In this article we will discuss about the advantages and disadvantages of equity shares.
An equity interest in a company may be said to represent a share of the company’s assets and a share of any profits earned on those assets after other claims have been met. The equity shareholders are the owners of the business; they purchase shares, the money is used by the company to buy assets, the assets are used to earn profits, which belong to the ordinary shareholders.
After satisfying the rights of preference shares, the equity shares shall be entitled to share in the remaining amount of distributable net profits of the company. The dividend on equity shares is not fixed and may vary from year to year depending upon the amount of profits available.
The rate of dividend is recommended by the Board of Directors of the company and declared by shareholders in the Annual General Meeting. Equity shareholders have a right to vote on every resolution placed in the meeting and the voting rights shall be in proportion to the paid-up capital. As a source of long-term finance, ordinary shares carry a number of advantages and disadvantages for a company.
Advantages of Equity Shares:
(a) There are no fixed charges attached to ordinary shares. If a company generates enough earnings it will be able to pay a dividend but there is no legal obligation to pay dividends.
(b) Ordinary shares carry no fixed maturity.
(c) They provide a cushion against losses for creditors, thus the sale of ordinary shares rather than other securities increases the creditworthiness of the firm.
(d) Ordinary shares can often be sold more easily than debentures.
(e) Returns from the sale of ordinary shares in the form of capital gains are subject to capital gains tax rather than corporation tax.
Disadvantages of Equity Shares:
(a) The sale of ordinary shares extend voting rights or control to the additional shareholders who are brought into the company.
(b) More ordinary shares give more people the right to share with the existing owners in the company profits.
(c) The costs of underwriting and distributing new issues of ordinary shares are usually higher than those for underwriting and distributing preference shares or debentures.
(d) If the firm has more equity or less debt than is called for in the optimum capital structure the average cost of capital will be higher than necessary.
(e) Dividends payable to ordinary shareholders are not deductible as an expense for the purpose of corporation tax but debenture interest is deductible.