Equity - Basics

1. Equity - Basic Concept

Equity is one of the asset class in the context of finance. It is an ownership interest in a business.

Consider an example of two friends having equal ownership towards a firm that is running by themselves. In finance term, it can be re-stated as each of the friends has 50% equity or shares in their company or in another words each of the friends has ownership towards 50% of the total asset of their company. 

In reality when company grows and ownership is distributed among many people, valuation is done for total assets of the company and is distributed in units of shares having same denomination. 

Let’s take a case of a company CA and its total equity capital (owner's capital) is ₹A, denomination of each unit of share is ₹S – in this case total no of shares for the company CA will be ₹A/₹S.

Now if we consider absolute value:

₹A = 500000

₹S = 10

Total No. of Shares = N =₹A/₹S = 500000/10 = 50000

Now, if owner Owner-1 has 50 shares on the company CA, it can be said that Owner-1 has 50/50000*100% = 0.1% ownership to that company.

2. Important Factors:

An equity instrument has a factor called Face Value.

Now what is face value? - Face Value or simply Face or Par Value of an equity is the value printed on the share certificate and it is decided when the share is first available to sell.

The issue price of one unit of equity or simply one equity can be more or less than the Face Value of it. When an equity is issued at a higher price than its Face Value it is called as the instrument is issued with Premium on the other hand when an equity is issued at a lesser price that its Face Value, it is called as the instrument issued after Discount.

Usually Face Value of an equity remains unchanged unless modified by the managing board of that company. Face Value modification is thus part of a Corporate Action – details will be taken up later.

Face Value is usually used while calculating the Cash Dividend (one of the Corporate Action) benefit for the shareholder of the company.

3.  Issue of Shares:

Q. Why a company do needs to offer shares?

Ans. Most companies are usually started privately by their promoters. But sometimes the capital funded by promoters and borrowed from banks may not be sufficient for setting up or running the business for a long term. In this situations, companies invite public to invest on them. There are several ways by which companies can raise money from public. One can by borrowing money from public – which can be termed as issuing Fixed Income or Bond instruments. Another way is by distributing company’s shares or ownership to the public.

Primarily shares issues can be classified as following:

• Public
• Rights
• Preferential

The classification of issues can is illustrated below:

• Initial Public Offering (IPO): Is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public.

• Further Public Offering (IPO): Is when an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document.

• Rights Issue: Is when an already listed company offer rights to buy fresh securities to the existing shareholders as on a record date. Price of stocks offered through rights is usually lower than that of the market price of the particular security. The rights are normally offered in a particular ratio to the number of securities held prior to the issue. This route is best suited for companies who would like to raise capital without diluting stake of its existing shareholders. More will be discussed in Corporate Action chapter.

• Preferential Issue: is an issue of shares or of convertible securities by listed companies to a select group of persons. This issue is neither public nor rights. This is a faster way for a company to raise equity capital.

 

© Sumit Bhowmick