What is a Share?
Let’s understand with help of an example.
Assume I have a friend Ravi, a frustrated software engineer. He wants to start something on his own and decided to start a hotel business. Let’s assume that he estimated that around Rs10Lakh is needed to start a hotel.
But he has only Rs 6 lakh with him. Now, he can arrange remaining 4lakhs by taking loan from bank. But taking loan will have its demerits. He has to pay interest. Also, if the business doesn’t do well and if he fails to pay EMI, bank will auction his belongings. He does not want to get into all these.
He approaches me and says, “Hey look, give me 4Lakh and I will make you 40% partner in my business. If I make Rs1lakh per month, I will share Rs40,000 to you”. Because he is my best friend and I have belief in him, I decided to invest Rs4lakh in the business.
But instead of word of mouth undertaking, we decided to form a Company and registered it as “ABC Private Limited”. Please pay attention to word “Private”.
Valuation of the Company
Now, at present the ABC company is valued at Rs10lakh as we have not started the operation yet.
We now divide this value into 10,000 small parts. Hence, value of each part will be Rs10lakh/10,000 = Rs100
Each part divided like this is called a *Share* and price of each share is Rs100. The value of share arrived like this initially is called *Face Value*. Please remember this term Face Value and we will use it often in future.
So, Ravi now will have 6000 Shares and I will have 4000 shares making me 40% owner of ABC.
Benefits of Share
Assume you own 3BHK house in your city and one room in the house is no longer used because your kids have grown up moved away.
Now you can not sell only one room to somebody, right? Or if you need some money urgently, you can not take loan only on that room. You need to pledge your entire house to borrow even a small amount.
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But If we have 10,000 shares of ABC company, each of Rs100 (Yesterday’s example) then it becomes very easy to borrow money from others.
If we need Rs1lakh, all we need to do now is to sell 1000 shares to someone, we don’t have to sell entire company.
Remember, by doing so, we are making that third person 10% owner of the company since he now owns 1000 shares. So, in nutshell, shares allow us flexibility which would have not possible if Ravi and me just had 60:40 agreement.