Definition: The Equity Capital refers to that portion of the organization’s capital, which is raised in exchange for the share of ownership in the company. These shares are called the equity shares.
The equity shareholders are the owners of the company who have significant control over its management. They enjoy the rewards and bear the risk of ownership. However, their liability is limited to the amount of their capital contributions. The Equity Capital is also called as the share capital or equity financing.
Advantages of Equity Capital
It has several advantages:
- The firm has no obligation to redeem the equity shares since these have no maturity date.
- The equity capital act as a cushion for the lenders, as with more and more equity base, the company can easily raise additional funds on favorable terms. Thus, it increases the creditworthiness of the company.
- The firm is not bound to pay dividends, in case there is a cash deficit. The firm can skip the equity dividends without any legal consequences.
Disadvantages of Equity Capital
There are several disadvantages of raising the finances through the issue of equity shares which are listed below:
- With the more issue of equity shares, the ownership gets diluted along with the control over the management of the company.
- The cost of equity capital is high since the equity shareholders expect a higher rate of return as compared to other investors.
- The cost of issuing equity shares is usually costlier than the issue of other types of securities. Such as underwriting commission, brokerage cost, etc. are high for the equity shares.
- The cost of equity is relatively more, since the dividends are paid out of profit after tax, but the interest payments are tax-deductible.
Note: Number of equity shares to be issued to the shareholders is based on the regulations laid down in the Companies Act and SEBI guidelines.