1. Types
1.1. Ordinary shares—this represents the permanent capital and is most common.
Ordinary shares normally have a nominal value, which is the limit of the shareholder's ability to contribute to the debts of the company on an insolvent liquidation.
As initial costs for issuing shares are relatively low, companies will seek to obtain as much share capital as possible.
An existing company can increase its share capital through a rights issue. Where applicable, pre-emptive rights allow existing shareholders first refusal to acquire new shares issued by a company in a rights issue.
1.2. Preference shares—these shares pay a fixed dividend:
They were popular with UK "building societies" (but most of them are now listed on the London Stock Exchange).
There is great diversity in the preferred share market but two key categories are cumulative and non-cumulative preference shares.
1.3. Convertible loan stock—these are fixed-return securities, either secured or unsecured, which may be converted into ordinary shares at a later date:
Prior to conversion, the holders have creditor status;
Sometimes conversion price is increased to stimulate early conversion; and
Part conversion is also possible, whereby only a portion of the stock is converted into shares, normally 50%.
Advantages of convertible loan stock include:
Obtaining finance at a lower rate than a debenture;
Encourage investors with the prospect of future profits;
and Deferred equity with a tax break.
2 Raising Equity Finance
Equity finance can be raised by two general methods:
a. Issuing new share capital.
b. Reinvesting profits (retaining earnings) rather than paying out dividends.
3 Issuing Share Capital
For large companies, whose shares are listed on a stock market, new shares can be issued using a rights issue (i.e. to existing shareholders in proportion to their existing shareholdings). The rights issue is usually organised by an investment bank or other authorised financial institution.*
4. Retained Earnings
Few organisations pay out all of their profits as dividends, and retained profits are the most important source of equity finance. The decision about how much capital to retain is the complement of the dividend decision.
5.Advantages and Disadvantages of Share Capital
Share capital is a low-risk source of finance as there is no legal requirement to pay dividends if profits are insufficient to do so. The higher the portion of share capital in a company's capital structure, the lower its gearing (i.e. less financial risk).
Because share capital is a low-risk source of finance to the company, it is of high risk to shareholders. They will, therefore, expect a higher return in terms of dividends and growth in share price. It is an expensive source of finance. If shareholders do not obtain the return they require, they will sell their shares, which will push down the market price of the company. This may lead to dissatisfaction with the management of the company.
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