Imagine a company, ABC Ltd., issuing 10,000 shares at Rs. 75 each. The payment terms are as follows:
- Application: Rs. 20 per share
- Allotment: Rs. 15 per share
- First call: Rs. 25 per share
- Second call: Rs. 15 per share
Now, let us say an investor applies for 50 shares. At the time of application, they pay Rs. 1,000 (50 shares * Rs. 20 per share). When the shares are allotted to them, they make the allotment payment of Rs. 750 (50 shares * Rs. 15 per share).
However, at the first call stage, the investor fails to pay the Rs. 1,250 due. Consequently, ABC Ltd. decides to forfeit the shares owned by this investor.
Reissue of forfeited shares
Once the shares are forfeited, the company has the option to reissue them. This process involves setting a new price and offering the shares to new investors. The reissuing of forfeited shares can contribute to the company's capital and liquidity.
Effects of share forfeiture
The following are key impacts of share forfeiture:
1. Loss of ownership
For shareholders, the forfeiture of shares results in a complete loss of ownership rights. This includes voting rights, dividend entitlements, and any potential appreciation in the value of the shares.
2. Loss of potential gains
Shareholders who forfeit their shares also forfeit any potential gains that may have accrued had they retained ownership. This loss can be significant, especially if the company experiences growth and an increase in share value.
3. Impact on financial ratios
Forfeited shares can impact various financial ratios of a company. Metrics like earnings per share (EPS) and return on equity (ROE) may be affected, as the number of outstanding shares is reduced.
4. Impact on treasury stock
Forfeited shares are often classified as treasury stock, which refers to the shares a company holds in its own treasury. These shares can be reissued or cancelled, impacting the company's equity structure.
5. Legal and tax implications
There are legal and tax implications associated with the forfeiture of shares. Companies need to adhere to regulatory requirements, and shareholders may face tax consequences depending on the jurisdiction and prevailing tax laws.
Benefits of forfeited shares
While forfeited shares are typically associated with penalties for shareholders who fail to meet their obligations, there are certain benefits from an investor's perspective as well. Investors, whether existing or potential, can find advantages in the forfeiture of shares, particularly when considering the broader impact on the company and its market dynamics. Here are several benefits of forfeited shares from an investors' perspective:
1. Enhanced earnings per share (EPS):
For existing shareholders, the forfeiture of shares leads to a reduction in the total number of outstanding shares. This reduction can result in an increase in earnings per share (EPS), a key financial metric that measures a company's profitability per share. Investors often appreciate a higher EPS as it indicates a more robust financial performance on a per-share basis.
2. Improved return on equity (ROE):
Similar to EPS, the reduction in outstanding shares positively influences return on equity (ROE). ROE measures a company's ability to generate profits from its shareholders' equity. With fewer outstanding shares, the equity base is reduced, potentially enhancing the ROE and signalling improved efficiency in utilising shareholder funds.
3. Potential for increased dividends:
As a result of enhanced financial metrics such as EPS and ROE, companies may be better positioned to distribute higher dividends to shareholders. Existing investors can benefit from increased dividend payouts, providing them with a steady income stream and potentially attracting new investors seeking dividend-paying stocks.
4. Control and voting rights:
With the forfeiture of shares, existing shareholders may find themselves in a position of increased control and voting rights. A reduction in outstanding shares means that each remaining share represents a larger percentage of the company, potentially giving investors more influence in key decision-making processes during shareholder meetings.
5. Positive signal of financial discipline:
For investors, the forfeiture of shares can be interpreted as a positive signal of the company's commitment to financial discipline. It demonstrates that the company is actively managing its shareholder base and taking steps to ensure adherence to financial obligations, instilling confidence in the management's ability to navigate challenges effectively.
6. Increased liquidity in the market:
Reissuing forfeited shares contributes to increased liquidity in the market. This liquidity can be advantageous for investors looking to buy or sell shares, as a more liquid market generally allows for smoother transactions and reduced-price volatility.
7. Alignment of employee interests:
In the case of employee share forfeiture, existing shareholders may view this as a positive measure. It aligns employee interests with the company's long-term success by incorporating performance-based vesting conditions, ensuring that employees contribute meaningfully to the organisation's growth.
Conclusion
While the forfeiture of shares may initially seem like a negative event, it serves as a strategic tool for companies to maintain financial stability, raise capital, and align shareholder interests with organisational objectives. It shapes the financial landscape, influencing ownership structures, financial ratios, and the overall health of companies. As investors navigate the market, being aware of the potential risks and benefits associated with forfeited shares is a crucial aspect of making informed decisions. By comprehending this intricate aspect of the financial world, stakeholders can better position themselves in the ever-evolving Indian markets.
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