A business needs money for its operations. There are two ways in which it procures capital: debt and equity. Debt capital is the money that the company gets from its creditors as a loan agreeing to pay them assured sums as interest at periodic intervals. The other form of procuring capital is equity capital. The company issues shares to these investors for the sum that they invest. Two types of shares are issued: equity shares (common stock) and preference shares. Venturesome investors buy equity shares, and risk-averse ones buy preference shares.
An equity share is a financial instrument that accords to its owner ownership rights in the company. The owner also has a claim on the profits of the company and on its assets. The claim on the assets arises in the event of the liquidation of the company. Equity shareholders have voting rights in the company. After discharging all financial obligations such as payments of interest, tax, depreciation and payments to the preference shareholders, the company lets the equity shareholders distribute the remaining profits.
The price of the equity shares is determined by the financial standing of the company, its progress, its strategies for growth and on the general trends of the stock market. Risk taking and venturesome individuals invest in common stock. Equity shares can be bought through many outlets, such as stock brokers, online stock brokers and trading accounts, the stock markets and banks.
The ownership in the company is determined by the number of equity shares a particular shareholder has in relation to the total number of shares that the company has issued. An individual who has 100 equity shares out of a total issued 10,000 shares has ownership rights to the extent of 1 percent. His voting rights are to the level of 1 percent.
Equity shareholders are the owners of the company. Though the creditors and preference shareholders invest a lot of cash in the company, they have no say in the conduct of the business. Often, the equity shareholders steer the direction in which the company progresses and expands. Also, the earnings of the equity shareholders are high when the company makes exceptional profits. The creditors of the company are paid interest income whether or not the company makes profits. The preference shareholders are paid dividends whenever the company makes profits. Both these investors are paid at a preset rate, irrespective of the volume of profits.
The equity shareholders have to face huge risks. Even when the company makes profits, they are always paid last. The payments to the creditors and preference shareholders get priority over the payments to the equity shareholders. Therefore the amount that remains to be shared goes down.