A business is created with the aim of achieving its financial objectives and growth. None of these is possible without capital, which a company raises through equity and/or debt.” The concept of “authorized capital” is key in this respect. This refers to the total amount of capital that a company is permitted to issue to shareholders, as stipulated in its corporate charter or memorandum of association. Although companies start with a certain amount of authorized capital, companies might increase their authorized capital for growth, acquisitions or to handle increased operations.
The impact of increasing the authorized capital, both positive and negative, can be far-reaching, making it a significant decision for any business. This blog will discuss increasing authorized capital, its benefits, disadvantages, and the effect it has on businesses.
What Is Authorized Capital?
Authorized capital is the maximum value of shares that can be issued by a company according to law. This figure is mentioned in the company’s memorandum of association and is indicative of the company’s financial strength. The number of securities that may be issued can be obtained by dividing the authorized capital from the nominal value of the share.
Authorized capital should not be confused with issued capital. Issued capital is the number of shares actually issued by the company to shareholders, whereas authorized capital is the maximum number of shares a company can issue.
Factors for Increasing the Authorized Capital
There can be several reasons why a company may opt to increase its authorized capital:
- To Raise More Money: One of the most common reasons for increasing the authorized capital is to raise money for expansion or investment opportunities. Raising capital by issuing additional shares allows the company to expand, fund research and development, or make acquisitions, and may even open up business opportunities to drive growth or increase its capital base by bringing in new investors.
- Debt Reduction: When authorized capital increases, debt can also decrease. Issuance of new shares can further help in raising funds the company can use this capital to pay off existing loans, thereby improving its balance sheet and reducing interest expenses.
- Strategic Acquisitions or Mergers: When a company is considering an acquisition (or a merger) with another company, it may also need to raise its authorized capital to pay for the acquisition. This can be done by issuing a greater number of shares to fund the asset without stacking it on an unreasonable measure of obligation.
- Employee Stock Options (ESOs): A few companies increase their authorized capital to make their stock incentive plans for employees possible. It is worth noting that in the context of start-ups and high-growth firms, share offerings to employees also aid in talent retention since they act as an additional entrepreneurial incentive for employees to stay and work towards the company’s success.
- Market Impression and Liquidity of Shares: Some corporations increase their authorized capital to enhance the liquidity of their shares. A higher share count can make for more active trading, which can boost market perception and help make a company’s stock attractive to potential investors.
Pros of Increasing Authorized Capital
Here are some potential benefits of increasing authorized capital for a company:
- Enhanced Financial Flexibility: The advantage of raising the authorized capital is that it gives financial freedom to the company. A company can raise money by issuing additional shares of stock without accruing additional debt. This is especially helpful for growing companies that may not be interested in earning higher interest expenses associated with debt.
- Increased Market Confidence: Companies that look to increase authorised capital and successfully raise more funds from shareholders or the public can experience a boost of confidence in the market. Investors typically consider firms with a greater capital foundation to be more consistent, with the ability to endure market fluctuations and economic downturns.
- Growth Opportunities: If a company has cash, they’re in a better position to open themselves to different avenues for growth. This extra capital can allow the company to explore new markets and new products or even expand the facilities it operates in without waiting for profits to trickle in.
- Debt Management: Unlimited authorized capital for companies with a high debt burden is a much-needed relief solution. Issuing new shares and raising funds can help to improve the company’s debt to equity ratio by using the funds to pay off liabilities and making the company a healthier organization overall.
- Attracting Strategic Partnerships: An authorised capital hike can make the company more appealing to strategic partners. Having a bigger capital base can reflect strength, resilience, and the capability to finance large-scale projects, which is a magnet to investors and collaborators.
Drawbacks of Increasing Authorized Capital
There are many benefits of increasing authorized capital, but there are also some downsides:
- Dilution of Existing Shareholder Value: When increasing authorized capital, the most critical concern is the dilution of existing shareholders’ equity. More shares mean a lower percentage of ownership of existing shareholders when a company issues more shares. Such dilution could reduce the value of their current shares and could undermine investor confidence, particularly if the new shares are offered at a bargain.
- Administrative and Legal Costs: The thing that you have to do to raise authorized capital is to go through the legal process and get it approved by the shareholders and the regulatory compliance. The increase in the company’s stock price may also be handled by lawyers, accountants, and the corporate priesthood. This can result in a higher expense being incurred against the company.
- Potential Market Volatility: Issuing new shares can shock the stock price, which is especially the case when the market gets the impression that the company is in financial trouble or is unable to raise other funds. This increase in the sheer number of shares may lead to a short-term dip in share price which can dent investor confidence and reflect in the general market valuation of the company.
- Loss of Control for Founders: Increasing authorized capital may mean a loss of control for the founders of the company or major stakeholders in some instances. If the company raises capital through the issuance of a large number of new shares, the ownership distribution may change, potentially leading to new shareholders or institutional investors having a greater influence in the company’s governance.
- Risk of Overcapitalization: For example, the authorized capital may be increased if a company is unnecessarily overcapitalized, which means that there is more capital than the company is able to use effectively. In this situation, companies often have excess funds that they find difficult to invest in profitable opportunities, which results in lower returns on equity than their potential suggests.
Conclusion
Therefore, the only way to increase a company’s financial network to give it time to prepare for a sale is to increase the authorized capital by using all the ways to benefit the company in the future. This has advantages, including making capital available for expansion, paying off debt, and inviting active partners, but also risks. Collectively, these include dilution of existing shares, administrative expenses, and the possible loss of control by the company’s original shareholders.
It should go without saying that before a company takes a leap in increasing its authorized capital, it should weigh all the advantages and disadvantages. Is this a beneficial decision for the company going forward, and will it lead to increased shareholder value in the long term; these are steps that can only be taken with the aid of a financial expert on the board.
However, any action to increase authorized capital should be carefully considered and evaluated in the context of the company’s overall strategic goals and its ability to effectively utilize the new capital. If carried out carefully and with adequate planning, the authorized capital increase can assist in opening new doors for a company and drive it to a larger success.
Related Services
