Incorporating a company involves numerous financial and legal considerations, one of which is establishing an initial capital structure. Share capital is a crucial component of a company's structure, representing the funds raised by issuing shares to shareholders.
This article explores what share capital is, its various types, and its significance in corporate finance.
What is Share Capital?
Share capital is the aggregate amount of funds a company generates by issuing shares to its shareholders. This capital forms the financial backbone of a company, enabling it to fund operations, invest in growth, and fulfil long-term objectives.
When a company issues shares, it essentially allows investors to buy ownership in the company, making them shareholders who hold equity in the organization.
Share capital plays a critical role in a company’s financial structure, as it represents a commitment from shareholders and allows the company to operate without relying solely on debt.
The capital structure generally involves two main types of funding:
Equity financing (through share capital) and
Debt financing (through loans).
Equity financing, achieved through share capital, helps balance the company's capital structure and minimize debt risks.
More details can be shared when, you consult company secretary consultant.
Importance of Share Capital
Share capital is fundamental for various reasons:
- Fundraising: Share capital allows a company to raise substantial funds without taking on debt obligations.
- Ownership and Control: Issuing shares divides the ownership of the company, enabling control to be spread across multiple shareholders.
- Creditworthiness: A well-capitalized company is often perceived as more creditworthy by financial institutions, enhancing its ability to secure loans.
- Growth and Expansion: Share capital enables companies to invest in expansion, purchase assets, and pursue long-term strategies.
Types of Share Capital
The types of share capital can be categorized based on different aspects, including the rights attached to shares, the company’s structure, and legal classifications. Here’s a look at the main types of share capital:
1. Authorized Share Capital
Authorized share capital, also known as nominal or registered capital, is the maximum amount of capital that a company is legally permitted to issue to shareholders. This limit is established during the company's incorporation and stated in the Memorandum of Association (MOA).
For example, if a company’s authorized share capital is set at ₹50 lakh, it can only issue shares worth ₹50 lakh to its shareholders unless it follows legal procedures to increase this limit.
Significance:
- Sets an upper limit on the funds the company can raise through equity.
- Requires regulatory approvals and specific procedures to increase.
2. Issued Share Capital
Issued share capital is the portion of authorized capital that a company has officially allocated to shareholders by issuing shares. When a company decides to raise funds by issuing shares, it only issues a part of its authorized capital, which becomes the issued share capital.
For instance, if a company has authorized share capital of ₹50 lakh but has only issued shares worth ₹30 lakh, then ₹30 lakh is the issued share capital.
Significance:
- Reflects the actual value of shares distributed to shareholders.
- Helps maintain a reserve within the authorized capital for future funding needs.
3. Subscribed Share Capital
Subscribed share capital is the portion of issued capital that investors have subscribed to, meaning they have committed to purchase it. Companies may not have all their issued shares subscribed to by investors.
Example: If a company issues shares worth ₹30 lakh, but shareholders subscribe to only ₹25 lakh, then the subscribed capital is ₹25 lakh.
Significance:
- Indicates the level of investor interest in the company's shares.
- Helps gauge market perception and trust in the company.
4. Paid-up Share Capital
Paid-up share capital is the amount of subscribed capital that shareholders have paid to the company. It represents the actual funds received by the company from its shareholders and forms the working capital the company can use immediately.
For example, if a company has ₹25 lakh in subscribed capital but has received only ₹20 lakh, then its paid-up share capital is ₹20 lakh.
Significance:
Indicates the company's available liquid capital for immediate use and affects its financial flexibility and overall solvency.
Classification Based on Rights and Preferences
Beyond these structural classifications, share capital can also be divided based on rights and privileges attached to different classes of shares. The two primary categories under this classification are Equity Share Capital and Preference Share Capital.
5. Equity Share Capital
Equity share capital refers to the funds raised through ordinary shares, which represent ownership in the company. Equity shareholders have voting rights in the company and may receive dividends based on profits. However, they carry the highest risk, as they are the last to receive returns in case of liquidation.
Significance:
- Grants shareholders ownership and voting rights.
- Provides residual claims on profits after preference dividends.
6. Preference Share Capital
Preference share capital is raised by issuing shares that offer preferential rights over equity shares regarding dividends and asset distribution upon liquidation. Preference shareholders receive dividends at a fixed rate and are paid before equity shareholders. However, they lack voting rights.
Types of preference shares include:
- Cumulative: Dividends accumulate if unpaid in any given year.
- Non-Cumulative: Unpaid dividends do not carry over.
- Convertible: Convertible to equity shares after a certain period.
- Non-Convertible: Cannot be converted to equity shares.
Significance:
- Offers a less risky investment option for shareholders.
- Provides companies with capital without diluting control or incurring heavy interest obligations.
How Share Capital Impacts Company Structure and Governance
A well-defined share capital structure can:
- Influence Decision-Making: The number of equity shareholders impacts voting outcomes in company decisions.
- Affect Funding Flexibility: Companies with sufficient authorized and issued capital have greater flexibility to raise funds without restructuring.
- Enhance Credibility: A sound capital structure shows stability and trustworthiness, making it attractive to investors.
Conclusion
Understanding the types of share capital and their implications is crucial for shareholders, potential investors, and corporate decision-makers. When you consult any certified company secretary you can get clear picture of it.
