Shares Explained: Equity & Preference Shares | Companies Act 2013

Definition of Share

The term “share” basically means a part or portion. The share capital of a company is divided into a number of equal parts, and each such part is known as a share. For example, if the capital of a company is ₹400,000 divided into 4,000 parts of ₹100 each, each part is called a share.

A share is a unit of ownership that represents an equal proportion of a company’s capital. It entitles the shareholder to a proportionate claim on the company’s profits and also carries a corresponding obligation to bear the company’s losses and liabilities.

A share represents the interest of a shareholder in a definite portion of the company’s capital and establishes a proprietary relationship between the company and the shareholder. Although a shareholder is a proportionate owner of the company, he does not own the company’s assets, as the company is a separate legal entity.

A share is a movable property and constitutes a personal estate. It is capable of being transferred in the manner prescribed by the Articles of Association. Shares may also be mortgaged or pledged. Under the provisions of the Sale of Goods Act, 1930, shares are included in the definition of “goods”.

Every share issued by a company under its common seal specifies the shares held by a member. A share certificate is the prima facie evidence of the title of the member to such shares. However, a share certificate is not a negotiable instrument.

According to Section 2(48) of the Companies Act, 2013, a share means a portion of the share capital of a company.

Characteristics of Shares

1. Movable Property Shares or the interest of a member in a company are considered movable property. They are transferable in accordance with the provisions of the Companies Act and the Articles of Association of the company.
2. Share Certificate A company issues a share certificate under its common seal to every shareholder. The certificate serves as evidence that the shareholder is the owner of a specified number of shares in the company.
3. Registration of Shares The company maintains a Register of Members, in which it records the name, address, number of shares held, and the amount paid by each shareholder.
4. Rights and Interests A shareholder enjoys certain rights and interests, such as the right to receive dividends and vote in meetings. At the same time, the shareholder is subject to certain liabilities, limited to the extent of unpaid amount on the shares held.

Types of Shares

According to the Companies Act, 2013, a company having share capital can issue two types of shares:

1. Preference Shares
2. Equity Shares

1. Preference Shares

Preference shares, also known as preferred stock, are those shares that carry preferential rights with respect to:

• Payment of dividend, and
• Repayment of capital in the event of winding up of the company.

The holders of preference shares are entitled to receive a fixed rate of dividend before any dividend is paid to equity shareholders. Generally, preference shareholders do not have voting rights except in special circumstances.

Conditions of Preference Shares

A preference share must satisfy the following two conditions:

1. It must carry a preferential right to receive dividend at a fixed rate; and
2. In the event of winding up, it must carry a preferential right to the repayment of paid-up capital.

Types of Preference Shares

1. Cumulative and Non-cumulative
2. Convertible and Non-convertible
3. Redeemable and Irredeemable
4. Participating and Non-participating

Features of Preference Shares

1. Claim on income and assets
2. Fixed dividend
3. Cumulative dividend facility
4. Redemption (through sinking fund or call option)
5. Participation feature
6. Convertibility

These are the two dominant characteristics of preference shares. In addition, preference shares may or may not carry the following rights:

1. A preferential right to any arrears of dividend
2. A right to share in surplus profits by way of additional dividend
3. A right to be paid a fixed premium, if specified in the memorandum
4. A right to share in surplus assets on winding up, after repayment of all capital

Advantages of Preference Shares

1. Risk-less leverage
2. Postponement of dividend
3. Fixed and stable income
4. Limited voting rights, ensuring control remains with equity shareholders

Limitations of Preference Shares

1. Dividends are not tax-deductible
2. Obligation to pay dividend, even in low-profit years (if cumulative)

2. Equity Shares

Equity shares, also known as ordinary shares or common stock, are those shares which are not preference shares. They entitle shareholders to share in the profits of the company as and when they arise and to vote at the Annual General Meeting and other meetings of the company.

Equity shareholders are the residual owners of the company. They may receive higher dividends when the company performs well, or no dividend when the company incurs losses.

In the event of winding up, equity shareholders are entitled to the surplus assets remaining after payment of liabilities and preference share capital, unless the Articles of Association provide otherwise.

According to Section 43 of the Companies Act, 2013, all shares of a company which are not preference shares are called equity shares. Equity shares generally constitute the major portion of the company’s share capital. Dividend and return of capital on equity shares are paid only after preference shareholders are satisfied.

Rights of Equity Shareholders

1. Right to vote and participate in management
2. Residual claim on profits and assets
3. They are the real owners of the company

Issuance and Transfer of Shares

This section discusses the issuance and transfer of shares in a company, with emphasis on the legal and procedural requirements prescribed under the Companies Act, 2013.

1. Issuance of Shares

Companies issue shares primarily to raise capital. The Companies Act, 2013 lays down the rules and procedures governing the issue of shares. This process involves:

• Determining the type and class of shares to be issued,
• Making an offer to the public or private investors, and
• Ensuring compliance with statutory and regulatory requirements, including disclosures and approvals.

2. Transfer of Shares

Shareholders generally have the right to transfer their shares, subject to the provisions of the Companies Act, 2013 and the Articles of Association of the company. The transfer may take place:

• Between existing shareholders, or
• In favour of external parties.

The transfer of shares usually requires:

• Execution of a proper instrument of transfer,
• Approval of the Board of Directors, and
• Compliance with prescribed procedures and timelines.

3. Share Register

An important aspect of share management is the maintenance of an up-to-date Register of Members (Share Register). This register records all share-related transactions, including:

• Issue of shares, and
• Transfer of shares.

The share register serves as prima facie evidence of ownership and plays a vital role in determining the rights and obligations of shareholders.

Cumulative and Non-Cumulative Preference Shares

With regard to the payment of dividend, preference shares may be classified as cumulative or non-cumulative.

Cumulative Preference Shares

In the case of cumulative preference shares, if the profits of the company in any year are insufficient to pay the fixed dividend, the unpaid amount (arrears of dividend) accumulates. Such arrears must be paid out of the profits of subsequent years before any dividend is paid to holders of any other class of shares.

Non-Cumulative Preference Shares

In the case of non-cumulative preference shares, the dividend is payable only out of the net profits of the relevant year. If the company does not earn profits in any particular year, the right to dividend for that year lapses and cannot be claimed in subsequent years.

Presumption

Preference shares are presumed to be cumulative unless they are expressly stated to be non-cumulative. Mere ambiguous language in the Articles of Association is not sufficient to make preference shares non-cumulative.

Participating and Non-Participating Preference Shares

Participating Preference Shares

Participating preference shares are those shares which, in addition to a fixed rate of preference dividend, carry the right to participate in the surplus profits of the company along with equity shareholders after they have received their fixed dividend.

Such shares may also carry the right to participate in the surplus assets of the company in the event of winding up. However, these additional rights must be expressly stated in the Memorandum of Association, the Articles of Association, or the terms of issue.

Non-Participating Preference Shares

Non-participating preference shares are entitled only to a fixed rate of dividend and do not share in surplus profits beyond this fixed return. Preference shares are presumed to be non-participating unless participation rights are expressly provided in the Memorandum, Articles, or the terms of issue.

It is important to note that the mere grant of a right to participate in surplus profits does not automatically imply a right to participate in surplus assets on winding up. Such a right must be separately and expressly conferred.

Redeemable Preference Shares

According to Section 55 of the Companies Act, 2013, a company limited by shares, if authorised by its Articles of Association, may issue redeemable preference shares. Such shares may be redeemed either:

1. After a fixed period, or
2. Earlier, at the option of the company, subject to statutory conditions.

In contrast, irredeemable preference shares are those in which the capital is returned only on the winding up of the company. (Under the Companies Act, 2013, the issue of irredeemable preference shares is prohibited.)

Conditions for Redemption of Preference Shares

Redeemable preference shares can be redeemed only subject to the following conditions:

1. Fully Paid Shares Redemption can be made only if the preference shares are fully paid-up.
2. Source of Redemption Redemption must be effected either:
• Out of distributable profits, or
• Out of the proceeds of a fresh issue of shares made specifically for the purpose of redemption.
3. Premium on Redemption Any premium payable on redemption must be paid out of:
• Profits of the company, or
• The Securities Premium Account.
4. Capital Redemption Reserve (CRR) Where shares are redeemed out of distributable profits, a sum equal to the nominal value of the shares redeemed must be transferred to the Capital Redemption Reserve Account (CRR).
• The CRR is treated as paid-up capital of the company.
• The provisions relating to reduction of share capital apply to it.
• The amount credited to CRR cannot be distributed as dividend, but it may be used to issue fully paid bonus shares.

Additional Provisions

1. Redemption of preference shares does not amount to a reduction of authorised share capital.
2. Shares already issued cannot be converted into redeemable preference shares.
3. In case of non-compliance, the company and its officers in default are liable to penalties as prescribed under the Act.
4. The redemption must be notified to the Registrar of Companies within the prescribed time.
5. Where redeemable preference shares are issued, the Balance Sheet must disclose:
• The portion of share capital represented by such shares, and
• The earliest date on which the company is entitled to redeem them.

Conclusion

Shares represent more than mere financial instruments; they symbolize ownership and participation in the success of a company. Equity shares provide shareholders with voting rights and the opportunity to participate in management and profits, while preference shares offer stability through fixed dividends and preferential claims on assets in the event of liquidation.

The Companies Act, 2013 lays a strong legal foundation for shareholder rights and obligations, ensuring a balanced framework for effective corporate governance. Furthermore, recent amendments have modernized the legal structure to meet evolving business requirements, thereby enhancing transparency, accountability, and fairness in the corporate sector.

Frequently Asked Questions (FAQs) on Shares

What is a share? What are the main types of shares a company can issue?

A share is a unit of ownership representing a portion of the share capital of a company, as defined under Section 2(48) of the Companies Act, 2013. A company can issue equity shares and preference shares.

What are equity shares and preference shares?

Equity shares are ordinary shares that carry voting rights and entitle holders to residual profits and assets after all obligations are met. Preference shares carry preferential rights regarding payment of dividend and repayment of capital in the event of winding up.

Do preference shareholders have voting rights?

Generally, preference shareholders do not have voting rights, except in matters directly affecting their rights or when dividends are in arrears.

What is the difference between cumulative and non-cumulative preference shares?

Cumulative preference shares allow unpaid dividends to accumulate, while non-cumulative preference shares do not carry forward unpaid dividends.

What is a share certificate? Are shares transferable?

A share certificate is a document issued by the company as prima facie evidence of ownership of shares held by a shareholder. Yes, shares are movable property and can be transferred in accordance with the Companies Act, 2013 and the Articles of Association.

What is a Register of Members?

It is a statutory register maintained by the company containing details of shareholders and their shareholdings.

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