Authorised share capital is the maximum number of shares a company can issue, as outlined in its Memorandum of Association or Articles of Incorporation. Management often does not fully utilise this capital, reserving the unissued shares for future needs, such as raising additional capital quickly. Retaining shares in the company’s treasury also helps maintain a controlling interest in the business.
Understanding authorised share capital
Authorised share capital is the maximum number of shares a company can issue as per its Memorandum of Association or Articles of Incorporation. Authorised capital is often not used completely by company management. This leaves room for additional stock issuance in the future whenever the company needs to raise additional capital. Keeping shares within the company’s treasury also helps retain a controlling interest in the business.
Understanding Authorised Share Capital
Authorised share capital is defined in the company’s Memorandum of Association (MOA) and specifies the upper limit of funds the company can raise by issuing shares. Companies are required to specify their authorised capital when they are incorporated.
This figure does not necessarily represent the actual funds that the company has raised or intends to raise immediately. Instead, it establishes the company’s potential ability to issue shares in the future without requiring changes to its legal documents.
Authorised share capital and paid-up capital are important concepts related to a company’s capital structure. The others include subscribed capital and issued capital. To understand it completely, authorised share capital should be viewed within the context of its relationship with these concepts.
Subscribed Capital:
Subscribed capital refers to the portion of a company’s authorised capital allocated and offered to investors through the issuance of shares that are a part of the company’s IPO. It represents the total value of shares that shareholders have agreed to purchase, whether they have paid for them or not.
Paid-up Capital:
Paid-up capital represents a portion of the authorised capital that shareholders have subscribed to and paid for and can be less than or equal to the company's authorised capital.
Issued Capital:
Issued capital depicts the actual quantum of shares issued to the company’s shareholders. This number is usually lower than the authorised capital and can be equal to or less than the subscribed capital.
Special Considerations:
While a company’s shares or stock outstanding will change depending on whether it buys back or issues more shares, the authorised capital will not increase even after a stock split (or some other dilutive measure). The shareholders set the authorised capital, which cannot increase without their approval.
Additional read: What is Split Stock
Significance of authorised capital
In the world of corporate finance and business operations, authorised capital is important for several reasons.
- Legal framework: Authorised capital represents the maximum amount of capital a company can legally raise by issuing shares. It sets the upper limit prescribed by the company’s charter documents, such as its MOA, and provides a legal framework within which the company can operate.
- Investor confidence: Having substantial authorised capital indicates that the company can raise additional funds if needed, instilling confidence in potential investors and lenders. These additional funds may be necessary for expansion, acquisitions, or managing unexpected financial challenges.
- Flexibility: Companies can adjust their authorised capital levels over time by increasing or decreasing them through formal processes. This flexibility allows them to adapt to changing financial needs and market conditions. For instance, if a company plans a significant expansion, it can increase its authorised capital to accommodate the issuance of more shares.
- Credibility and reputation: A higher authorised capital can enhance a company’s reputation in the eyes of investors, partners, and customers. It may be seen as a sign of stability and long-term viability, which can attract investment and business opportunities.
- Regulatory compliance: Many jurisdictions require companies to have a minimum authorised share capital to maintain their legal status. Adhering to these requirements is essential to remain in good standing with regulatory authorities.
- Protecting shareholder interests: Authorised capital safeguards existing shareholders by limiting the extent to which new shares can be issued without their approval. This can help prevent dilution of ownership and protect the interests of current shareholders.
ow does the authorised share capital work?
Typically, authorised share capital limits are determined during the process of incorporation by filing articles of incorporation or a corporate charter. These papers outline essential information about the company, including its name, purpose, and details of its authorised share capital. Issued or paid-up capital is not considered when determining the authorised share capital of a company.
If a company wants to increase its authorised share capital, it has to amend its articles of incorporation or corporate charter. However, this usually requires approval from the existing shareholders. Once approved, the company issues more shares than the initially authorised limit. However, issuing of additional shares has several implications. Additional shares can potentially dilute the shareholding of existing investors, affecting their investment value.
Key components of authorised capital
Following are the key components of authorised share capital:
Authorised shares:
Authorised shares are simply the maximum number of shares a company can legally issue. The limit on authorised shares is outlined in a company’s Memorandum of Association (MoA) or Articles of Incorporation.
Par value per share:
The nominal value assigned to each share as per the company’s charter is known as the par value per share. It is important to note that par value may not be the market value of the shares.
How to calculate the authorised capital?
Authorised share capital can be calculated using the aforementioned key components: authorised shares and par value per share. Multiplying the number of authorised shares by the par value per share gives you authorised share capital. In other words, the authorised share capital formula is as follows:
Authorised capital = Number of authorised shares x Par value per share
Let’s take an example to understand these calculations better. Let’s say corporation ‘ABC’ has decided to authorise 15,00,000 shares. As per its Articles of Incorporation, the par value of each share is set at Rs. 20. In this case, the authorised share capital will be Rs. 3,00,00,000 (15,00,000 shares x Rs. 20/share).
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Example of Authorised Share Capital
Consider a company called XYZ Pvt. Ltd. This company specifies an authorised share capital of Rs. 50 crore in its MOA. This indicates that the company is legally authorised to issue shares to its shareholders up to a total value of Rs. 50 crore. However, this doesn’t mean the company has immediately raised this amount; it signifies the maximum potential funds it can raise through future share issuance.
As XYZ Pvt. Ltd. progresses and requires capital for expansion, investments, or other business activities, it can issue new shares to existing or new shareholders. This would increase the paid-up capital of the company. Suppose the company foresees the need for larger fundraising in the future. In that case, it can raise its authorised share capital, which would involve seeking shareholder approval and adhering to regulatory procedures.
In this example, the authorised share capital of Rs. 50 crore sets the upper limit for the potential funds XYZ Pvt. Ltd. can raise by issuing shares. This authorised capital provides flexibility for the company’s growth and financial requirements in the future.
Conclusion
Authorised share capital is the maximum value of shares a company can legally issue to its shareholders, as stated in its Memorandum of Association. It indicates the potential size of the company, and the company can issue shares up to this authorised capital to raise funds for future financing needs.
