What is Junior Equity?
Every business requires funds which can be procured either through debt or equity. Debt always comes with an obligation to repay. However, equity represents ownership of shares in a company and also the amount that would be returned to the shareholders if the company is liquidated. There are various levels of equity ownership. Here is a detailed analysis of the class of equity that is the last to receive certain payouts or reimbursements in case of bankruptcy - junior equity.
Junior equity
Junior Equity is a category of shares in a company subordinate to the other categories. Every business has risks and rewards associated with it. Junior equity holders bear the most risk.
Junior equity holders are at the bottom of the priority ladder to receive dividends or profit shares. If the company is not making sufficient profits or the management decides to plough back profits into the business, junior equity shareholders do not receive any dividend. In other words, the dividend fluctuates. For preference shareholders, on the other hand, the dividend rate is fixed, which they receive before any amount is paid to the equity holders.
In case of liquidation of a company as well, junior equity shareholders are the last in line to receive their share of payouts. The company’s assets will most likely be exhausted by the time they reach the junior equity holders. This implies that they may not be able to receive anything at all. Before making any payment to the junior equity shareholders, wages of workmen, taxes/ penalties owed to the government, amounts due to secured and unsecured creditors, and preferred stockholders are all to be settled.
Advantages of junior equity
Junior equity holders rank the lowest in the pecking order. What makes someone invest in junior equity then where there is a considerable possibility of no returns? For the high risk involved, the junior equity provides an equally substantial return. The junior equity shares come with voting rights where junior equity holders get to participate in the company’s decision-making.
Capital appreciation is also another advantage of being a junior equity shareholder. The price of junior stock appreciates as the company’s performance improves. Compare this to the price of preference shares. Due to the fixed rate of dividend attached, they tend not to move farther from their actual issue price.
To sum up, the advantage is two-fold - Capital Appreciation and Voting Rights.
An example of junior equity
Company X is in the process of liquidation. Its losses have been mounting for the past three years now. The primary sources of funds for Company X are -
| Particulars | Amount in INR |
|---|---|
| Junior equity share capital (5 lac shares of INR 1 each) | 5,00,000 |
| 10% Preference/ senior share capital (10 lac shares of INR 1 each) | 10,00,000 |
| 10% Debentures (1 lac debentures of INR 10 each) | 10,00,000 |
| Other outstanding liabilities - | |
| Workmen dues | 2,00,000 |
| GST dues | 2,00,000 |
Other than the liabilities stated above, it has to pay liquidation expenses of INR 1 lac. The market value of Company X’s total assets (including cash) stood at INR 20 lacs.
The sequence of making payments out of Company X’s assets worth INR 20 lacs would be -
Total assets - 20,00,000
Less: Liquidation expense - 1,00,000
Less: Workmen dues - 2,00,000
Less: Debentures including 10% interest thereon - 11,00,000
Less: Government dues - 2,00,000
Balance left for preferred stockholders - 4,00,000
The Preference shareholders get paid the balance amount on a proportionate basis.
Falling last in the priority of payments, the junior equity holders are left with no returns.
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Frequently Asked Questions
Basic equity is another word for junior equity - no mandatory dividends and no obligation to redeem the shares.
Equity shares can be of two types -
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Junior equity shares - These shares include voting rights and are entitled to the company’s assets only after all the others have received their dues. Distributing profits to them is also discretionary. They are rewarded through capital appreciation and voting rights in the company.
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Senior equity shares - These are also known as preference shares. Preference shares come with no voting rights, and their dividend rate is fixed. Additionally, their claim on the company’s assets falls before that of junior equity holders.