Authorised Share Capital: Meaning, Importance and How it works

As a business owner and investor, understanding key financial concepts like authorised capital is important for making informed decisions about the company’s growth and financing. This guide will explain the meaning of authorised share capital, how it works, and how authorised capital is decided. With a simplified understanding of authorised share capital, you can leverage it strategically when raising money, expanding operations, attracting investors and more.

Also read- Share Capital : What Every Investor Should Know

What is Authorised Share Capital?

Authorised capital is also known as: Registered capital, Nominal capital, Authorised stock, and Authorized capital stock, is the maximum amount of capital a company can issue through shares and stocks to raise funds legally. It is the maximum limit a business can raise through equity issuance without needing regulatory or legal changes. Authorised share capital is specified in a company’s charter documents when incorporated.

How Authorised Capital Works?

When a corporation issues equity to raise money, it cannot exceed the authorised capital amount set out in its incorporation documents. For example, if a company has ₹1 million of authorised capital, it can issue and sell up to ₹1 million worth of common stock shares. Once a company sells stock and receives cash from investors up to its authorised amount, it must take legal steps to increase its authorised share capital if it wants to issue more shares later.

Authorised Capital vs. Paid-up Capital

Here is a comparison between Authorised Share Capital and Paid-up Share Capital:

Why Authorised Capital is Important for Businesses

Setting the appropriate authorised capital amount gives companies more flexibility to access funding, ease growing pains, and attract investors:

• Flexibility in Raising Capital: With sufficient authorised capital, companies can raise equity funding over time without continuously updating their legal documents, making the process faster and simpler.
• Ease of Expansion: Additional authorised share capital allows room for growth since companies can sell more ownership shares to raise money for hiring, equipment purchases, office spaces, and funding working capital.
• Investor Attraction: A higher authorised share capital relative to paid-up capital shows investors that the company has room for their investment dollars to grow the business before maxing out its equity issuance ability.

Factors to Consider When Setting Authorised Capital

The key factors to consider when setting authorised share capital include:

• Expected funding needs and growth plans for the next 3-5 years
• Typical equity funding rounds and valuations in your industry
• Projected market share and valuations comparable companies have achieved
• Appetites of potential investors you aim to attract
• Legal and regulatory requirements in your jurisdiction

Projecting future capital requirements and potential company valuations requires financial modelling and analysis. Hiring a chartered accountant or financial advisor can help determine an appropriate authorised capital amount personalised for your business’s expected expansion needs and opportunities.

How Public and Private Companies can Increase Authorised Capital?

Public Companies

Public companies can raise additional capital by increasing their total authorised share capital. The most common avenues are an Initial Public Offering (IPO) or a Follow-On Public Offering (FPO).

An Initial Public Offering (IPO) is the first time a private company offers shares to the general public. This opens up the opportunity for a large number of retail and institutional investors to purchase shares in the company and become shareholders. An IPO enables the company to raise significant capital funds that get added to its registered capital. The funds raised can be utilised for business operations, expansion plans, paying off previous debts, or other such purposes.

A Follow-On Public Offering (FPO) is when a publicly traded company again issues fresh shares to the public. This follows the company’s IPO and stock exchange listing. A follow-on public offering gives existing publicly listed companies an additional opportunity to raise more capital from public investors. Just like an IPO, the funds raised via an FPO can also be used by the company to invest in further growing the business.

Private Companies

Private companies rely more on private investors rather than retail investors to raise funds by issuing fresh shares. Two ways they can do this is through Private Placements and Rights Issues.

In a Private Placement, shares are selectively offered to institutional investors like venture capitalists, private equity firms, accredited investors or high networth individuals. By regulating wider ownership, private placements allow companies to access large investments from financial institutions. Such investors also bring their business expertise and networks.

Another approach is through Rights Issues where existing shareholders are given the first right to purchase newly issued shares. This allows private companies to raise additional capital from current shareholders before opening share subscription to the public through an IPO. Shareholders can choose to exercise rights to maintain their proportional ownership and control.

Conclusion

Authorised capital is the maximum equity funding a company can raise by selling shares without needing formal approvals to lift the authorised ceiling. This guide explains what authorised capital means, how it compares to paid-up capital, why it matters, what goes into determining appropriate authorised capital levels, its advantages, and the process of calculating it. With this foundational understanding, business leaders can more strategically leverage authorised capital as a funding source and flexibility for achieving growth plans.

Consultation with legal and accounting experts is key during company incorporation to optimise authorised capital settings.

Frequently Asked Questions – FAQs

1. Why is authorised capital important?

Sufficient authorised capital provides companies flexibility in fundraising, ease of expansion and attracts potential investors by signaling growth capability.

2. What factors should be considered when deciding authorised capital?

Key factors include expected funding needs, industry valuations and funding rounds, projected market share and valuations, appetites of potential investors, and legal requirements.

3. Can a company increase its authorised share capital?

Yes, both public and private companies can increase their authorised capital by following certain legal procedures in their jurisdiction.

4. How do public companies raise additional capital?

Public companies can raise funds by conducting an Initial Public Offering (IPO) or a Follow-On Public Offering (FPO).

Author: All Content is verified by SMC Global Securities.