As you progress through the multiple disciplines of commerce, you will become familiar with how companies raise their capital. Raising capital is perhaps the most challenging task for any company. Most private and public limited enterprises increase their corpus via share capital.
There are several different types of share capital. At first glance, it might seem complicated. But here – at Vedantu – we will try and highlight these technical issues in lucid language.
You will have to first understand what share capital means.
Meaning of Share Capital
Simply put, share capital is the total sum raised by any organisation by issuing shares. All organisations need a steady flow of capital to continue their expanding business. Remember that a company is an artificial person with its own legal identity.
When people voluntarily contribute money to an entity’s owned corpus, they automatically become co-owners of that entity. Keeping this in mind, the total capital collected by any organisation is its share capital, and its contributors are shareholders.
When modern business structures first started, share capital and its types were limited and easy to understand. Shareholders were co-owners of a company whose shares they had bought.
As businesses evolved, share capital types increased. Since the ownership of an organisation also amounts to bearing responsibility, sharing day-to-day operations and passing around losses incurred, individual shareholders backed away. They buckled under the added pressure.
Others stepped in. They were rewarded with preferred shares. Promoters of large companies were also offered extra advantages. Thus, the kinds of share capital became complicated.
The Companies Act (2013) has specific guidelines for all existing companies and the various ways they issue shares.
When it comes to organisations, the terms ‘capital’ and ‘share capital’ are practically synonymous.
When a company is registered, its papers, including the Articles & Memorandum of Association, must reflect the total capital.
Break Down of Share Capital
The shareholders equity section on the balance sheet has a report of the share capital by the firm. The same is bifurcated in different sections and line items based on the source of funds. There are usually three different line items as follows:
On a balance sheet, the stock sales are listed at nominal par value. Whereas, the additional paid-in capital is listed at the actual price paid over par for the shares.
When a company publishes the amount of share capital it would contain only the payments which are made directly from the company of acquisitions. The share capital of the company is not impacted later by the sales and acquisitions of the securities or even the rising and falling rates of the same on the open market.
It is the company’s choice to have more than one public offering after the initial public offering also known as IPO. The later sales would have an impact and increase the share capital on the balance sheet.
The term share capital has a different context and could mean different things. A company can legally raise an amount of money on selling the shares and hence there are few contexts to the term as it could mean several types of share capital.
Classification of Share Capital
There are two different classes of share capital. They are:
Equity Share Capital
Consisting only of equity shares and sans preference shares, this class carries the maximum benefits and also maximum losses. If a company’s shares are doing well on the Stock Exchange, shareholders will benefit as their company will pay extra dividends. Plus, their shares will also have higher resale values.
However, if an organisation loses money, its equity shareholders have to bear the burden of losses. At times, they might even have to sell their shares at below-par values. It is this risk factor that many prospective shareholders cannot stomach.
Note that those who hold equity shares are eligible to vote at every organisation’s Annual General Meetings or AGMs.
It consists only of preference shares. As the name suggests, those who hold preference shares receive preferential treatment. These extra advantages are laid out clearly under Section 43(b) of the Companies Act (2013).
Preferential shareholders have the right to receive dividends before an equity shareholder. They are, indeed, treated differently. Note that if a certain company is running in losses and is unable to issue dividends, preferential shareholders will also receive no extra bonuses.
Furthermore, preference shareholders are eligible to receive their share of a company’s capital if the organisation winds up.
Tasks for advanced commerce students: Now that you know of Stock Exchanges, find out the details of some of the world’s largest exchanges. You will be surprised by the wide range and how various exchanges operate. Then, you can look up on NASDAQ, FTSE, Tokyo Stock Exchange and other entities.
In India, the BSE and NSE are the largest exchanges. Did you know that every day, a brass bell is rung to announce the commencement of operations?
Different Types of Share Capital
There are several types of shares capital. Follow this list carefully and try and differentiate what each kind entails.
Authorised or Registered Capital: Also known as ‘nominal capital’, it is the maximum share capital, which any company can legally issue. When a company is registered, it has to provide its Memorandum of Association, as previously mentioned. This MoA indicates how much capital a specific company can raise via the issue of shares.
This type of share capital indicates an organisation’s maximum amount of share capital. If it is a Limited company, its MoA will also have details on how much capital is being used to start that enterprise besides how many shares it intends to issue.
If the authorised share capital is increased under any situation, the concerned regulators must be notified.
Issued Capital: Whenever shares are floated for general consumption, only part of the total authorised share capital is perused. This portion of the total share capital is issued capital. Issued capital will always be much lower than an entity’s authorised or registered capital.
In extraordinary situations, a company may decide to issue its entire share capital. Such situations arise when a market is in a bear-hug. Only then will issued capital be equal to registered capital.
Find out what the words ‘bear’ and ‘bull’ mean when it comes to stock markets. You can also use the Internet to see the famous sculpture of a bull standing menacingly near New York’s Wall Street.
Fun Fact: It is popularly called ‘Charging Bull’ and was installed following the 1987 stock market crash.
Subscribed Capital: Once the issued capital is put up for shareholders, the total subscribed part – that which is booked by potential stakeholders – is termed as subscribed capital.
Of note here is the fact that not the entire issued capital may be lapped up immediately. Some companies may have difficulties finding buyers. The performance of a share issue depends on its subscribed capital. If this percentage (subscribed/issued capital) falls too low, that organisation may have to sell another round of shares.
Called-up Capital: It must be kept in mind that shareholders may be unable to pay the total sum of the shares they buy in one episode. They require time to settle the full amount outstanding. Therefore, terms like ‘First Call’ and ‘Final Call’ are used in every stock exchange.
Companies do not like waiting, however. Shareholders will be asked to pay a certain amount whenever they purchase shares. The total amount thus collected constitutes a company’s called-up capital.
Uncalled Capital: Remember called-up capital? Well, the unpaid portion that all shareholders will have to pay later, and which will then be regarded as subscribed capital, is uncalled capital.
A company may set a fixed date by which all outstanding dues are to be settled. Note that the terms mentioned during the share issue is final and no organisation can breach those pre-set conditions.
One reason why every share issue has terms and conditions is to ensure that companies do not resort to mala fide practices while a certain amount is yet to be paid by a shareholder. Usually, uncalled capital constitutes a large portion of share capital.
Paid-up Capital: The amount which shareholders pay as soon as they buy shares of an entity is known as paid-up capital. It is shown on the asset side of a balance sheet. The greater the paid-up capital, the higher the sum raised during the share issue. The amount thus generated is channelled into an organisation’s cash flow.
Reserve Capital: Reserve capital is defined as that uncalled capital owned by an enterprise that can be issued only in the event of that company’s dissolution of business – regardless of the reason. If a certain firm is not going ‘under’, it cannot issue its reserve capital.
This concept of reserve capital is governed by The Companies Act’s Sec. 99.
Under existing law, no company can turn reserve capital into ordinary capital, save for a court’s orders. This reserved portion cannot be put up by an enterprise as collateral for any loans. Also, if a firm decides to reduce its core capital, it cannot cancel its portion of reserve capital.
Fixed Capital: A company’s existing assets constitute its fixed capital. Such assets may include land, machinery, Intellectual Property, plants or mills and any similar unmovable assets.
Knowing these topics will give up an edge over your competitors in exams! Refer to Vedantu’s website to read up on more such topics. You can also go through study materials for senior secondary commerce and attend live interactive classes for difficult topics.
Advantages of Raising Share Capital
Raising capital through sales of shares has many advantages to the company raising capital through sales of shares. The company does not have to pay any interest on the raised capital nor it has any repayment terms that have to be adhered to by the company. In case of loans from banks or investors the company will be entitled to regular repayments and will be charged interest as well depending upon the current market and lender terms.
There are payments of dividends to shareholders that have to be paid but the same is not a compulsion and can be halted if necessary. Hence, the company gets more flexibility over its financial management.
There are no set rules or obligations attached to the share capital raised through sales of shares. Whereas, a creditor can have certain terms of usage of the capital invested or loaned. This will restrict the company from taking relevant and quick decisions related to finance.
Raising capital through equity shares can be controlled by the company. The number of shares to be released to the public is decided by the company. The amount per share is decided by the company too. In case, there is any further requirement of capital the company can again decide to release more shares to the public for buying and raising more capital.
The risk of bankruptcy subsides as well as shareholders cannot force a company into bankruptcy unlike banks and creditors if the company fails to pay the interest or repayments.
Disadvantages of Raising Share Capital
Every share sold to the public to raise share capital is losing a bit of ownership of the company. It effectively reduces the control over the company as shareholders have the right to vote on business deals and decisions. The corporate policy and even the management of the company would have interference by the shareholders. In the event, the shareholders have the majority of the shares of the company, they can decide to change the current leadership and bring their choice of management into the company.
Shareholders take more risk than creditors as they can not force a company into bankruptcy and hence demand higher ROI (Return on Investment) from the company.