Financing of Business: Methods of Raising Long Term Finance, Issue of Shares and Equity Shares (For CBSE, ICSE, IAS, NET, NRA 2022)

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Methods of Raising Long Term Finance

You have already learnt about the purpose for which long-term finance is required by the business. In small organisations the long-term finances are generally provided by the owners. But for large organisations like joint stock companies there are various options available to raise the funds. Followings are the most commonly used methods of long-term finance.

Methods of Raising Long Term Finance

Issue of Shares

Share is the smallest unit into which the total capital of the company is divided. For example, when a company decides to raise ₹ 50 crores of capital from the public by issuing shares, then it can divide its capital into units of a definite value, say ₹ 10/- or ₹ 100/- each. these individual units are called as its share. After deciding the value of each share and number of shares to be issued, the company then invites the public to buy the shares. The investing public then buy the shares as per their capabilities. The investors who have purchased the shares or invested money in the shares are called the shareholders. They get dividend as return of their investment. In order to tap the savings of different types of people, a company can issue two types of shares, viz.

  • Equity Shares, and
  • Preference shares.

Equity Shares

Equity shares are shares, which do not enjoy any preferential right in the matter of claim of dividend or repayment of capital. The equity shareholders get dividend only after making the payment of dividends on preference shares. There is no fixed rate of dividend for equity shareholders. The rate of dividend depends upon the surplus profits. In case there are good profits, the company pays dividend to the equity shareholders at a higher rate. Again, in case of winding up of a company, the equity share capital is refunded only after refunding the claims of others. In fact, they are regarded as the owners of the company who exercise their authority through the voting rights they enjoy. The money raised by issuing such shares is known as equity share capital. It is also called as ownership capital or owners՚ fund.

Merits of Equity Shares

Table of Merits of Equity Shares
From Shareholders point of view
  • The equity shareholders are the owners of the company.
  • It is suitable for those who want to take risk for higher return.
  • The value of equity shares goes up in the stock market with the increase in profits of the concern.
  • Equity shares can be easily sold in the stock market.
  • The liability is limited to the nominal value of shares.
  • Equity shareholders have a say in the management of a company as they are conferred voting rights.
From Management Point of View
From Management point of view
  • A company can raise capital by issuing equity shares without creating any charge on its fixed asset
  • The capital raised by issuing equity shares is not required to be paid back during the lifetime of the company. It will be paid back only when the company is winding up.
  • There is no binding on the company to pay dividend on equity shares. The company may declare dividend only if there are enough profits
  • If a company raises more capital by issuing equity shares, it leads to greater confidence among the creditors.

Limitations of Equity Shares

Table of Limitations of Equity Shares
From Shareholders point of view
  • Equity shareholders get dividend only when the company earns sufficient profits. The decision to declare dividend lies with the Board of Directors of the company.
  • There is high speculation in equity shares. This is particularly so in the time of boom when profitability of the companies is high.
  • Equity shareholders bear a very high degree of risk. In case of losses they do not get dividend, and in case of winding up of a company, they are the last to get the refund of their money invested. Equity shares actually swim and sink with the fate of the company.
Table of from Management Point of View
From Management point of view
  • It requires more formalities and procedural delay to raise funds by issuing equity shares. Also, the cost of raising capital through equity share is more as compared to debt.
  • As the equity shareholders carry voting rights, groups are formed to garner the votes and grab the control of the company. This may lead to conflict of interests, which is harmful for the smooth functioning of a company.

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