UNIT- 2

CAPITAL 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 They are entitled to dividend as a
payment of dividend to preference preferential right before dividend is
shareholders. paid to equity shareholders.
2. They have preferential rights over the
Their capital is repaid to them only after
equity shares in the matter of
repayment of capital to preference
repayment of capital in the event of
shareholders.
liquidation.
3. The dividend is paid out of profits as
recommended by the board and approved They are paid to them at a fixed rate
by the members in the annual general subject to profits.
meeting.
4. In case of cumulative preference
Dividends payable to equity shares are non-
shares the arrears of dividends are
cumulative only.
cumulative until it is paid.
5. They cannot be redeemed except:
They may be redeemed by the
• As reduction of capital u/s 100 with
company over a period of time u/s
court approval
80. Irredeemable preference shares
• Buy back of shares u/s 77(a)
are not supposed to be issued.
6. Their voting rights are
They are entitled to voting right on restricted and arise only in
every resolution placed before the certain specified circumstances
general meeting. or matters affecting their
interests.
7. They are entitled to right/bonus shares They are not entitled to any
when declared by the company. right/bonus shares.
8. Though equity shareholders do not enjoy
preferential rights, they are more preferred
by the investing public because the listed Preference shares are illiquid.
equity shares enjoy more liquidity in the
stock market.
9. As the rate of dividend on preference
In case of equity the market value
shares is fixed or stable, the market
fluctuates as the dividend rates are not
value of preference shares remain
stable.
more or less stable.
10. As there is steady dividend like rent
There is a lot of risk in equity shares so it is
preference share capital is
considered as risk capital.
considered as rentier capital.
11. Preference shares appeal
Equity share capital to the
to the cautious investors
adventurous investors who are
who want to take up less
prepared to assume risk.
risk.
12. Preference shares except
The equity shareholders can participating preference shares
participate in the surplus profits and cannot participate in the
in surplus assets in case of winding surplus profits and in surplus
up of a company. assets in case of winding up of
a company.
13. The equity shareholders have much Preference shareholders have
control over the management of the no much control over the
company. management of the firm.
14. Preference shareholders are
Equity shareholders are the real
not the real owners of the
owners of the company.
company.
15. Equity shares provide only long term Preference shares provide both
capital. long and medium term capital.
16. Preference shareholders
Equity share holders are
are ready to sacrifice
ready to sacrifice stability but
prosperity but not
not prosperity
stability.
17.
Equity shares can never be Preference shares can be
converted into preference shares converted into equity shares.

18.
Comparatively less risk
Equity shareholders are the
involved from the preference
Primary risk bearers
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 It constitutes a loan
a company
The shareholders are Debenture holders are creditors.
members/owners of the
company
Shares do not carry any charge Debentures generally have a charge
on the assets of the company. on the assets of the company.
Shareholders are entitled to get Debenture holders are entitled to get
dividend interest.
The dividend varies from year The rate of interest is fixed.
to year depending upon the
profit of the company and the
Board of Directors discretion.
Shareholders enjoy voting Debenture holders do not have any
rights. voting rights.
Dividend can be paid to Interest is payable even if there
shareholders only out of the are no profits i.e., even out of
profits of the company. capital.
Dividend paid cannot be Interest paid on debentures is
claimed as allowable allowable as business expenditure for
expenditure. the purpose of income tax.
Shares may be fully paid or Debentures are always fully paid.
partly paid.
Share capital is not refunded or Debentures are repaid after a certain
repaid during the existence of period.
the company except preference
shares.
When the company is wound up Claims of debenture holders will be
the claims of shareholders will considered first in the order of
be secondary. payment.
Share certificates can be issued Debenture certificates can be issued
even before the last call on the only when the last instalment or call
shares is paid. 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.