Many people buy and sell shares of companies. It is a kind of investment by the consumers. But what does it mean for a company? A simple answer is that a company issues shares to earn some capital, known as share capital. However, it is not as simple as this. The Companies Act lays down different share capitals and guidelines on dealing with the shares. This article will try to explain the concept of shares and share capital.

What are shares and share capital?

A share has been defined under section 2(84) of the Companies Act, 2013, as “share” means a share in the share capital of a company and includes stock.” It simply refers to the capital of the company comprising numerous individual units with specific amounts, collectively known as a company’s share capital.

Most companies are registered with a share capital than without it. But what exactly is share capital? It basically refers to the total cash the corporation received from selling shares. A company may raise share capital by issuing common or preferred stock. A company’s share capital or equity financing may alter over time with public offerings. The share capital was described in the case of In Re: S.N.D.P. Yogam v. Unknown by the Kerala High Court. In order to support the point that the terms “capital” and “share capital” are interchangeable, the court cited Buckley on The Companies Acts and Palmer’s Company Law. In order for a corporation to have a share capital, its memorandum must specify the quantity and its division. Even if the issuance of shares represents the payment, share capital is distinct from the membership fee. The sum specified in the memorandum becomes the company’s authorised capital; from that, the whole or a part can be issued as shares.

Thus, shares play an important role in raising money to acquire movable and immovable property to run the business, which helps in the growth and development of the company’s business.

What are the types of Share Capital?

The Companies Act permits only two kinds of share capital. They are a) Equity share capital and b) Preference share capital. Equity share capital or ordinary share capital can further be divided into (i) with voting rights; or (ii) with differential rights as to dividend, voting as otherwise in accordance with such rules and subject to such conditions as may be prescribed. While Preference Share Capital is further divided into cumulative and non– cumulative preference shares, participating and non– participating preference shares, and redeemable and non– redeemable preference shares.

Equity Share Capital

Equity shares, when referring to a company, are those that come with voting power but no preferential rights. In accordance with Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014, a business may issue sweat equity shares with differing dividends and voting rights. Some of the conditions are:

• Such shares should be issued in accordance with the articles.
• A regular resolution adopted by the shareholders’ general meeting must authorise the issuance of such shares.
• The shares may not represent more than 26% of the total paid-up equity share capital after the issuance.
• Over the past three years, the company has consistently generated distributable profits.
• The company did not miss a deadline for submitting its annual reports and financial statements during the previous year.
• The company has not missed a dividend payment as of redemption.
• Neither the company’s loan repayment nor the payment of dividends on preferred shares has fallen behind schedule.  
• The company has not been convicted of breaking any laws and punished.
• The company may not convert equity share capital that now has voting rights into equity share capital with differential voting rights and vice versa.

Preference Share Capital

Preference share capital is the portion of a company’s share capital that satisfies both of the following criteria:

a) A preferential dividend must be guaranteed for the duration of the company. The amount payable as a preferential dividend may be computed at a defined rate, for instance, 5% of the nominal value of each share, or it may consist of a fixed sum (for example, Rs 50,000 over the course of a year) paid to preference shareholders before anything is paid to the regular shareholders.

b) The sum paid upon the preference shares must be repaid before anything is paid to the regular shareholders on the company’s dissolution. This is known as a preferential right to be paid. Unless otherwise specified, this preference only applies to the amount paid up or presumed to have been paid up on the shares.

Cumulative and Non-Cumulative Preference Shares

The preference shares are said to as cumulative if there are no profits in a given year and the arrears of dividends are to be carried forward and paid out of the earnings of succeeding years. However, the shares are non-cumulative preference shares if an unpaid dividend expires. The terms of the issue and clauses in the company’s articles will determine whether they belong to one category or the other. However, preference shares are assumed to be cumulative in the absence of any explicit language to the contrary. In this sense, Foster v. Coles, Foster & Sons Ltd. is a well-known case. In that case, the article of the company was revised to delete the word “cumulative” with an intent to change the preference shares into non-cumulative shares. However, unless the articles made it explicitly plain otherwise, they were assumed to represent cumulative preference shares. Hence, preference shares are cumulative and otherwise expressly provided for non-cumulative shares.

Participating and Non– Participating Preference Shares

There may be surplus profits that are thought to be dispersed among the shareholders after the specified amount of dividend has been paid to the preference shareholders, and some amount has been given to the regular shareholders by way of dividends. The issue is whether the preference owners have an equal right to share in the excess distribution. Again, suppose a firm is wound up. In that case, the question of whether preference owners are also entitled to a share in the distribution of the surplus will arise after paying back both the preference and ordinary shareholders. If so, they will be referred to as participating preference shares. Preference Shares are generally assumed to be non-participating. Unless there is a specific clause in the memorandum, the terms of issue, or the articles giving the holders of such shares the right to participation, they are not entitled to any share in the distribution of any such surplus. According to Scottish Insurance Corpn Ltd v. Wilsons & Clyde Coal Co Ltd, preference shares are assumed to be non-participating if the right to join in the excess is not expressly stated in the conditions of the issue.

Redeemable and Non– Redeemable Preference Shares

In accordance with Section 55, a firm may issue redeemable preference shares. However, the company’s articles of incorporation must contain the ability to issue such shares. The company has the option of redeeming the shares, therefore, it is up to the company whether to reimburse the holders of such shares. Paying back is referred to as redemption. No company limited by shares may issue a preference share that is irredeemable after 20 years, according to Section 55(1). Companies are allowed to offer preference shares for infrastructure projects for a duration longer than 20 years. A predetermined portion of these shares may be redeemed annually at the option of preference owners.

Principal Differences Between an Ordinary Shareholder and a Preference Shareholder

1. An ordinary shareholder has a vote on every issue that the corporation faces. Relating to preference share capital, a preference shareholder’s ability to cast a vote is only permitted on matters that directly affect the rights linked to his preference shares except when the dividend has remained unpaid, in which case he may vote on any resolution.
2. Preference shares provide a lucrative and secure investment option. Even if the set rate of income is guaranteed, there is significantly less risk than there would be for an ordinary shareholder.
3. Regarding redeemable and non- redeemable shares, ordinary shareholders cannot be paid back unless through a plan involving capital reduction, though the corporation may decide to do so. However, preference shares are more like debentures, which earn a fixed rate of interest and are, thus, entitled to a fixed rate of dividend.

Conclusion

Share Capital is crucial for a company as well as the investors. Hence, it becomes immensely important for the company to know the nitty-gritty of the concept of shares to get the maximum benefit out of them and comply with the Companies Act to avoid legal battles. Investors also need to be cautious before investing in shares and should look into the kind of shares so that they know the rights they are entitled to.

References

1. Companies Act, 2013.
2. Company Law book by Avtar Singh.
3. Company Law book by Rinita Das.
4. In Re: S.N.D.P. Yogam v. Unknown, ILR 1969 Ker 516.
5. Bucha F. Guzdar v. Commissioner of Income Tax, Bombay, 1955 ITRSC 271.
6. Foster v. Coles, Foster & Sons Ltd., (1906) 22 TLR 555.
7. Scottish Insurance Corpn Ltd v. Wilsons & Clyde Coal Co Ltd, 1949 AC 462.
8. Indian Legal Solution, https://indianlegalsolution.com/the-concept-of-share-capital-under-companies-act/ (Last visited on 10^th October 2022).
9. Ipleaders Blog, https://blog.ipleaders.in/shares-and-share-capital-of-the-company/ (Last visited on 10^th October 2022).
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