Share Capital

Introduction

In the post-pandemic era, there is a significant increase in retail investments in connection with the financial markets. The return from equity instruments tends to outperform any other investment avenues. Within equity instruments, there are various alternatives available to investors. The most common source of equity investment is share capital.

The shareholders of a company invest in the company. The maximum liability of the shareholders is capital investment. In return, shareholders attain voting rights to company matters. The shareholders also appoint the board of directors. Additionally, shareholders earn returns by way of dividends and capital appreciation. There are various types of share capital based on the rights and obligations offered to the investors.
 

What is Share Capital?

The Share capital definition refers to the funds raised by an entity to issue shares to the general public. Simply put, share capital is the money contributed to a firm by its shareholders. It is a long-term capital source and facilitates smooth operations, profitability, and financial growth. 

Primarily, capital represents the assets used to carry on a business. Alternatively, it may be the resources required to launch a venture. The terms capital and share capital are interchangeable. In the Indian Companies Act, share capital refers to a company's percentage of capital or interest.

The Company's Memorandum of Association mentions the maximum amount of share capital. The company may increase the maximum share capital with an amendment to its Memorandum of Association. Moreover, a company limited by stock issues share capital, whereas a company limited by guarantee does not have any capital.

From a financial reporting standpoint, share capital appears under liabilities in a balance sheet. In the case of liquidation, the shareholders receive the residual assets after payment of all other liabilities.
 

Classes of Share Capital

Broadly, there are two classes of share capital available to a company –

A.    Preferred Share Capital
Preferred share capital refers to funds raised by the issue of shares with privileged rights. Preferential rights include fixed dividends. Also, preferred share capital entitles shareholders to receive share capital before common shareholders. A company must pay preferred dividends irrespective of cash flows like debt instruments. The company may accrue dividends and pay preferred equity holders at a later date or upon maturity.
 
B.    Common or Equity Share Capital
Common equity refers to share capital raised with the issuance of ordinary shares. Equity share capital extends a share in profits and voting rights to the shareholders. However, the company is under no obligation to pay dividends. Additionally, the company may offer bonus shares or right issues to its common shareholders.

Types of Share Capital 

1.    Authorized Share Capital
Authorized share capital refers to the maximum number of shares a company may issue. The Memorandum of Association limits the authorized capital to a fixed amount. Authorized share capital is more than the total outstanding shares. 

A company may increase its authorized capital for several reasons, such as acquiring another company or employee stock options. Any change in the authorized capital requires shareholder approval since an increase in the authorized capital may shift the balance of power between the shareholders and other stakeholders. 
 
2.    Unissued Share Capital
Unissued shares still need to be issued to the general public or employees. Unissued stock forms part of the company's treasury and does not impact the shareholders. The Board of Directors controls unissued shares. Unissued shares are not tradeable in the secondary market. 

Most companies hold a significant percentage of their unissued shares. The value of unissued share capital is low. The objective is to sell or allocate unissued shares at a premium in the future. The company may use unissued stock to pay off debt or to raise money for new investments. Directors may even allocate unissued shares to a minority shareholder if necessary. 

3.    Issued Share Capital
Issued share capital is the number of shares a company issues to its shareholders. Issued share capital is a mix of common equity shares and preferred capital. 

It is a major component of the shareholder's funds under the liabilities of a balance sheet. Also, analysts use issued capital to evaluate the worth of common equity stock. For example, ABC Ltd issues thousand shares with a face value of Rs. 10. The company issues the shares for Rs. 15 per share. Therefore, ABC Ltd. raises Rs. 10,000 from the initial sales of shares. Rs. 5,000 is surplus and constitutes the company's reserves. 

4.    Subscribed Capital
A company's authorized share capital is equal to its registered capital. A fraction of the issued capital is the subscribed capital. Shareholders promise to purchase or subscribe to a company's shares. The payment of subscribed share capital may be in instalments.

Subscribed capital represents the portion of a company's issued capital accepted by the public. The public shows interest in a company by way of a subscription. A company can only issue part of the share capital in one instance.

It may issue additional shares over time. Moreover, the company may only require payment of part of the share's entire face value. 
 
5.    Paid-Up Capital
Paid-up capital is investment received by a company from a share issue. Typically, a company issues fresh capital to raise funds. Fresh share capital constitutes the company's paid-up capital. As per the Companies Act 2013, the minimum paid-up capital requirement is Rs. 1 lakh. 

Paid-up Capital is essential for fundamental analysis. A company with a low paid-up capital may have to rely on debt to finance its operations. Conversely, high paid-up capital signifies less reliance on borrowed funds. 
 
6.    Called-Up Capital
Called-up Capital is the subscribed capital section that consists of the shareholder's payment. The balance sheet separately captures called-up capital under the shareholders' equity. Called-up capital is useful for companies with unforeseen or emergency fund requirements.

On issuance of shares, the company calls upon its shareholders to pay a part of the capital. Thus, called-up capital offers more flexibility in the investment and payment terms. 

7.    Reserve Share Capital
Reserve capital refers to share capital that a company cannot access except in case of bankruptcy. The company can issue reserve share capital only with a special resolution. Moreover, a company cannot modify the articles of association to issue reserve share capital. The purpose of reserve share capital is to make liquidation easier. Reserve capital represents the company's emergency funds and is subject to multiple restrictions. 
 
8.    Uncalled Share Capital
Uncalled share capital is shares issued but not claimed. Uncalled share capital appears in the company's contingent liabilities. It represents the balance amount after the adjustment of the called-up capital from the total shares allotted.
 

Representation of Share Capital in the Balance Sheet

Representation of Share Capital in the Balance Sheet  

The Balance Sheet of the company captures the types of share capital. Below is an extract of the same –

Balance Sheet of XYZ Ltd as of 31st March 

Liabilities

Shareholder's Funds:
1.    Share Capital
2.    Reserve and Surplus
3.    Money received against shares
 
Notes as per Schedule VI – 

Share Capital:

●    Authorized Share Capital
XX equity shares of Rs. (x) each
XX preference shares of Rs. (x) each

●    Issued Share Capital
XX equity shares of Rs. (x) each
XX preference shares of Rs. (x) each
 
●    Subscribed Share Capital
XX equity shares of Rs. (x) each
XX preference shares of Rs. (x) each
 
●    Called-up Share Capital
XX equity shares of Rs. (x) each
XX preference shares of Rs. (x) each
 
●    Paid-up Share Capital
XX equity shares of Rs. (x) each
XX preference shares of Rs. (x) each
Less: Calls in Arrears
Add: Forfeited shares
 

Advantages of Raising Share Capital

a.    Fixed Cost – Contrary to debt instruments, share capital restricts the company's fixed cost. While the company must pay interest on loans or fixed instruments, the dividend payment is voluntary.
 
b.    Creditworthiness – Investors and lenders prefer companies with a minimum level of share capital. Share capital signifies financial security. An overly leveraged company may raise concerns for liquidity or stability.
 
c.    Financial Flexibility - Share capital allows companies flexibility and discretion for fund usage. However, lenders may prescribe certain conditions to use capital. Companies also have a prerogative over issued capital and the share's nominal value. They may raise additional funds in the future.
 
d.    Default Risk - Share capital increases confidence level concerning default or bankruptcy. Shareholders have an inherent interest in the company's overall success and function in the company's best interest. 
 

Disadvantages of Raising Share Capital

a.    Control and ownership – Share capital bequeaths voting rights to investors. Hence, it reduces the control and ownership of founders.
 
b.    Share dilution – An additional share issue may dilute the cost of existing shareholders. It will also affect dividend payments and voting rights.
 
c.    Public Disclosure – Public companies are subject to extensive compliance and reporting requirements. Also, it provides more access to the public about the company's finances.
 
d.    Shareholder Risk – An increase in the nominal value of shares increase the shareholder's future limited liability. It is significant, especially in case of liquidation or winding up.
 
e.    IPO cost – The cost of an initial public offering is extremely high. It involves the preparation of a prospectus, underwriting cost, finance, legal fees, listing charges, and advertising.

Conclusion

Share capital is the par value of a company's asset. The sale of shares to the general public generates funds for the business and is a primary source of capital finance. However, the issue of shares has its pros and cons. Therefore, companies must carefully evaluate all possible alternatives while making financing decisions.