1. Share versus stock
  2. Different types of shares
  3. Rights issue of shares
  4. So, what’s the point in doing rights issue?
  5. To reduce the debt: equity ratio
  6. Bonus shares
  7. Employee stock option scheme
  8. Restricted stock unit (RSU)

Share versus stock

  • Suppose the company has issued 1000 shares, worth Rs.10 each
  • You purchased 50 shares of this company. So you have to pay 50 shares x 10 Rs. Each = Rs.500
  • That means you own “50 Shares” of this company and
  • You own “stock of Rs.500” in this company.
  • In short, when we talk about shares we refer to the number of papers held by you.
  • When we talk about stocks, we refer to the money value of those papers held by you.
  • But ultimately, both shares and stocks suggest the same thing: “Equity”.

Different types of shares

  • Normal shares
  • It comes with voting rights. This is what you get from routine IPO>>Share thing
  • Preferential shares
  • Already discussed in the SBI capital infusion article

Still There are some topics related to shares

Rights issue of shares

  • You launch IPO, get funds from the public, and start a company. (Equity)
  • After some years you want some more money to expand the company, so you want to issue additional shares. But under the companies act, you can issue additional shares to the existing shareholders only. This is called “rights issue of shares”
  • Here, you give notice to the existing shareholders, offer them to buy your new-shares, you cannot offer any other “outsider” to purchase the shares.
  • If you do not want “rights issue of shares”, you have to hold a general meeting of shareholders and pass a resolution that “company does not need to offer new shares to the existing shareholders, and these new shares are available for anybody to purchase”

Rights issue of Shares?

Well the direct utility of rights issue= obviously to gather more money to expand your company. ut it is also used for other purpose as well, such as:

To reduce the debt: equity ratio

  • From Debt VS Equity article: There are ‘credit rating agencies’ S&P, CRISIL etc. they give rating to your company’s bonds. AAA,BBB etc.
  • Lower the rating = higher the interest rate you’ve to offer, to seduce the people into buying your bonds. (Recall the Junk Bonds.)
  • But before giving rating to your bonds, the credit rating agency will look into your company’s performance, assets, liability everything. And one of the thing they’re interested in, is “Debt to Equity” Ratio
  • The company with high debt to equity ratio = it has more debt = compulsory interest payment = trouble = lower rating.
  • If such company issues more bonds to gather money, it’ll have trouble; its new bonds will receive even lower credit rating. So, what can they do?
  • Another case: You’re kingfisher. You’re not doing good, nobody is helping you. So you want some foreign investor to come and help you. But he’ll also look into debt:equity ratio before finalizing the terms of deal. What can you do to appear ‘good’ in front of him?
  • Obviously: reduce the Debt to Equity ratio. But how?
  • Simple: offer new equity (shares) to existing shareholders @ a discounted rate. (=Rights issues of shares). You’ve offer it at a discounted rate, else no one would buy it. You’re doing this whole exercise, because you’re in trouble in the first place.

For example: Here is my offer of “Rights issue”:

  • 1:1, Face value Rs.100, @ Discount of Rs.50
  • Meaning, if you already have 10 shares of my company, you can buy 10 more shares from me (1:1), Each of these shares will have “Worth Rs.100” printed on it but I’ll give it to you for Rs.50 only.
  • What good does it do to me? Well in the legal record, for the calculation of Debt Vs Equity =they’ll calculate using Rs.100 face value. Thus my Debt:Equity ratio will go down, and I’ll look good when credit rating agency / FDI investor starts evaluating me.

Bonus shares

  • In the debt versus equity article, you saw that a company can collect money from people by issuing shares (IPO/Equity/Stock whatever you want to call it), but every year, company reports the profit to the board of directors. The board of directors will decide how much profit is to be re-invested in the company and how much profit is to be shared with the shareholders.
  • The profit, thus shared with the shareholders is called “dividend”. Generally dividend is sent to the shareholders via cheques.
  • But sometimes,company also gives you extra shares.
  • It means company paid the money to purchase shares on your behalf and gives it to you. So you got free shares and next year when company distributes the dividends (cash), you will get more dividend, because now you are holding more shares. Alternatively, you can sell away these bonus shares to someone else and take out the money.
  • These are called “bonus shares”
  • What is the difference between Bonus shares and “rights issues”
  • Well, as a shareholder, you get shares for free under “bonus shares”.
  • But you’ll have to pay money for buying new shares under “rights issue”

Employee stock option scheme

  • Here the company issues shares its employee at a discount price.
  • This is done to make the employees committed to the success of company because if the company makes more profit, they can walk away with higher dividends.
  • Such shares have minimum lock in period: for example if your boss gives it today, you cannot sell it for one or two years.

Restricted stock unit (RSU)

  • This is also a form of Employee Stock Option but here the company promises to deliver shares to its employee in future date.
  • For example, Apple’s new CEO Tim Cook: he’ll get $900,000 of cash salary and a $377 million in RSU.
  • Apple will deliver him 500,000 shares of Apple stock in 2016, and 500,000 more shares in 2021 — as long as he stays employed at the company.