The most common types of shares that we’ve heard about are the equity or preference shares. However, did you know that a company has many types of shares in its share capital like issued shares, authorised shares, paid-up shares, etc.?
Let’s understand the meaning and nuances of authorised shares.
What Are Authorised Stocks?
Authorised stocks, also known as authorised shares of a company, are the maximum number of stock units that a company is permitted to issue. The maximum number of authorised shares is mentioned in the company’s legal formation document, known as Articles of Association (AoA).
There is no particular limit set for the maximum or minimum number of authorised shares that a company can authorise. A company can increase its authorised share capital if allowed by its AoA and approved by its members.
How Do Authorised Stocks Work?
During the formation of a company, the owners and stakeholders need to submit the required documents to register their Article of Incorporation (AoI) and Memorandum of Association (MoA). These official documents will explain the kind of stocks that the company plans to issue to the investors as well as the total number of shares that will be issued. These are known as authorised shares.
The number of shares available to investors in the open market may be a part of a company’s authorised stock, or it may be all of it. If outstanding shares are lesser than authorised shares, the difference between the two are the unissued stocks, which the company chooses to retain in its treasury.
The number of outstanding shares can never exceed the number of authorised shares, as it is the maximum number of shares a company can offer to the public. However, there is no specific limit set on the minimum or maximum number of authorised shares that a company can authorise.
Additionally, when a company wishes to go public, they can issue authorised shares to investors through Initial Public Offering (IPO).
Example of Authorised Stocks
Let’s say you are the founder of ABC Company and you are planning to expand your manufacturing unit by opening a new factory plant. For setting up a new factory plant, you will require ₹1 crore.
Your company’s total number of authorised shares is 12,000. You see that the company has issued only 6,000 of the 12,000 authorised shares.
If the cost per share is ₹10,000, and you have to raise a capital of ₹1 crore, you will have to issue an additional 1000 shares.
Therefore, you will have to take the decision to sell 1000 of the remaining 6000 shares. Your company’s total number of authorised shares will remain the same, but the number of issued shares will increase from 6,000 to 7,000. This will help you generate ₹1 crore for business expansion.
Importance of Authorised Stocks
Authorised shares act as limiting devices to control management’s ability to issue new shares. Suppose a company doesn’t have authorised shares. In that case, management of the company will get unrestricted right to issue new shares whenever they want, which might change the balance of control between shareholders.
The number of authorised shares is usually more than what a company actually needs so that it can issue stocks in the future as employee benefits or secondary offerings to raise more money. To prevent hostile takeovers and maintain a controlling interest in the company, companies do not issue all of their authorised shares at once.
How Many Shares Can a Company Authorise?
There is no specific limit set on how many shares a company can authorise. Companies primarily issue authorised shares when they go public through an IPO round.
During an IPO, it is of utmost importance for the company to make sure that enough shares are available to fulfil the objective of offering equity. Companies can also issue authorised shares as employee compensation which they can redeem at a particular date and generate income.
What Are the Types of Authorised Shares?
Authorised shares include all types of shares that a company can issue. They are:
- Common Shares
It is a type of security that represents equity ownership in a company. It is also referred to as ordinary shares, common stocks or voting shares.
Common shareholders can claim a specific portion of the company’s earnings. This portion depends on the percentage of equity the shareholder has in the company.
These shares also give voting rights to shareholders, which means that they can elect a board of directors during annual shareholders’ meetings and implement any company decisions.
- Preferred Shares
It is similar to common shares, but these shareholders get a better claim over company assets and earnings than common shareholders. Preferred shareholders get more priority than common shareholders when it comes to dividend payments. However, they do not have voting rights.
Preferred shareholders also get priority when it comes to claiming assets in case the company defaults. It is possible to convert this type of share into common shares. Issuers can repurchase this type of share at specific dates in future.
- Restricted Shares
Most corporate officers, senior executives, and directors of a company get this type of share. These are non-transferable shares until the shareholder meets certain conditions, like serving for a particular period of time. After meeting the conditions, the company officially transfers the shares to the shareholder.
It acts as an excellent motivation for employees as they become part owners of the company after receiving it and get voting rights. This improves an employee’s overall performance and motivates him/her to work hard for the company.
Difference between Authorised Stocks and Issued Stocks
Authorised shares are the maximum number of shares that a company can legally issue to shareholders. On the other hand, issued stock is the number of shares that have been issued in the public market.
As companies usually do not issue all authorised shares, the number of authorised shares will always be more than the number of issued shares. The number of issued shares can never exceed the number of authorised shares.
Issuance of authorised shares helps a lot when it comes to maintaining a controlling interest in the company as well as the well-being of the shareholders. From maintaining profitability of the company to preventing hostile takeovers, authorised shares take responsibility for the welfare of the company.
Frequently Asked Questions
Can a company change its authorised shares?
Yes, a company can change the number of authorised shares it can issue. Public companies need to notify existing shareholders and ask for their votes. All shareholders will review the proposition in the shareholders meeting. However, existing shareholders do not get any compensation for changes in the number of authorised shares.
When can a company issue more shares?
A company can issue more shares when they have authorised shares still left to be issued. In case, they have issued all the authorised shares and wish to increase the same, it can be done via Board approval.
What are the consequences of non-compliance with provisions concerning authorised shares?
If the company does not follow provisions in relation to an increase in authorised shares, every director or officer in default of provision has to pay a penalty. ₹500 is chargeable for every day of default. This can go up to ₹5,00,000 for a company and ₹1,00,000 for the person in default.
Who decides the number of authorised shares for any company?
Owners of a particular organisation decide the number of authorised shares they should have in accordance with the valuation of the company. Apart from this, any other changes are implemented only after discussing them with all the shareholders of the company.
Anuj is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.Com (Hons) in St. Xavier’s College, Kolkata and holds PGDM (Finance) degree from GIM. He is currently working as Investments Principal at Wint Wealth. He has been working in the debt capital market space for the past 4+ years and is also an NISM certified mutual fund expert.