If you have ever come across the balance sheet of any public or private limited company, you must have noticed the term ‘share capital’. It’s the first thing on the liabilities side. What is it? Why do companies have share capital even though it’s stated as a liability?
Stay with us for the next few minutes and we’ll look to break down share capital for you.
This article covers:
- What is share capital?
- Features of share capital
- Why do companies issue share capital?
- Types of share capital
- Disadvantages of issuing share capital
Share capital as defined under Section 2 (84) of the Companies Act, 2013 is the amount raised by the company for use in the business. The capital is procured from shareholders by the issuance of common or preferred stock. The share capital can be altered by introducing public offerings in future.
Though the share capital is employed in the company’s expansion motives, the money belongs to the shareholders. Thus they are entitled to ownership in the company proportionate to their holding.
Features of share capital
- Limited liability: No matter what, the shareholders are only liable towards the company to the extent of the face value of their shares. They cannot be forced to bring any additional capital against their current shareholding.
- Voting rights: Section 47 of the Companies Act, 2013 extends voting rights to each shareholder on every resolution related to the company. The voting rights are in proportion to the paid-up equity share capital held. Note: only equity shareholders are provided with voting rights and not the preference shareholders.
- Remains with the company: The share capital remains with the company until it decides to wind up its operations or liquidate.
- Enhances the creditworthiness: Equity and debt are the two available sources of finance to a company. While debt financing is considered the least favourable because of the strict repayment schedules and high-interest rates, financing through equity helps maintain your debt-equity ratio, hence attracting more creditors to provide additional debt financing in the future.
- No charge: While issuing share capital, no charge is created on the assets held by the company.
- Bonus shares: The company may decide to reward its shareholders by offering them bonus shares free of cost from time to time.
Why do companies issue share capital?
Apart from raising money through share capital, a company has minimal options. They can resort to debt financing to a certain extent, and the promoters have a visible limitation to bring in funds to the company.
Companies issue share capital for a variety of reasons. Some of them are:
- Raising capital to commence business.
- Financing the expansion of the business.
- Strengthening the balance sheet as one with decent equity appeals to lenders.
- Recording ownership stakes of founders by providing them sweat equity shares or stocks at lower the market price.
Types of share capital
The share capital of a company is classified into the following types:
Authorised/Registered/Nominal share capital
This is the threshold amount of capital a company can issue via public subscription. It is the maximum limit to which a company can issue shares. Every company has to specify its authorised capital in its Memorandum of Association. An alteration to the authorised capital can be routed through the Memorandum of Association by filling Form SH-7.
For example, the authorised share capital of Reliance Industries Ltd for the FY 2020-21 is Rs 14,000 cr. Let’s break down this statement.
This statement infers that Reliance Industries Ltd can issue share capital worth Rs 14,000 cr at any given point in time. However, it may decide not to issue the entire authorised capital.
It is that portion of the authorised capital offered to the public for subscription. It is at the company’s discretion to decide how much of its authorised share capital it is willing to issue. The company may issue shares as and when it deems fit.
Taking forward the case of Reliance Industries Ltd, the authorised capital is Rs 14,000 cr while the issued capital is only Rs 6,762.07 cr.
This means that Reliance Industries Ltd can further call for the subscription of the unissued portion of the share capital, which is Rs 14,000 – Rs 6,762.07 = Rs 7,237.93 cr.
This is that portion of the issued capital for which the public has subscribed. Subscribed capital is the part of issued capital for which the shareholders agree to pay consideration in cash or kind. The amount of issued capital that remains unsubscribed constitutes unsubscribed share capital.
For example, let’s say company ABC Limited invited applications for 2,000 shares of Rs 10 each. But the applications were received only for 1,500 shares. So in this case, 1,500 shares at Rs 10 each would be the subscribed capital of ABC Limited.
Called up share capital
A company doesn’t need to ask for the entire face value of the share upfront; it can direct the shareholders to pay in instalments. Called up capital is the amount of subscribed capital for which the company asks its shareholders to pay.
For example, continuing the above example, suppose ABC Limited asks for Rs 3 per share in the above example and decides to ask for the remaining capital in future calls.
Here 1,500*3, = Rs 4,500 would be the called up share capital.
Paid-up share capital
The company’s payment against the called up capital is known as paid-up capital. The balance amount yet to be received by the company is termed as calls in arrear.
For example, suppose a shareholder, Mr X holding 200 shares, doesn’t pay Rs 1 each on his 200 shares.
Here the paid-up share capital won’t be the same as called up share capital.
The paid-up share capital would be 1,300*3 + 200*2 = Rs 4,300 (as Mr X decided not to pay Rs 1 per share).
This is that portion of the uncalled capital reserved for meeting the company’s liquidation expenses or winding up. Reserve capital can only be called at the time of liquidation or winding up and not before that. Moreover, it cannot be called as long as the company is a going concern.
Disadvantages of issuing share capital
Share capital is not the panacea for all ills of a company; it does have some downsides such as:
- Dilution of ownership: with each share a company issues, it provides the shareholders with a percentage of ownership in the company. By issuing share capital, you lose control over your business and pass it to the investors. If you dilute your majority stake in the company, you are always at the risk of being removed from the ownership. However, that’s very unlikely but technically possible.
- Paying out dividends at higher rates: shareholders are exposed to a greater degree of risk than outside creditors. Thus, the company needs to compensate them for the risk by paying out handsome dividends.
- No tax savings: In the case of debt financing, the interest element in the repayment of debt can be shown as an expense in the profit and loss account of the company. This brings down the tax payable by the company as the net profit comes down. And companies in the highest tax bracket are always looking for ways to cut short their tax implications. While in the case of share capital, you cannot take any tax benefits of profit paid out as dividends.
- Increases cost: Moreover, to raise funds through issuing shares, the company needs to take care of various activities like coming up with an IPO, incurring advertising costs to inform public investors about their decision, hiring underwriters and paying underwriting commission.
Share capital has emerged as a powerful financing tool and proved to be the lifeline for companies that would have otherwise struggled to accumulate funds for expansion. The worth of issuing share capital for any company is highlighted when a comparison is drawn between share capital and debt financing. Investors are rewarded with ownership of the company coupled with impressive returns in the form of dividends. Hence Share capital is an important tool for shaping the structure of any company.
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