In the stock market, an equity share represents a fraction of the company. The equity share may be of different types like common stock (ordinary share), preferred stock, bonus share, right issues etc. Companies issue these shares to raise money from the investors.
When we talk about equity share in the market we mostly talk about common stocks, companies issue them through an IPO. These shares trade publicly in the stock market and are transferable from one person to another. Bonus shares and right issues are also common stocks that companies issue at different times than IPO. The owners of these shares are called the shareholders.
Shareholders are the real owners of a company. Private companies are owned by private shareholders and their shares do not trade openly on stock exchanges. While public companies are owned by common shareholders. Anyone can buy shares of a public company.
As common shareholders are the real owners of the public company hence they take maximum liability in case of the company goes bankrupt. In the liquidation process of a company, common shareholders will get the last claim on the assets. Creditors of the company have the first right on assets because the company owe its creditors. The second claim will be of preferential shareholders.
In most cases, common investors will not get anything when the company goes bankrupt because they are the owners of the business so they have to bear maximum losses. But in the case of the company doing great in business, the equity shareholders will reap the maximum rewards in the form of share’s value appreciation and dividends. The shareholders invest their money to get a return in the form of a share’s price appreciation, dividend or bonus share.
These two similar terms have different meanings in finance. Equity is simply the net worth of a firm. It is calculated by total assets minus the total liability. For example, if a firm has $5 million of assets and it has $2 million in debt then its total equity will be $3 million. The equity may also be called shareholders/stockholders/owners equity. It can be of both of a corporation as well as of an individual.
On the other hand, equity shares are a fraction of the total equity. It only represents the part of the total net worth of the firm.
Equity shareholders get voting rights which they use for selecting the board of directors and for deciding merger and acquisition of the firm and in several other important decision makings. Voting rights are mostly one vote per share. Any investor owning a bigger stake in a company can play a vital role in the firm’s decision making.
This is the reason why big institutional investors want a controlling stake in any company they invest in. With a bigger stake in the corporation, institutional investors enjoy the decision making power within it. Using this power they can take decisions to make the company more profitable and grow their invested capital. However only common stocks come with voting rights, preferred stocks do not have voting rights in most cases.
The liability of equity shareholders is limited to their investments only. An investor can not lose more money than he has invested in the company.
In case of firm loses its value, the creditors can not recover their loans from the owners of the firm’s equity shares.
The supply and demand of the equity share at the stock exchange determine its price.
Any company doing great in business will earn more profit and more investors will try to buy its shares this will lead to higher demand, leading to higher price of the company’s equity shares.
Similarly, any company making losses will lose investors interest, thus demand for its shares will decrease leading to a drop in its prices.
Equity shares can be transferred from one person to another similar to any other asset. The legal owner of the shares can sell or transfer them to others.
There is no penalty or any rule that prohibit the transfer of shares. For transferring equity shares you do not need to sell them either. You can easily transfer them similar to any other asset. This transfer however can be taxable for the donor and receiver.
Shareholders also can choose a nominee same as in the case of other assets.
Companies share profit with their investors in the form of a dividend. But common investors are not guaranteed the dividend. Several big companies do not pay dividends to their common investors. They rather hold the capital to finance their expansion and growth.
However, if companies decide to pay dividends to their investors, common shareholders get dividends after preferential shareholders.
Dividends are non-taxable for investors as companies pay tax on dividend payments. Tax paid by a company on its dividend distribution is one of the main reasons why companies avoid paying dividends.