Merits & Demerits of Equity Shares

Merits of Equity Shares

The important merits of raising funds through issuing equity shares are as follows:

i)     Equity shares are suitable for those investors who are ready to take risk for higher returns.

ii)    Payment of dividend is not compulsory for equity shareholders. Therefore, there is no burden on the company for payment of dividend to them.

iii)   Equity capital is a permanent capital.  It is repaid only at the time of liquidation of a company. The claims are paid after all settlement.  Therefore, it works as cushion for creditors in case of winding-up of company.

iv)   It provides credit worthiness to the company.  It also provides confidence to prospective loan providers.

v)    Funds may be raised through equity issue without creating any charge on the assets of the company. The assets of a company may not be required to be mortgaged for the purpose of borrowings.

vi)   The voting rights of equity shareholders facilitates democratic control over management of the company.


Demerits of Equity Shares

The demerits of equity shares are as follows :


A) To the Shareholders

1)    Uncertainty about payment of dividend: The equity share-holders get dividend only when the company is earning sufficient profits and the Board of Directors declare dividend. In  case of  preference shareholders, equity shareholders get dividend only after payment of dividend to the preference shareholders.


2)    Speculative: There may be speculation on the prices of equity shares. This may happen at the time of boom when company pays high dividend.


3)    Danger of over–capitalisation: If the management is not able to predict long-term financial requirements, it may raise more funds than required by issuing shares. This may lead to over-capitalisation. The over-capitalisation results into low value of shares in the stock market.


4)    Ownership in name only: The holder of equity shares becomes the owner of the company. They have got  voting rights. They manage and control the company. This may be true theoretically. In fact,  few persons may control the voting rights and thus, they may manage the company. Board of Directors take the decision to declare dividends.


5)    Higher Risk: Equity shareholders take high degree of risk. In case of losses,  they do not get dividend. In case of winding-up of a company, they are the last persons to get refund of the money which they have invested. Equity shares actually swim and sink with the company.


B) To the Management

1)    No trading on equity: It refers to the ability of a company to raise funds through preference shares, debentures and bank loans,  etc. The company has to make payment at a fixed rate on the funds. When profits are high, the equity shareholders get a higher rate of return. The major part of the profit earned is paid to the equity shareholders. This is done because borrowed funds carry only a fixed rate of interest. The company may get advantage of trading on equity if  a company has only equity shares and does not have either preference shares, debentures or loans.


2)    Conflict of interests: You are aware that the equity shareholders carry voting rights. Therefore, the groups are formed to corner the votes. Such groups grab the control of the company.  The conflict of interests may develop which may be  harmful for the smooth functioning of a company.

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