Share Capital: Meaning, Factors & Advanatages
Share capital represents the funds raised by a company through the issuance of shares to its shareholders. It serves as the financial foundation upon which companies build their operations and pursue growth opportunities. As an investor, understanding share capital is essential for you. Because it allows you to assess a company’s financial strength and potential returns.
In this blog, we will be shedding light on the intricacies of share capital and its role in shaping the financial landscape.
What is Share Capital?
Share capital in company law refers to the total value of funds raised by a company through the issuance of shares to its shareholders. Share capital is also known as shareholders capital, equity capital, contributed capital, or paid-in capital.
Moreover, it is an essential component of a company’s capital structure. It plays a crucial role in determining its financial position and investment potential. The funds raised through shareholders’ capital can be used by the company to finance its operations, invest in new projects, acquire assets, or repay debts.
Why Do Companies Raise Share Capital?
Companies raise shareholders’ capital for several reasons, including:
- Expansion and Growth: One of the primary reasons for raising shareholders’ capital is to fund the expansion and growth initiatives of the company. The additional funds obtained through issuing new shares can be used to invest in new projects, expand operations, enter new markets, or acquire assets and resources.
- Capital Requirements: Companies may raise shareholders’ capital to meet their capital requirements. It allows them to raise funds without incurring debt, reducing their reliance on loans and interest payments. By increasing their shareholders’ capital, companies can strengthen their financial position and have more resources at their disposal.
- Funding Acquisitions: Companies can raise shareholders’ capital to finance acquisitions and mergers. When a company intends to acquire another business, a company may issue new shares to the shareholders of the target company as part of the consideration. This allows the acquiring company to use its shares as currency for the transaction.
- Debt Reduction: Companies may choose to raise shareholders’ capital to reduce their debt burden. By issuing new shares and using the proceeds to repay debts, companies can improve their financial stability, reduce interest expenses, and enhance their creditworthiness.
- Enhancing Investor Confidence: It can be seen as a positive signal by investors. As it indicates the company’s growth prospects and financial strength. It demonstrates the company’s ability to attract investments and can increase investor confidence in the business.
Types of Share Capital
There are multiple kinds of share capital that a company can have. Here is a list of various kinds of share capital.
- Authorized Share Capital: It refers to the maximum amount of shareholders’ capital that a company is authorized to issue as per its constitutional documents. This represents the total value of shares that can be issued by the company.
- Issued Share Capital: This type of share capital of the company is the portion of authorized shareholders’ capital that the company has actually issued. These are the shares that are in circulation and held by investors.
- Subscribed Share Capital: It refers to the part of issued capital subscribed by investors or agreed to be taken up by shareholders. This represents the shares that shareholders have committed to purchasing.
- Paid-Up Share Capital: It represents the portion of subscribed shareholders’ capital that has been paid by shareholders. It reflects the actual amount of money received by the company in exchange for the shares issued.
Features of Share Capital
Here is a list of several key features that may define its role and impact on investors.
- Divisibility: Shares, the units of share capital, are divisible. Investors can own part of a company through fractional shares, making ownership accessible to a wider range of investors.
- Limited Liability: Shareholders’ liability is limited to the amount of capital they have invested in the company. This means, they are not personally liable for the company’s debts beyond their investment.
- Voting Rights: Each shareholder is granted voting rights on every resolution concerning the company under Section 47 of the Companies Act, 2013. Shares often come with voting rights, allowing shareholders to participate in certain company decisions like dividend distribution or board member appointments. This empowers investors and ensures stakeholder involvement.
- No Charge: When issuing share capital, no charge is created on the company’s held assets.
- Bonus Shares: Companies may choose to reward shareholders by periodically offering them bonus shares at no cost.
Classes of Share Capital
Classes of shareholders’ capital are categories of shares that a company can issue. Here are two common classes:
1. Equity Share Capital
2. Preference Share Capital
Let’s understand these two classes in detail:
What is Equity Share Capital?
Equity Share Capital, also known as ordinary shares or common stock, equity shares represent ownership in a company. Equity shareholders have voting rights and are eligible for a share in the company’s profits in the form of dividends. They bear the highest risk but also have the potential for higher returns.
What is Preference Share Capital?
Preference shares have certain preferential rights over equity shares. They typically have a fixed dividend rate and are paid dividends before equity shareholders. Preferred shareholders have a higher claim on the company’s assets in case of liquidation. However, they usually do not have voting rights or have limited voting rights.
How to Calculate Share Capital?
To calculate the shareholders’ capital of a company, you need to consider the following components:
Authorized Share Capital: Determine the maximum value of shares that a company is legally allowed to issue as specified in its constitutional documents.
Issued Shareholders’ Capital: Identify the actual portion of authorized shareholders’ capital that has been allocated and offered to shareholders. This information is usually disclosed in the company’s financial statements.
Nominal Value Per Share: Determine the nominal or face value assigned to each share issued by the company. Thus, the maximum amount of share capital of a company is mentioned in Memorandum of Association (MoA).
Once you have the above information, you can calculate share capital using the following formula:
| Share Capital = Number of Issued Shares × Nominal Value per Share |
Let’s understand how to calculate shareholders’ capital with the help of an example. Suppose a company has issued 50,000 shares with a nominal value of Rs. 100 per share.
In this case:
shareholders’ capital = 50,000 shares × Rs. 100 = Rs. 50,00,000
Therefore, the shareholders’ capital of the company would be Rs. 50,00,000
Balance Sheet of Share Capital
The inclusion of shareholders’ capital in a balance sheet holds utmost importance as it signifies the funds contributed by shareholders to the company. This crucial information aids investors in evaluating the financial stability of the company.
Shareholders’ capital is subject to modifications as the company may issue new shares, repurchase existing ones, or declare a stock split. Such alterations are duly recorded in the share capital balance sheet, ensuring transparency regarding changes in the shareholders’ capital.
Representation of Share Capital in Balance Sheet
The shareholders’ capital amount is recorded as a separate line item under the liabilities section. It represents the total value of the company’s issued shares.
The balance sheet also includes other liabilities, such as loans, long-term debts, and accrued expenses, which are recorded separately from share capital. The total liabilities section shows the sum of all liabilities.
Share Capital Structure
The structure of shareholders’ capital refers to the composition and arrangement of different types of shares issued by a company. It represents how the company’s capital is divided among shareholders and reflects the ownership and funding structure of the company. The capital structure represents structure of shareholders funds in balance sheet, typically consists of various types of shares, such as:
- Equity Shares (common shares): These are the most common type of shares that a company issues. They represent ownership in the company and provide shareholders with voting rights and a share in the company’s profits through dividends.
- Preference Shares: These shares come with preferential rights and privileges over equity shares. Preference shareholders have a fixed dividend rate and receive dividends before equity shareholders. They also have priority in receiving capital in case of liquidation but usually do not possess voting rights.
- Cumulative Preference Shares: These shares carry a right to accumulate unpaid dividends if the company is unable to pay dividends in a particular year. The accumulated dividends must be paid to cumulative preference shareholders before any dividends are paid to equity shareholders.
- Redeemable Shares: These shares can be repurchased or redeemed by the company at a future date or upon meeting certain conditions. Redeemable shares provide flexibility to the company in managing its capital structure.
- Non-Voting Shares: Some companies issue non-voting shares, which do not carry voting rights. These shares are typically offered to investors who seek capital appreciation but are not concerned with voting in company matters.
Factors Affecting Share Capital of Company
When it comes to the shareholders’ capital, there are several factors that come into play. Let’s take a closer look:
- Company Size and Growth Prospects: The size of a company and its potential for growth have a direct impact on its share capital. Bigger companies with exciting growth prospects usually need more capital to fund their expansion plans. As a result, their shareholders’ capital tends to be higher.
- Capital Requirements and Funding Needs: Companies often have specific capital requirements, such as financing new projects, acquiring assets, or paying off debts. If a company requires a significant amount of funding, it may increase its shareholders’ capital to meet those requirements.
- Industry and Market Conditions: The industry and market conditions also come into play. Industries experiencing rapid growth or technological advancements tend to attract more investments, which can lead to higher shareholders’ capital. On the other hand, unfavourable market conditions may make it challenging to raise capital.
- Investor Expectations and Share Pricing: Investor expectations and the pricing of company shares can significantly impact shareholders’ capital. If investors have high expectations for a company’s future profitability, they are more likely to invest, which can increase share capital. Likewise, if the share prices are attractive to investors, it can draw more investors to contribute to higher share capital.
Alteration of Share Capital
Alteration of shareholders’ capital refers to the changes made to the existing share capital structure of a company. Thus, there are different kinds of alteration of share capital that can happen for various reasons.
Increase in Share Capital
A company may decide to increase its shareholders’ capital to raise additional funds for expansion, acquisitions, or other business purposes. Companies do this through the issuance of new shares to existing or new shareholders. The increase in share capital leads to an infusion of fresh capital into the company, enabling it to finance its growth plans.
Decrease in shareholders’ capital
In certain situations, a company may opt to reduce its shareholders’ capital. This could be due to reasons such as consolidation, restructuring, or eliminating accumulated losses. Shareholders’ approval and compliance with legal requirements are necessary for a decrease in shareholders’ capital.
Share Split or Subdivision
A share split involves dividing existing shares into a larger number of shares without changing the overall value of the share capital. For example, a company may split one share into multiple shares, such as splitting one share into two or three shares. Usually, companies do this to enhance liquidity, increase marketability, and make shares more affordable to investors.
Share Consolidation or Reverse Split
The opposite of a share split is a share consolidation or reverse split. It involves combining multiple shares into a smaller number of shares. For instance, a company may consolidate five shares into one share. Usually, companies do this to increase the share price, meet listing requirements, or attract a different class of investors.
Conversion of Securities
Alteration of share capital may also occur through the conversion of securities. For example, convertible preference shares or convertible debentures can be converted into equity shares based on predefined terms and conditions. This conversion leads to a change in the shareholders’ capital structure of the company.
Advantages of Raising Share Capital for Investors
Some of the advantages of raising shareholders’ capital for investors are as follows:
- Dilution of Risk: When a company raises shareholders’ capital, it allows investors to diversify their investment across a larger pool of shareholders. This can help reduce the risk associated with investing in a single company.
- Potential for Capital Appreciation: If the company successfully utilizes the raised capital to drive growth and increase its value, investors can benefit from capital appreciation on their shares.
- Voting Rights and Influence: Shareholders who participate in the increased share capital may gain voting rights. This can provide them with a voice in the company’s decision-making processes and influence its direction.
- Access to Future Offerings: By investing in the company during a shareholders’ capital raise, investors may gain preferential access to future offerings or investment opportunities, which can potentially offer additional benefits.
Disadvantages of Raising Share Capital for Investors
Some of the advantages of raising share capital for investors are as follows:
- Dilution of Ownership: When a company issues new shares, the existing shareholders’ ownership percentage in the company may decrease. This dilution can impact their influence and control over the company’s affairs.
- Potential Decrease in Earnings Per Share: If the company’s earnings remain unchanged while the number of shares increases, it can lead to a decrease in earnings per share. This could affect the value proposition for investors.
- Oversupply of Shares in the Market: Raising shareholders’ capital can result in an oversupply of shares in the market, potentially leading to downward pressure on the stock price if demand does not match the increased supply.
- Increased Competition for Dividends: With more shareholders, the company’s profits may need to be divided among a larger pool of investors, resulting in a lower dividend per share.
To Wrap It Up…
It says a crucial role in the financial structure of a company. It represents the funds raised from shareholders and is an essential component of the balance sheet. Through shareholders’ capital, companies can raise capital for growth, expansion, and financing of their business activities.
Understanding share capital and its implications is crucial for both companies and investors. By comprehending the structure, benefits, and factors affecting shareholders’ capital, investors can make informed decisions, while companies can effectively manage their capital structure to support their growth and financial objectives.
FAQs
Share capital meaning is the total value of common and preferred shares issued by a company to its shareholders.
The share capital represents a part of a company’s equity raised through the issuance of common or preferred shares, distinguishing it from other forms of equity accounts.
According to the SEBI regulations, companies must allot shares within 30 days of closing the subscription of a public issue.
Generally no. It’s permanent, providing stability for creditors and long-term sustainability. Exceptions like buybacks exist, but require careful procedures.
A broader term encompassing share capital, debt, and retained earnings, representing the total financial resources available to the company for operations and growth.
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