What is Share Capital? A Comprehensive Guide

Disclaimer: Investments in the securities market are subject to market risks. This content is for educational purposes only and does not constitute financial advice.

Introduction

In the post-pandemic era, retail investments in financial markets have seen a significant rise. Among equity instruments, share capital stands out as a primary source of funding for companies and a popular investment avenue for individuals. But what exactly is share capital, and how does it work? Let’s explore.

What is Share Capital?

Share capital refers to the funds a company raises by issuing shares to the public. It represents the money contributed by shareholders and serves as a long-term source of capital for the company. This capital is used to fund operations, drive growth, and achieve financial stability.

In simpler terms, share capital is the portion of a company’s capital that comes from issuing shares. It is mentioned in the company’s Memorandum of Association, which specifies the maximum amount of share capital a company can issue. This limit can be increased by amending the Memorandum of Association.

From a financial reporting perspective, share capital appears under liabilities on the balance sheet. In the event of liquidation, shareholders receive residual assets only after all other liabilities are settled.

Classes of Share Capital

Share capital is broadly classified into two categories:

1. Preferred Share Capital
   • Preferred shareholders enjoy privileged rights, such as fixed dividends.
   • They are paid before common shareholders in the event of liquidation.
   • Dividends are mandatory, similar to debt instruments, and can be accrued if not paid immediately.

1. Common or Equity Share Capital
   • Common shareholders have voting rights and a share in the company’s profits.
   • Dividends are not mandatory and depend on the company’s performance.
   • Common shareholders may also receive bonus shares or rights issues.

Types of Share Capital

1. Authorized Share Capital
   • The maximum number of shares a company can issue, as specified in its Memorandum of Association.
   • Example: A company may have an authorized capital of ₹10 crore, divided into 1 crore shares of ₹10 each.

1. Issued Share Capital
   • The portion of authorized capital that has been issued to shareholders.
   • Example: If a company issues 50 lakh shares out of 1 crore authorized shares, its issued capital is ₹5 crore.

1. Subscribed Capital
   • The portion of issued capital that investors have agreed to purchase.
   • Example: If investors subscribe to 40 lakh shares out of 50 lakh issued, the subscribed capital is ₹4 crore.

1. Paid-Up Capital
   • The amount of money a company has received from shareholders in exchange for shares.
   • Example: If shareholders have paid ₹3 crore for 40 lakh shares, the paid-up capital is ₹3 crore.

Pros of Raising Share Capital

• Fixed Cost: Unlike debt, share capital does not require mandatory dividend payments, reducing fixed costs.
• Creditworthiness: Companies with higher share capital are viewed as financially stable by investors and lenders.
• Financial Flexibility: Share capital provides flexibility in fund usage without restrictive conditions.
• Default Risk: Shareholders have a vested interest in the company’s success, reducing the risk of default.

Cons of Raising Share Capital

• Control and Ownership: Issuing shares dilutes the control and ownership of founders.
• Share Dilution: Additional share issues can reduce the value of existing shares and impact dividends.
• Public Disclosure: Public companies must comply with extensive reporting requirements.
• IPO Costs: The cost of an initial public offering (IPO) is high, including legal, underwriting, and advertising expenses.

Conclusion

Share capital is a cornerstone of a company’s financial structure, providing the necessary funds for growth and operations. For investors, it offers an opportunity to participate in a company’s success through dividends and capital appreciation. Whether you’re a beginner or an experienced investor, understanding share capital is essential for making informed investment decisions.

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