Author: Jim Riley Last updated: Sunday 23 September, 2012
Introduction to share capital (equity)
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
ordinary shares of UK companies typically have a nominal or 'face' value (usually
something like £1 or 5Op, but shares with a nominal value of 1p, 2p
or 2Sp are not uncommon).
However, it is important to understand that the market value
of a company's shares has little (if any) relationship to their nominal or
face value. 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
In your studies, you may also come across "Deferred
ordinary shares". These 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
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
- Where a company sells the new shares to existing shareholders
in proportion to their existing shareholding in the company, this is known
as a "rights issue".
(2) The company might want to issue new shares
partly to raise cash but more importantly to 'float' its shares on a stock
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: i.e. retaining profits,
rather than paying them out as dividends. This is the most important source
(2) Rights issues: i.e. an issue of new
shares. After retained profits, rights issues are the next most important
(3) New issues of shares to the public: i.e. an issue of new shares to new shareholders. In total in the UK, this
is the least important source of equity finance
Each these sources of equity finance are covered in separate
tutor2u revision notes.
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