PRESENTATION ON EQUITY SHARES

SOURCES OF FINANCE
Internal Sources Retained profit, sale of assets, reducing stocks, trade credit External Sources Personal savings, commercial banks, building societies, factoring services, share issue, debentures INTERNAL SOURCES OF FINANCE: Definition These are sources of finance that come from the business' assets or activities.

1. Retained Profit If the business had a successful trading year and made a profit after paying all its costs, it could use some of that profit to finance future activities . This can be a very useful source of long term finance, provided the business is generating profit. 1.Reducing Stocks Stock is a type of asset (see balance sheet work for more on assets) and can be sold to raise finance. Stock includes the business' holdings of raw materials (inputs), semi-finished products and also finished products that it has not yet sold.

 Trade Credit a business does not normally pay for things before it takes possession of them. Instead, it will usually place an order for supplies / inputs and will pay after receiving the items. It is good practice to pay quickly (often within one month) as this will help the business develop a good relationship with its suppliers.

SHARE

DEFINITION A share represents a participation in the capital of a company. A shareholder is in theory a partner in the company. It gives him the rights, proportionally to his holdings, to participate in the management of the company, to receive the profits and to dispose of the net assets of the company.

 Types of shares A company may have many different types of shares that come with different conditions and rights. There are four main types of shares: Ordinary Shares: These shares are standard shares with no special rights or restrictions. They have the potential to give the highest financial gains, but also have the highest risk. Ordinary shareholders are the last to be paid if the company is wound up. Preference shares: These shares typically carry a right that gives the holder preferential treatment when annual dividends are distributed to shareholders. Shares in this category have a fixed value, which means that a shareholder would not benefit from an increase in the business' profits. However,

 usually they have rights to their dividend ahead of ordinary shareholders if the business is in trouble. Cumulative preference shares: These shares give holders the right that, if a dividend cannot be paid one year, it will be carried forward to successive years. Dividends on cumulative preferred shares must be paid, despite the earning levels of the business. Redeemable shares: These shares come with an agreement that the company can buy them back at a future date - this can be at a fixed date or at the choice of the business. A company cannot issue only redeemable shares.

EQUITY Introduction What is equity? Equity is the term commonly used to describe the ordinary share capital of a business. Ordinary shares in the equity capital of a business entitle the holders to all distributed profits after the holders of debentures and preference shares have been paid.

Ordinary ( equity) shares Ordinary shares are issued to the owners of a company. The market value of a company's shares is determined by the price another investor is prepared to pay for them. In the case of publicly-quoted companies, this is reflected in the market value of the ordinary shares traded on the stock exchange (the "share price"). In the case of privately-owned companies, where there is unlikely to be much trading in shares, market value is often determined when the business is sold or when a minority shareholding is valued for taxation purposes. These SHARES are a form of ordinary shares, which are entitled to a dividend only after a certain date or only if profits rise above a certain

 amount. Voting rights might also differ from those attached to other ordinary shares. Why might a company issue ordinary shares? A new issue of shares might be made for several reasons: (1) The company might want to raise more cash For example might be needed for the expansion of a company's operations. If, for example, a company with 500,000 ordinary shares in issue decides to issue 125,000 new shares to raise cash, should it offer the new shares to existing shareholders, or should it sell them to new shareholders instead? - Where a company sells the new shares to existing shareholders in proportion to their existing shareholding in the company, this is known as a RIGHT ISSUE.

 (2) The company might want to issue new shares partly to raise cash but more importantly to 'float' its shares on a stock market. When a UK company is floated, it must make available a minimum proportion of its shares to the general investing public. (3) The company might issue new shares to the shareholders of another company, in order to take it over There are many examples of businesses that use their high share price as a way of making an offer for other businesses. The shareholders of the target business being acquired received shares in the buying business and perhaps also some cash.

 Sources of equity finance There are three main methods of raising equity: (1) Retained profits: That is retaining profits, rather than paying them out as dividends. This is the most important source of equity. (2) Rights issues: That is an issue of new shares. After retained profits, rights issues are the next most important source. (3) New issues of shares to the public: That is an issue of new shares to new shareholders. In total in the UK, this is the least important source of equity finance.

 SHARE HOLDERS VOTING RIGHTS: Equity share holders enjoy the right to elect the board of directors of the company. There are 2 systems of voting may be followed for this purpose Majority rule voting proportionate rule voting 1.Majority rule voting: This system is commonly used in India. Under this system of voting , Each share carries one vote and each director position is filled individually.

 This means that if a shareholder owns 100 equity shares of a company which has 7 director positions, he has 100 votes for each of the 7 director positions. Thus, he is entitled to cast 100 votes when position 1 is being filled up, 100 votes when position 2 is being filled up, 100 votes when position is being filled up, so on and so forth. From the above recital it is clear that a group which has more than 50 percent of outstanding equity shares can ensure that each director position is filled by a candidate of its choice. In practice of course this can often be ensured with a much smaller equity holding, say between 20 and 30 percent , because the remaining equity shareholders usually do not participate In voting or fail to exercise their effectively

 2.PROPORTINATE RULE SYSTEM: Under this system of voting the number of votes enjoyed by a shareholder is equal of shares held by him times the number of directors to be elected. For example: If a share holders holds 1000 shares and the number of directors to be elected is seven , the shareholders will have 7000 votes .He may spread his votes in any manner he likes.

 DIFFERENCE BETWEEN MAJORITY RULE VOTING AND PROPORTINATE RULE VOTING The principal difference between the majority rule and proportionate rule voting systems is that under the former a majority is able to elect all the members of the board whereas under the later significant minority, if it casts its votes intelligently, is assured of some representation on the board. Is there a way of determining the number of shares needed to guarantee the election of a certain number of directors? Yes, the following formula helps in doing precisely that:

 Number of shares required to elect a certain number of directors= Number of shares outstanding * Number of directors desired to be elected Total number of directors to be elected+1 To illustrate, consider the following information about a company: (i) number of outstanding shares: 1 million, (ii) director positions: 7,and (iii) directors desired to be elected: 2. the number of shares required to guarantee the election of two directors is: 100,000 * 2 +1= 250,001 7+1

 An important source of long-term financing, equity capital offers the following advantages: 1.There is no compulsion to pay dividends. It the firm has insufficiency of cash, it can skip equity dividends without suffering any legall consequences. 2. Equity capital has no maturity date and hence the firm has no obligations to redeem. 3. Because equity capital provides a cushion to lenders, it enhances the creditworthiness of the company. In general, other things being equal, the larger the equity base, the greater the ability of the firm to raise debt finance on favourable terms.

 4. Presently, dividends are tax-exempt in the hands of investors. The company paying equity dividend, however, is required to pay a dividend tax of 10 percent. The disadvantages of raising finances by issuing equity shares are as follows: Sale of equity shares to outsiders dilutes the control of existing owners. The cost of equity capital is high, usually the highest. The rate of return required by equity shareholders is generally higher than the rate of return required by other investors.

 Equity dividends are paid out of profit after tax, whereas interest payments are tax deductible expenses. This makes the relative cost of equity more. Partially offsetting this advantage is the fact that Equity dividends are tax-exempt whereas interest income is taxable in the hands of investors. the cost of issuing equity shares is generally higher than the cost of issuing other types of securities. Underwriting commission, brokerage costs, and other issue expenses are high for equity issues.

RIGHTS OF EQUITY SHARE HOLDERS

Right to Control: Equity shareholders as owners of the firm elect the board of directors and have the right to vote on every resolution placed before the company. The board of directors, in turn selects the management which control the operations of the firm. Hence, equity shareholders in theory, exercise an indirect control over the operations of the firm.

 Pre-emptive Right: The pre-emptive right enables existing equity shareholders to maintain their proportional ownership by purchasing the additional equity shares issued by the firm. The law requires companies to give existing equity share holders the first opportunity to purchase, on prorata, basis, additional issues of equity capital.

 This pre-emptive right ensures that the management cannot issue additional shares to persons or groups who are favorably disposed towards it and there by strengthen its control over the firm. More important, the pre-emptive right protects the existing share holders from the dilution of their financial interest as a result of additional equity issue.

 1.Right to income: The equity investors have a residual claim to the income of the firm. The income left after satisfying the claims of all other investors belongs to the equity share holders. This income is simply equal to profit after tax minus preferred dividend. It may be noted here that equity shareholders are entitled to dividend that is declared by the board of directors. The dividend decision is the prerogative of the board of directors and equity shareholders cannot challenge this decision in a court of law. The income of equity shareholders may be retained by the firm or paid out as dividends

 In this respect the position of equity shareholder differs markedly from that of suppliers of debt capital : Debentures holders, for example, can take legal action against the company for its failure to meet contractual interest payment and principal repayment, irrespective of the financial circumstances of the company. Equity shareholders, on the other hand, cannot challenge the dividend decision of the board of directors in a court of law, however impressive the financial performance of the company may be.

 Right in Liquidation: As in the case of income, equity share holders have a residual claim over the assets of the firm in the event of liquidation. Claims of all othersdebenture holders, secured lenders, unsecured lenders, others creditors, and preferred shareholders- are anything in the event of liquidation because the liquidation value of asset is not adequate to meet fully the claims of others.

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