Types of Equity Share: A Complete Investor's Guide

Equity share classes are the basis of corporate ownership and investing strategies in the stock market. Learning about the types of equity shares is a crucial part of the knowledge base, whether you are an individual investor taking your first step into the market or a seasoned market professional. Equity shares – also known as ‘ordinary shares’ – give you a stake in a company. Equity shares do not make you a lender. It means you become a co-owner, with the right to receive a part of the profits made by the company.

The following section discusses the definitions and characteristics of certain different types of equity shares that are common in today’s market and provides a detailed analysis of the same.

What are Equity Shares and Their Types?

Before we go into the types of equity shares and what they mean, let us first understand what equity shares are and what they mean. Equity shares, or ordinary shares, or common stock, are the securities which represent the ownership of a company.

Equity shareholders are entitled to any remaining profits the company makes in the form of dividends, voting power at the annual general meeting and a claim for asset proportion depending on the amount of shares held if the company goes into liquidation, but only after the debts are paid off.

The equity share value is constantly changing due to the performance of the company, macroeconomic environment, industry trends and investor sentiments. Here is a discussion on different types of equity shares.

Types of Equity Shares in Stock Market

Understanding the different types of equity shares is essential for making informed investment decisions. Here are the main types of equity shares available in the share market:

1. Authorised Shares

‘Authorised shares’ refers to the maximum number of equity shares a corporation may legally issue as provided by the memorandum of association (MOA) or the corporate charter. This number is set at the time of formation of the company and is a limit (ceiling) on the number of shares a company can authorise.

2. Issued Shares

Issued shares can be the most tangible of all Equity Share Types, as these are the shares that have been allotted by the company to investors and shareholders. A portion of these shares may be traded on stock exchanges, while others may be held by promoters or strategic investors. This means the company has the ability to issue shares up to the number of authorised shares that remain unissued, allowing companies to retain issuing capacity for  future strategic requirements.

3. Subscribed Shares

Subscribed shares are the shares offered by the company which the shareholders agree to buy, usually at the time of the Initial Public Offering (IPO) or through the process of rights issues. If an IPO is issued, the subscription for shares starts from here. The investors bid for the shares, and the shares for which the commitment to buy is made by the shareholders, irrespective of their payment, are called subscribed shares.

In the Indian context, subscribed shares become relatively more important when an IPO is issued in India. As per SEBI guidelines, the company must also achieve a minimum threshold of subscription rate of 90 per cent to be able to proceed with the process of allotment.

4. Paid-Up Shares

Shares for which the company has received the full amount of the subscription. From an operational point of view, paid-up shares make up the bulk of all shares issued nowadays because payment of the total issuing amount is required before allocation of the shares.

Paid-up capital is a significant element in determining a company’s value and creditworthiness. The paid-up capital of a firm is often used by lenders as one of the factors for assessing the financial strength of a company.

5. Bonus Shares

Bonus shares are new shares issued free to the existing stockholders in proportion to their existing shareholding position. Instead of distributing dividends in cash, companies can distribute reserves and surplus to share capital and issue them to their stockholders as bonus shares.

For example, a bonus share allocation ratio of 1:1 means that every existing stockholder will get one new share for each existing share held, doubling his/her shareholdings without any additional money. The total number of outstanding shares increases, but each stockholder’s percentage of ownership does not change. Bonus shares are often viewed positively by investors as they may reflect management’s confidence in the company’s future prospects, although market reactions can vary depending on business fundamentals. Bonus shares always have good market perception.

Bonus shares are one of the most common forms of corporate actions involving equity shares in India.

6. Rights Shares

The rights issue is giving the shares to the existing shareholders at a discounted price before making them open to the general public, in relation to the number of shares already owned. This approach has two objectives. The first is that it helps the corporation make money; the second is that it allows them to keep their stake in the company and prevent it from being diluted.

For example, a company may issue a one-for-five rights issue at a 25% discount to the current market price. There are three options available to investors: buy, sell or let them lapse. In India, rights issues are commonly used by large corporations to raise additional capital or to acquire other companies.

7. Sweat Equity Shares

The company issues sweat equity shares as a payment to the directors and/or employees as compensation in the form of shares for their contribution in terms of intellect or skills, which have added great value to the company without the payment of money. Instead of paying the contributor in cash, the company offers shares as a way of aligning the contributor’s interests with the company’s interests.

The Indian laws governing sweat equity shares are the Companies Act, 2013, and SEBI (Issue of Sweat Equity) Regulations. Sweat equity shares may be issued at a discount or for free. However, the issuance of these shares needs the approval of the board and the shareholders. Sweat equity shares are one of the kinds of different types of equity shares.

8. Preference Shares

Preference shares occupy a middle position in the capital structure of corporations. Preference shares are hybrid securities but are sometimes referred to in the context of equity shares because of their nature of ownership rights in the business enterprise. Preference shareholders receive a fixed dividend, which must be paid out before any dividend is paid to common equity shareholders, and they have priority in the distribution of assets in the event of liquidation.

Preference shares are of different types, like cumulative, non-cumulative, redeemable and convertible. For example, the holders of the convertible preference shares will be allowed to convert their shares into common equity shares after some time period.

Why Understanding Types of Equity Shares Matters for Indian Investors

The stock markets in India have grown exponentially in the last couple of decades, with thousands of companies listed on either the NSE or the BSE. If you are someone who wants to invest your money in such an environment, it is important to know what are the types of equity shares.

Each type of equity share has a different risk and return profile and a different level of liquidity and other regulatory requirements. For example, buying equity shares in a rights issue could be a very smart move in the case of a fundamentally strong company at a discounted rate. Another one is bonus shares. In the case of bonus shares, the number of shares increases according  to the bonus ratio announced by the company. However, investors should not fall into the trap of assuming that bonus shares automatically increase their wealth, as the share price is adjusted to reflect the increased number of shares.

The knowledge of various types of equity shares helps the promoters and the businesses to manage the capital efficiently. For example, sweat equity shares can be issued to key employees to retain them without parting with cash. Also, holding authorised but not issued shares offers flexibility.

Key Takeaway

In India, there are different types of equity shares that cater to the wide range of the needs of investors, corporates and regulatory requirements. From authorised and issued equity shares, which form the capital structure of a business, to bonus and rights shares, which reward the existing shareholders, and sweat equity shares, which give recognition to the key players, each of these has its own purpose.

An informed investor, who knows what is  equity shares are and the types, can use this knowledge while evaluating corporate actions, taking investment decisions and managing his/her investment portfolio. Whether you are subscribing to an IPO, contemplating a rights issue or analysing a balance sheet, having an understanding of different types of equity shares shall prove to be one of the most enduring skills.

To the investors who wish to explore their full potential when it comes to types of equity shares in India, it would be recommended to combine such basic knowledge with market research and professional finance advice wherever required. The stock market has always been a rewarder of intelligent and disciplined minds.

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Frequently Asked Questions (FAQs)

What is the difference between equity and preferred stock?

Equity shares in a business give you the right to be an owner and a voter, while preference shares essentially give you dividend rights that are paid first to preference shareholders before dividends are paid to equity shareholders upon liquidation or dividend payout. Equity shareholders usually enjoy higher growth while preferred shareholders get a more stable income.

How can Equity Shares generate returns on Investments?

Equity shares generally give returns in the form of capital gains and dividends. A capital gain occurs when the equity price is higher than what you paid for it. Companies may also pay dividends to their shareholders out of the company’s profits.

Are Ordinary shares good Investments for the Future?

Equity shares can be considered good investments for building long-term wealth. Equity shares provide better returns over a period of time as compared to fixed deposits and savings accounts and can also beat inflation.

What are the Advantages of Issuing Equity over borrowing?

Equity shares are issued by companies as a way to raise funds without increasing liabilities or paying interest. Moreover, this is more flexible from the point of view of finance and helps in the enhancement of the financial position of a company.