What is a Share?

The rise and fall of share prices is a part of our daily conversation. When we talk about generating long-term wealth, investing in shares is one of the first things that comes to our mind. You might also be putting your money in shares, if not directly then indirectly. But, have you ever tried to understand the basics of shares? What is this share for which you pay money and hope for an increased return?

Don’t worry if you don’t know those answers. In this write-up, we are telling you all the basic details of a share that you ought to know. Because you put your money and trust in shares you should know what exactly is a share!

Understanding Shares

A share is a unit of equity i.e. ownership of a company. So, being a shareholder means being an owner of that company. Obviously, your ownership rights are limited to the value of the shares you hold.

NOTE: There is difference between a share and stock

Let us understand the concept of equity and share it with an example. Suppose two friends Fredrick and John wish to start a new business and for this, they contribute $100 each. Because they both are contributing equally to the business, they will also share the profits equally. Now, a third friend Lisa wants to be a partner too. Lisa brings $50 for the company. The total capital of the company now rises to $250. If their business is divided into shares Fredrick and John will have 2/5 part (40%) of the shares each and Lisa will have 1/5 part (20%) of the total share according to their capital contribution. Profit and loss of the business will be divided among them in the 2:2:1 ratio.

This is a very simple example just to make you understand the entire concept in easy terms. You may not go and meet the founders of a company directly, as Lisa did in the above example. However, buying shares has the same impact. When you buy shares of a company you become the owner of that much part of the company. You’ll share profits and losses of the company in that proportion too.

Why Do Companies Issue Share?

A share is directly related to ownership rights. You might wonder why do companies offer shares to the general public. Let us explain this in easy-to-understand language.

See as the size of a business grows it requires more and more capital. The current owners have two options –

• Take a loan by using instruments like a debenture certificate
• Take capital from new shareholders

If a company chooses the first option and takes debt, they are bound to repay that loan within a specified period and also give interest thereupon. On the other hand, a company choosing the second option can take money from the general public without any obligation to pay interest or repay the amount. They only have the obligation to share profit, if it happens. Those who buy shares consent to bearing losses and sharing the profit. Further, the shares issued by any publicly listed company are of such small denomination that the retail holders hardly gain any practical control or rights over the company. So, issuing shares is practically a win-win strategy for any listed company. However, they also take debts as and when needed.

What are the Types of Shares?

Shares are basically of two types – Equity Shares and Preference Shares.

Let’s understand both these classes of shares briefly.

1. Equity Shares – When we talk about shares, in general, we talk about equity shares, unless stated otherwise. This is the reason they are also called ordinary shares or common shares. These are the shares that carry all rights and responsibilities of an owner of the company.
2. Preference Shares – Preference shares slightly differ from equity shares in terms of rights and responsibilities. A preference shareholder gets preference over equity shareholders in case of liquidation of the company. They also receive dividends before equity shareholders. These are a safer investment but they have lesser rights in the company as an owner. Their voting rights are limited as compared to equity shares.

[Note: When we mention share or stock or shareholder we are referring to equity shares and not preference shares.]

The Rights You Gets as a Shareholder

As discussed earlier, shareholders are owners of the company. So, they must have certain rights. If you hold shares of any company you need to be aware of your rights including –

• Entitlement to Profit – When shareholders are owners, they naturally get entitlement to the profits of the company. This profit is declared and distributed to shareholders as dividends. The management of the company has the right to decide whether the earned profit should be reinvested in the business or distributed to the owners. Normally, some portion is reinvested and some portion is declared a dividend. Once the decision to distribute certain profits as dividends is made, shareholders are entitled to get a dividend in proportion to their equity.
• Voting Power on Major Issues – Whenever a company has to take major decisions like electing directors, a merger of the company, etc. shareholders have the right to vote. They can join AGM or can even mail their votes. Today lots of companies have started the facility of e-voting.
• Right to Transfer Ownership – If you are a shareholder you do not need to take permission for transferring your ownership to someone else. It is this right that enables trading on a stock exchange. Only the people who are allotted shares during initial public offering (IPO) get those shares directly from the company. After that, all the transaction in the stock market is simply a transfer of ownership where an existing shareholder sells their holding to someone else.
• Right to be informed about the company’s financial health – The management of the company is given the duty to take care of the operation of the business. But, they are still accountable to the owners of the business. Being a shareholder you are entitled to get information related to the operation and financial health of the company. If you wish you can also inspect the basic books of the company. That’s your right.