Ordinary Shares Definition
Ordinary Shares are the shares that are issued by the company for the purpose of raising the funds from the public and the private sources for its working, carries voting rights and is shown under owner’s equity in the liability side of the balance sheet of the company.
It is also called common shares and represents the equity ownership in a company proportionate to the number of ordinary shares with each investor. It does not have a pre-determined dividend i.e. the shareholders of such shares do not receive a mandatory dividend.
It is up to the company to pay the dividend if it seems prudent looking at the financial health of the Company. Each ordinary share represents a vote in the Company which can be used during the Annual General Meeting and other general meetings of the Company for the appointment of Directors, passing of other shareholders resolutions.
Example – Let’s say an investor holds 10,000 shares in a Company TNG Inc. which has 5,00,000 shares outstanding. Thus, he will have 10000/500000 = 2% ownership in the Company.
Change in Ordinary Shares
A number of ordinary shares outstanding with the Company can change over time if the Company chooses to take a corporate action. These corporate actions could be:
#1 – Stock Split
In the case of a stock split, the shares of the Company are broken in some proportion like 1:2, which means every shareholder having a single share will now have 2 shares.
#2 – Reverse Stock Split
In reverse stock splits, 2 or more shares are joined together to form a single share. Issuing more shares, the Company if requires to raise capital can issue a number of shares in the market.
source: genomeweb.com
#3 – Buyback
If the company has enough cash and does not have resources to deploy the capital can buy back the shares from the shareholders at prevalent market price thereby reducing the number of ordinary shares.
#4 – Bonus Shares
The company can issue bonus shares to the shareholders which can be considered as a stock dividend.
source: business-standard.com
The investors while analyzing the number of outstanding shares and the change in the number over a period of time should look for such corporate actions taken by the Company.
Pros
- It has the right to vote. Hence, the investors can elect the board Directors, take decisions on the Company’s affairs
- If the shares are traded on public exchanges, the shareholders can buy/sell the shares in the market with ease
- There are no obligations of the ordinary shareholders
- The ordinary shareholders benefit from capital gains and dividend provided by the Company
- For businesses issuing ordinary shares is an important way of raising capital. This helps the Company to expand its business without raising too much debt. High debt could be risky for the business as the debt holders are to pay back, however, the holders of common shares are not required to be paid back, however, the Company can share the profit with them in kind of dividend
- A number of shares outstanding are flexible as the Company can decide how many ordinary shared it wants to be floated in the market based on the needs. It can issue new ordinary shares, buy back some from the investors, split them, issue bonus shares, etc.
Cons
- Due to volatility in share prices i.e. the prices of ordinary shares, the shareholders can lose money.
- Companies can go bankrupt due to internal frauds or taking risky bets in business thus shareholders can lose the entire capital.
- There is no pre-defined dividend. Some times it may take years for the ordinary shareholders to gain significantly from holding the ordinary shares of the Company.
- In case of liquidation of the Company, ordinary shareholders receive the residual amount left after paying the creditors.
- An equity investor owns a very small proportion of the Company, thus there is hardly any impact on the decision of the Company using the voting rights.
Limitations
- There is limited control of the Company and in decision making.
- There is a limitation to whether the dividend is received or not.
- The price of it can be dependent on both the Company’s performance and external factors.
Conclusion
Ordinary Shares is the equity share capital of the Company which the Company issues to raise capital. They do not have a predefined dividend. It gives ownership of the Company to shareholders and gives the right to vote in the matters of the Company with 1 ordinary share having 1 vote each.
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