Ordinary Shares

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21 Aug, 2024

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Ordinary Shares Definition

Ordinary Shares are the shares issued by the company to raise funds from the public and the private sources for its working, carry voting rights, and are shown under owner’s equity in the liability side of the company's balance sheet.

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 predetermined 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 company's financial health. 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 different shareholders resolutions.

Example - Let’s say an investor holds 10,000 shares in a Company TNG Inc. with 5,00,000 shares outstanding. Thus, he will have 10000/500000 = 2% ownership in the company.

Ordinary Shares Definition

Change in Ordinary Shares

Several 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. Therefore, issuing more shares, the company requires to raise capital can issue several shares in the market.

source: genomeweb.com

#3 - Buyback

Suppose the company has enough cash and does not have resources to deploy. In that case, the capital can buy back the shares from the shareholders at the 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 a stock dividend.

source: business-standard.com

The investors, while analyzing the number of outstanding shares and the change in the number over 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 a crucial way of raising capital. This helps the Company to expand its business without increasing 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
Several outstanding shares are flexible as the company can decide how many ordinary shares 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 fraud or taking risky bets; thus, shareholders can lose the entire capital.
There is no predefined dividend. Sometimes it may take years for the ordinary shareholders to gain significantly from holding the company's ordinary shares.
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 Company's decision using 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.
Its price 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 pre-defined dividend. Instead, it gives ownership of the company to shareholders and assigns the right to vote in the matters of the company with one ordinary share having one vote each.