What are Authorized Shares?

Importance

Authorized shares are one of the ways through which companies raise funds. When a startup or an already established company wants to raise funds, there are basically four ways it may do so:

• Contributions from the business founders, their family, or friends.
• Taking a loan out from the bank.
• Issuing debt instruments.
• Issuing equity securities.

If the company decides that it will raise funds through equity securities, then there needs to be a provision for that in its certificate of incorporation. The certificate of incorporation is a legal document that outlines the roles and responsibilities of a company’s directors, how and to what extent shareholders exert control over the directors, the business objectives and the kind of business to be undertaken, the maximum number of shares they will offer, the types of shares they will issue, etc. It also governs all external and internal affairs that can affect the business.

Authorized share capital

Generally, companies set the maximum number of shares they will issue to ten million shares or more depending on how much funds they hope to raise through the sales of shares.

In some situations, some companies might decide to increase or decrease the maximum number of shares they can issue, if this arises, the current shareholders of the company will vote on the matter at a shareholder’s meeting. If the majority of the shareholders vote in favor of the change, then, the maximum number of shares can be increased or decreased; depending on what they want to do. The stock structure in its articles of incorporation is then changed to reflect the increase.

The number of shares a company has already issued is known as its outstanding shares. The authorized shares of companies are normally significantly higher than their outstanding shares; this enables the companies to offer more shares in the future. It is important to note that a company’s outstanding shares can never be more than its authorized shares; instead, they can be lesser or equal to them. The total funds a company can raise from the sale of all of its authorized shares is known as the authorized share capital or the nominal capital.

Authorized shares are also known as authorized stock. The authorized shares are mathematically expressed as; Authorized shares = Issued shares + Unissued shares.

Reasons why a company might not issue all its authorized shares

1. Maintain ownership
2. Raise funds in the future

Listed above are the major reasons why companies do not issue all their authorized shares at once. we shall discuss them further below:

Maintain ownership

Companies typically do not issue all their authorized shares at once during their initial public offering (IPO). Shares represent ownership in the company and grant shareholders the benefits of being part of the corporate and other operational decision-making processes that are voted on.

Therefore, the founders of the company reserve the larger part of the shares such that they will have a higher share in the company. This consequently means that they will have the deciding vote in the company matters similar to the golden shareholder. It is especially useful to prevent the company’s competitors from taking over the company through a hostile takeover.

Raise funds in the future

Companies usually offer a part of their authorized shares and leave some for future offers to investors. They do so to have more shares that they can offer to investors in a situation where they need to raise funds for the company and want to do so through the sale of shares.

Related: What are stock options?

Types of authorized shares

1. Common shares
2. Preferred shares
3. Restricted shares

Listed above are the three types of shares that companies usually issue. There are cases whereby a company may decide to repurchase some of the stocks it has already issued. They may do this in order to reduce their outstanding shares which might help boost their stock price. All the previously issued shares of a company that it repurchases are known as treasury shares.

Common shares

Types

1. Blue-chip stocks
2. Cyclical stocks
3. Defensive stocks
4. Growth stocks
5. Income or dividend stocks
6. Large-cap stocks
7. Mid-cap stocks
8. Penny stocks
9. Small-cap stocks
10. Speculative stocks
11. Value stocks
    

Features

1. Common shareholders have the right to vote on all processes that require voting. They can also attend annual and general meetings.
2. They typically have no maturity date which makes them a good source of permanent capital for the issuing company.
3. It gives its holders a residual claim on the issuing company’s distributions and assets at liquidity.
4. They are the most commonly issued shares and they are more likely to experience an upward increase in price which can serve as a source of capital gain for the shareholder.

Preferred shares

Types

1. Convertible preference shares
2. Cumulative preference shares
3. Exchangeable preference shares
4. Monthly income preferred stock (MIPS)
5. Noncumulative preferred stock
6. Nonparticipating preferred shares
7. Participating preference shares
8. Perpetual preferred stock
9. Preference preferred stock
10. Prior preference shares
11. Putable preferred stock

Features

1. Preferred shareholders receive a fixed and regular dividend payment either annually, quarterly, or monthly depending on what was stated in their prospectus.
2. They confer preference on their holders when it comes to having a claim on distributions and assets at liquidity.
3. They typically do not have voting rights and can therefore have no say in the issuing company’s affairs.
4. Preferred shares generally have no maturity date which makes them a good source of permanent capital for the issuing company. The ones with maturity dates have a long maturity date ranging from thirty years and above; these are a source of long-term capital.

Restricted shares

Types

1. Restricted share awards (RSAs)
2. Restricted share units (RSUs)

Features

1. They are usually issued to employees
2. Restricted shares have performance-based, time-based, or a combination of both as conditions for their issue.
3. They are issued for free or at a discounted price.

Conclusion

Whether you are an individual investor or a company, understanding what authorized shares are, is important. As a company, it guides you in protecting your company from a potential hostile takeover by your competitors and also serves as a source of long-term capital whenever you offer these shares to investors.

For individual investors, the authorized shares tell you the percentage ownership you have when you purchase the shares of a particular company as each share issued represents a fraction of ownership in the issuing company.

Additionally, it gives you insight into the possibility of the company decreasing or increasing its authorized shares.

An increase is likely to happen if the number of outstanding shares is almost equal to or equal to the authorized shares. A decrease might be likely if the current outstanding shares are far below the authorized shares. It is however not a common happening for companies to increase or decrease their authorized shares.