Additionally, raising funds through equity also provides the business the flexibility of undertaking future investments through debt from banks and FIs. This is because these institutions view the high proportion of equity favourably as the investors in equity (being owners) only have a residual claim on the assets of the business after meeting the claims of lenders (in the event of bankruptcy).

However, in return such equity holders (especially large investors or institutions) may seek a greater say in the management through nominees on the Board of Directors. Further, the returns to the equity holders would arise in the form of dividend (out of the distributable profits) and capital gain through enhanced value of their investment due to the current performance and future prospects of the business. Thus, investors in equity are willing to be subject to higher levels of risk in return for prospects of high level of returns.

The main characteristics of an equity instrument is thus as follows:

• Can be floated at face value or at a premium based on the valuation of the company and the portion of the equity offered for investment
• No guarantee of fixed returns to the investors
• Carries residual claim on the assets of the firm in the event of bankruptcy
• Limited liability for the investor or promoter to the extent of his investment. (for businesses incorporated as a limited company under the Companies Act).
• High risk, return characteristics

Types of Equity Instruments

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