UNIT- 2CAPITAL OF A COMPANY

Meaning of Capital:

According to Marshall, “Capital consists of all kinds of wealth, other than free gifts of nature, which yield income.” Therefore, every type of wealth other than land which helps in further production of income is called capital.

Types of capital:

Debt capital: It means the money borrowed which must be repaid before certain time period and generates income for the lender of money in the form of interest.

Equity capital: Money given to company to take the ownership of shares of the company is known as equity capital.

Meaning Of Share Capital:

Share capital denotes the amount of capital raised by the issue of shares, by a company. It is collected through the issue of shares and remains with the company till its liquidation.

Share capital is owned capital of the company, since it is the money of the shareholder and the shareholder are the owners of the company

PHASES OF SHARE CAPITAL

Authorized, registered, maximum or nominal capital

. Issued Capital

Subscribed Capital

Called Up Capital

Paid-up Capital

Reserve Capital

MEANING OF SHARES:

The capital of the company can be divided into indivisible units of fixed amount. These units are called shares. Holders of these shares are called shareholders or members of the company.

TYPES OF SHARES:

I. Equity shares: These shares are also known as ordinary shares. They are the shares which do not enjoy any preference regarding payment of dividend and repayment of capital. Equity shares will get dividend and repayment of capital after meeting the claims of preference shareholders.

FEATURES OF EQUITY SHARES:

(i) Right to Income

(ii) Claim on Assets/Liquidation Rights

(iii) Right to Control

(iv)Voting Rights: Each equity share carries one vote. Directors are elected in the annual general

(v) Limited Liability

(vi) Dividend Payments

(vii) Pre-emptive Rights

(viii) Risk/ loss absorption for other investors and other creditors

(IX)permanent in nature.

(x) Equity shareholders are the actual owners of the company and they bear the highest risk.

(xi) Equity shares are transferable,

(xii) Dividend payable to equity shareholders is an appropriation of profit.

(xiii) Uncertain returns

Advantages of equity shares

Advantages to company:

Long-term and Permanent Capital:

No Fixed Burden

Credit worthiness:

Risk Capital

Dividend Policy

Advantages to Investors

More Income/ Potential for Profit

Right to participate in the Control and Management

Capital profits:

An Attraction of Persons having Limited Income

Free Transferability

Share in the Growth

Limited Liability

Disadvantages of equity shares::

Dilution in control:

Trading on equity not possible

Over-capitalization:

No flexibility in capital structure

High cost

Speculation

Disadvantages to investors

Uncertain and Irregular Income

Capital loss During Depression Period

Loss on Liquidation

Different Types of Equity Issues

New Issue:

Bonus Issue

Rights Issue

Sweat Issue

II. Preference shares

These shares are those shares which are given preference as regards to payment of dividend and repayment of capital over the equity shareholders, as in the case of winding up of the company.

Sec. 45 of the Companies Act 2013 defines “preference shares as those shares which carry preferential rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of the company”.

Features of preference shares:

priority over ordinary shareholders not the owners of the company and as such they do not

have voting rights. Preference shareholders cannot interfere in the

management affairs of the company. They have the preference in getting back their capital

first before anything is paid to other classes of shareholders in the event of winding up.

They generally have voting rights only on those resolutions which directly affects their interest.

It is preferred by the cautious investors who do not want to undertake much risk.

DIFFERENCE BETWEEN EQUITY SHARES AND PREFERENCE SHARES :

Sl No. Equity shares Preference shares

1. They are entitled to dividend only after

payment of dividend to preference

shareholders.

They are entitled to dividend as a

preferential right before dividend is

paid to equity shareholders.

2.Their capital is repaid to them only after

repayment of capital to preference

shareholders.

They have preferential rights over the

equity shares in the matter of

repayment of capital in the event of

liquidation.

3. The dividend is paid out of profits as

recommended by the board and approved

by the members in the annual general

meeting.

They are paid to them at a fixed rate

subject to profits.

4.Dividends payable to equity shares are non-

cumulative only.

In case of cumulative preference

shares the arrears of dividends are

cumulative until it is paid.

5. They cannot be redeemed except:

• As reduction of capital u/s 100 with

court approval

• Buy back of shares u/s 77(a)

• On winding up of the company.

They may be redeemed by the

company over a period of time u/s

80. Irredeemable preference shares

are not supposed to be issued.

6.

They are entitled to voting right on

every resolution placed before the

general meeting.

Their voting rights are

restricted and arise only in

certain specified circumstances

or matters affecting their

interests.

7. They are entitled to right/bonus shares

when declared by the company.

They are not entitled to any

right/bonus shares.

8. Though equity shareholders do not enjoy

preferential rights, they are more preferred

by the investing public because the listed

equity shares enjoy more liquidity in the

stock market.

Preference shares are illiquid.

9.In case of equity the market value

fluctuates as the dividend rates are not

stable.

As the rate of dividend on preference

shares is fixed or stable, the market

value of preference shares remain

more or less stable.

10.There is a lot of risk in equity shares so it is

considered as risk capital.

As there is steady dividend like rent

preference share capital is

considered as rentier capital.

11.Equity share capital to the

adventurous investors who are

prepared to assume risk.

Preference shares appeal

to the cautious investors

who want to take up less

risk.

12.

The equity shareholders can

participate in the surplus profits and

in surplus assets in case of winding

up of a company.

Preference shares except

participating preference shares

cannot participate in the

surplus profits and in surplus

assets in case of winding up of

a company.

13. The equity shareholders have much

control over the management of the

company.

Preference shareholders have

no much control over the

management of the firm.

14.Equity shareholders are the real

owners of the company.

Preference shareholders are

not the real owners of the

company.

15. Equity shares provide only long term

capital.

Preference shares provide both

long and medium term capital.

16.Equity share holders are

ready to sacrifice stability but

not prosperity

Preference shareholders

are ready to sacrifice

prosperity but not

stability.

17.Equity shares can never be

converted into preference shares

Preference shares can be

converted into equity shares.

18.

Equity shareholders are the

Primary risk bearers

Comparatively less risk

involved from the preference

shareholder’s point of view.

Different Types of Preference Shares:

i. According to Redeemability

a. Redeemable Preference Shares

b. Irredeemable Preference Shares

ii. According to Right of Receiving Dividend

a. Cumulative Preference Shares

b. Non-cumulative Preference Shares

iii. According to Participation

a. Participating Preference Shares

b. Non-participating Preference Shares

iv. According to Convertibility

a. Convertible Preference Shares

b. Non-convertible Preference Shares

ADVANTAGES OF PREFERENCE SHARES

(A) Advantages from Company point of view

I. Fixed Return

II. No Voting Right

III. Flexibility in Capital Structure

IV. No Burden on Finance

V. No Charge on Assets

VI. No Interference

VII. Appeal to Cautious Investors

VIII. No Obligation for Dividends

IX. Flexibility

(B) Advantages from Investors point of view:

I. Regular Fixed Income

II. Preferential Rights

III. Voting Right for Safety of Interest

IV. Lesser Capital Losses

V. Fair Security

DISADVANTAGES OF PREFERENCE SHARES

(A) Demerits for companies

I. Higher Rate of Dividend

II. Financial Burden

III. Limited Appeal

IV. Low Return

(B) Demerits for Investors

I. No Voting Right

II. Fixed Income

III. No claim over surplus

IV. No Guarantee of Assets

V. Fear of Redemption

VI. Costly Source of Finance

III. Deferred shares: These shares are those shares which are held by the

founders or beginners of the company. They are also called as Founder shares or Management shares or promoter’s shares.

Deferred shares are shares whose right to receive dividend and their right to receive the refund of capital in the event of the winding up of the company is deferred or postponed to the end. In other words, these are the shares which get dividend only after the payment of dividend to preference and equity shareholders.

Companies act prohibits the issue of deferred shares by a public company. However an independent private company which is not a subsidiary of public company can issue deferred shares.

DEBENTURES:

If a company needs funds for extension and development purpose without increasing its share capital, it can borrow from the general public by issuing certificates for a fixed period of time and at a fixed rate of interest. Such a loan certificate is called a debenture

Meaning:

Debenture is an instrument that signifies the acknowledgement of a debt, given under the seal of the company and containing a contract for the repayment of principal sum at a specified date and for the payment of interest (usually half yearly) at affixed rate until the principal sum is repaid and it may or may not give a charge on the assets of the company as security for loan.

Definition:

Section 2(30) of the companies act, 2013 “a debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.”

Features of Debentures:

creditors of the company for the amount mentioned in the acknowledgement

redeemed after a fixed period of time and it is not a permanent capital.

Debentures may be either secured or unsecured. But it will be usually secured.

Interest payable on a debenture is a charge against profit and hence it is tax deductible expenditure.

Debenture holders do not enjoy any voting rights

Interest rate is predetermined. Cost of raising the debentures is lower than the

preference shares and equity shares. - cheap source of finance.

It is a risky capital It is a long term source of funds. Debenture holders will not bear any risk. Debenture

holders are entitled to regular interest even in case of incurrence of loss.

Debenture certificate always bears the seal/stamp of the company. However, when it is signed by 2 or more directors of the company but does not bear the seal is also a valid.

Debentures can be issued by a public company as well as private company. With effect from 1/1/1984, the standard denomination or face value of a debenture should be . 100.

Advantage of Debentures:

Preferred by Investors

Maintenance of Control/ no dilution in control

Reliable Source

Trading on Equity

Interest charged against Profits

Less Costly

Remedy against over capitalisation

Interest on debenture is a tax deductible

Interest on debenture is payable even if there is a loss

Even if company has loss

Disadvantages of Debentures

Permanent Burden

Danger of Liquidation

High Denomination

Loss of Credit worthiness in Stock Market

Costly

Debentures are issued to trade on equity but too much dependence on debentures increases the financial risk of the company

TYPES OF DEBENTURES

On the basis of convertibility:

Convertible debentures

Non-convertible debentures

On the basis of security

Secured/ mortgage debentures

Fixed charge

Floating charge

Unsecured/ ordinary debentures

On the basis of transferability/ registration:

Registered debentures

Bearer debentures/ Unregistered Debentures

On the basis of redeemability

Redeemable debentures

Irredeemable Debenture

Share Certificate: A share certificate is a document issued under the common seal of the company and it states the extent of the interest of its holder in the company's capital. This certificate is usually given free of charge to every member whose name is entered in the register of members.

Share warrant: A share warrant is a bearer document of title to shares and can be issued only by public limited companies and that too against fully paid up shares only. A share warrant cannot be issued by a private company, because the share warrant states that its bearer is entitled to a number of shares mentioned there in

DISTICNTION BETWEEN DEBENTURES AND SHARES:

SHARES DEBENTURES

Shares are part of the capital of

a company

It constitutes a loan

The shareholders are

members/owners of the

company

Debenture holders are creditors.

Shares do not carry any charge

on the assets of the company.

Debentures generally have a charge

on the assets of the company.

Shareholders are entitled to get

dividend

Debenture holders are entitled to get

interest.

The dividend varies from year

to year depending upon the

profit of the company and the

Board of Directors discretion.

The rate of interest is fixed.

Shareholders enjoy voting

rights.

Debenture holders do not have any

voting rights.

Dividend can be paid to

shareholders only out of the

profits of the company.

Interest is payable even if there

are no profits i.e., even out of

capital.

Dividend paid cannot be

claimed as allowable

expenditure.

Interest paid on debentures is

allowable as business expenditure for

the purpose of income tax.

Shares may be fully paid or

partly paid.

Debentures are always fully paid.

Share capital is not refunded or

repaid during the existence of

the company except preference

shares.

Debentures are repaid after a certain

period.

When the company is wound up

the claims of shareholders will

be secondary.

Claims of debenture holders will be

considered first in the order of

payment.

Share certificates can be issued

even before the last call on the

shares is paid.

Debenture certificates can be issued

only when the last instalment or call

is paid.

Shares can be forfeited Debentures are not forfeited.

BOOK BUILDING PROCESS:

Definition: SEBI (disclosure and investor protection) guidelines, 2000 defines book building as “a process by which a demand for the securities proposed to be issues by a body corporate is elicited and built up and the price for such securities is assessed for the determination of quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer documents.

Meaning:

Book building is the process of determining the quantum of shares to be issued and the price at which the shares are to be issued on a feedback from potential investors based upon their perception about the company

STAGES INVOLVED IN BOOK BUILDING PROCESS:

I QUANTITY ASSESSMENT STAGE:

Appointment of lead book runner

Preparation of information memorandum:

Sending the copies of information memorandum to qualified institutional buyers

Collection of information by syndicate members

Determination of quantity of shares to the offered and price band:

II. ISSUE STAGE

Entering into underwriting agreement Appointment of other financial intermediaries Sending application to stock exchange for listing: Preparation of draft red-herring prospectus Informing the registrar of companies Agreement with the depository Appointment of an advertising agency Despatch of application forms Opening the subscription list Receipt of bid-cum application forms Sending the bid forms on the closure of subscription list

III. ALLOTMENT STAGE

Determination of the cut-off price or issue price

Determination of the basis allotment

Crediting the Demat accounts

Listing of shares

Sending of final prospectus

SEBI GUIDELINES FOR THE ISSUE OF SHARES:

advertisement in a leading newspaper is given along with some important extracts of the prospectus, for the information of general public

application form and the prospectus for detailed information.

If a person is satisfied with thee profitability and other things, he fills up the application form and deposits the application money with the prescribed schedules bank.

As per sec 69(3) of companies act 1956, sum equal to atleast 5% of nominal value of shares must be received in cash by the company as application money, but as per SEBI guidelines minimum application money to be paid shall not be less than 25% of issue price.

Minimum number of shares for which application is to be made should be fixed at 500 shares of the face value of . 10 each, in case of public issue at par.

If the issue is at premium amount payable by each applicant shall not be less than . 5000 irrespective of the size of the premium.

Scheduled bank will send the application money along with a list of applicants to the company which will ultimately record this in its application and allotment book.

ubscription list should be kept open for at least 3 working days and disclosed in the prospectus.

After receiving application director takes steps to allot the shares. Directors have discretionary power either to reject or accept partially the application for the purchase of shares.

A public company cannot allot shares unless the following conditions are satisfied:

The minimum subscription stated in prospectus that is (90% of the issued amount) has been received. If not it should refund the amount within 120 days of issue of prospectus and pay interest at 6% per annum for delay by more than 10 days after this period of 120 days.

A prospectus or a statement in lieu of prospectus has been filed with registrar of companies before first allotment.

Application amount which is at least 25% of the issued price has been received.

A new company is defined as one which has not completed 12 months of commercial operations and its audited operative results are not available, and which is set by entrepreneurs without any track record. Such company will be permitted to issue capital to public only at par.

Where a new company is setup by existing companies with a 5 year track record of consistent profit, it will be free to price its issue. The participation of the promoting companies in such company should not be less than 50% of the equity and issue price must be made applicable to all investors uniformly. No private placement of promoters of shares shall be made by solicitation of share contribution from un-related investors through any kind of market intermediaries.

First issue by existing private /closely held companies:

The companies with 3 years of consistent profits are permitted to freely price the issue and list their securities on stock exchange.

Not less than 20% equity should be offered. Draft prospectus should be vetted by SEBI to ensure adequacy

disclosure. Pricing would be determined by the issuer and the lead

manager to the issue and would be subject to specific disclosure requirements including:

Disclosure of the net asset value of the company as per the last audited balance sheet.

Justification for the issue price.

PUBLIC ISSUE:

The eligibility criteria which have to be satisfied by the Unlisted Company to make public issue are as follows:

1. Pre-issue net worth of company should not be less than . 1 crore and it should be maintained for last 3 out of 5 years with minimum networth.

2. The net worth should be met for upcoming 2 years. 3. Tracking of the records of profits has to be maintained for at

least 3 years out of immediately upcoming 5 years. 4. Issue size should not be more than 5 times its pre-issue

networth. 5. In case these requirements are not satisfied then the company

can issue through book-building process, it has to allot at least 60% of issue size to Qualified Institutional Buyers.

Eligibility criteria for a listed company to make public issue:

The eligibility criteria which need to be satisfied by the listed company to make a public issue are as follows:-

1. If the issue size which is a collective combination of offer document, firm allotment, and promoters’ contribution is less than 5 times its pre-issue net worth.

2. The listed company goes through the book building process and allot 60% of the issue size to Qualified Institutional Buyers if issue size is more than or equal to 5 times of pre-issue net worth.

Promoter’s contribution:

In case of an Initial Public Offer (IPO).i., public issue by unlisted company, the promoters have to necessarily offer at least 20% of the post issue capital.

In case of public issue by listed companies, the promoters shall participate either to the extent of 20% of the proposed issue or ensure post-issue shareholding to the extent of 20% of the post issue capital.

GUIDELINES OF SEBI FOR THE ISSUE OF DEBENTURES

1. Issue of debentures should not exceed more than 20% of gross current assets and also loans and advances.

2. Debt-equity ratio in issue of debentures should not exceed 2:1. But this condition will be relaxed for capital intensive projects.

3. Any redemption of debentures will not commence before 7 years since the commencement of the company.

4. For small investors for value such as Rs. 5,000, payments should be made in one instalment.

5. With the consent of SEBI, even non-convertible debentures can be converted into equity.

6. A premium of 5% on the face value is allowed at the time of redemption and in case of non-convertible debentures only.

7. The face value of debenture will be Rs. 100 and it will be listed in one or more stock exchanges in the country.

8. Issue of FCD with a conversion period of more than 36 months: If the FCDs are issued having a conversion period of more than 36 months, it must be made optional with ‘Call’ and ‘Put’ option.

9 Purpose of Issue: Debenture issued by a company for financing or acquiring shareholding of other companies in the same group or providing loan to any company belonging to the same is not permitted. However, it is not applicable to the issue of FCD providing conversion is made within 18 months.

10 Credit Rating: The company must obtain credit rating from CRISIL or any other recognised credit rating agency if conversion of FCDs is made after 18 months or maturity period of NCDs/PCDs exceeds 18 months.

11 Debenture Trustees to be appointed: The name of the Debenture trustees must be stated in the prospectus and the trust deed should be executed within 6 months of the closure of issue. However, the same is not required if the debenture have maturity period of 18 months or less.

12 Predetermination of Premium on Conversion and Conversion Time: The premium of conversion of PCDs/FCDs and time of conversion, if any, must be predetermined which should be stated in the prospectus.

13 Rate of Interest: The rate of interest on Debentures is freely determinable.

14 Conversion Option: If the conversion of debentures is made at or after 18 months from the allotment date but before 36 months, the same must be made optional to the debenture-holders.

15 Disclosure of: Period of Maturity, Amount of Redemption and yield: Amount of redemption, period of maturity and the yield on redemption for NCDs/PCDs must be stated in the prospectus.

16. Discounting on Non-convertible portion of PCD: If the PCDs are traded in the market the rate of discount must be disclosed in the prospectus

17. Creation of Debenture Redemption Reserve (DRR): It is a must (except for debentures whose maturity period is 18 months or less).

18. Creation of Charge: If the company proposes to create a charge for the debentures which are issued for a maturity period of 18 months or less the same must be filed with the Registrar of Companies. If no charge is created, this compliance of the provisions of Deposit Rule should be ensured.

19. Roll over of PCD/NCD: Where the non-convertible portions of PCD/NCD are to be rolled over with or without change in the rate of interest, a compulsory option is to be given to such debenture-holders who either want to withdraw or en-cash from the programme of debenture.

Letter of information relating to roll over is required to be vetted by SEBI with regard to credit rating, resolution of the debenture-holders, option for conversion, and such other items which are prescribed by SEBI. The letter of option, however—for roll over or conversion of debenture, value of which exceeds Rs. 50,00,000, which are issued by a listed company—must be forwarded to SEBI for vetting through a merchant banker/lead manager.

20 Monitoring: The lead institution is required to monitor the progress relating to debentures for modernization, expansion, diversification, normal capital expenditure etc. The lead manager should also monitor if the debentures are issued for working capital purposes.

21 Creation of Security: The security must be created within a period of 6 months from the date of issue and if not created within 12 months the company is liable to pay @ 2% penal interest to debenture-holder. If it is not created even after 18 months, the debenture-holders may call upon a meeting within 21 days to explain the reasons and the date on which these will be created.

The company is also required to file with SEBI, together with a prospectus, a certificate from the bankers that the assets (which are secured) are free from any encumbrance, has been obtained or, if the assets are encumbered, No Objection Certificate has to be obtained from a bank/institution for a record.

22 Certificate from the Auditor: The trustees and the institutional debenture-holders must obtain from the auditors a certificate relating to the utilisation of funds during the period of implementation of projects. Certificate should also be obtained at the end of each accounting year, if the debentures are issued for the purpose of working capital.

23 Other Disclosures: Other disclosures include the existing/future equity and long-term debt ratio, servicing patterns of the existing debentures, payments of interest on term loan, or debenture, etc. together with a certificate from a bank or financial institution that they have no objection for a second charge.