investors. On the other hand, over-leveraged companies that have large sums of debt are often perceived less favourably. Positive market perception can make it easier for a company to establish and expand its business as required, thereby leading to improved profitability. 

• Access to Funds

Share capital also gives a company easy access to funds from a large pool of investors. The maximum amount of capital that can be raised is dictated by the memorandum of association (MoA) of the company, but it is often higher than the maximum amount a company may be able to raise through a single loan. This helps companies obtain significant funding with just one round of issuing capital.

Disadvantages of Raising Share Capital 

Despite the many advantages of issuing share capital, companies must also be aware of the downsides, which include the following limitations or risks. 

• Diluted Ownership

Issuing new shares can dilute the ownership of the existing investors in the company. Correspondingly, their rights and control in the company also trickle down since it is distributed to other shareholders. 

• Cost-Intensive Process

The process of issuing new shares through an Initial Public Offering (IPO) can be fairly high. That said, this downside is often offset by the potentially low overall cost of issuing capital when compared with the cost of taking a loan. 

• Potential Impact on Share Prices

Some investors may perceive fresh capital issues as an unfavourable development because of the potential dilution of ownership. This could negatively impact a company’s share prices. 

Conclusion

To sum it up, issuing share capital allows a company to raise funds for its operations, expansion and other business activities without having to take on the burden of debt. As an investor interested in leveraging the potential profitability of any company, you can invest in its shares via the share capital market — either in the primary market, where the company issues its shares for the first time (through an IPO), or in the secondary market through the NSE and the BSE. 

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