Oran Hall | Why companies create new shares
The Financial Gleaner of September 29, 2023, carried a report stating that food manufacturing and distribution company Seprod received approval from its shareholders to increase its authorised share capital. This will allow the company to put more of its shares into the hands of investors and allow it to raise more capital.
When a company is being set up, its directors determine what its authorised shares and authorised share capital will be. The former refers to the maximum number of shares that the company will have, and that can change from time to time
As normally happens, the shareholders are required to give their approval. The latter refers to the dollar value of the shares. It is determined by multiplying the number of shares by their face value.
The face value is also called the nominal value or the par value and is not the same as the market price, which is determined by the market, so it fluctuates as the stock trades. The market price is influenced by market conditions and how well the company is doing and is expected to do. Some companies issue shares that have no par value, however.
The par value of a stock generally remains unchanged except in the case of a stock split. In this case, there is a division of the shares such that the number of shares that the investor owns increases to reflect the change in the par value. For illustration: the nominal value of the ordinary shares of ABC Company Limited is $1. It declares a stock split of four for one. This results in the par value becoming 25 cents and the investor’s shareholding increasing fourfold from, for example, 1,000 to 4,000 shares.
A company need not issue all of its authorised shares. Thus, the issued shares owned by investors may be less than the number of authorised share capital. This gives the company the latitude to issue the remaining shares later. For example, the company may choose to offer bonus shares to shareholders in the future. These shares are issued to them in proportion to their existing shareholding. Thus, when a company declares a one-for-two bonus issue, each shareholder receives an additional share for every two owned.
As the shareholder does not pay for the new shares, the company receives no cash. What effectively happens is that the new shares are paid for from the profits retained in the company. This action does not change the value of the shareholders’ funds, also called shareholder equity. It does make a change, though, as the retained earnings are reduced by the same amount that the value of the issued shares increases by.
The increase in the number of issued shares is constrained by the authorised shares because the issued shares cannot be more than the authorised shares. When it becomes necessary to issue more shares than the unissued shares, the company has to increase the number of authorised shares, thereby facilitating the creation of new shares.
A company may also use a rights issue to put more shares into the hands of its shareholders. In this case, it gives them the right to buy shares directly from it at a price that is usually below the market price, but they may renounce their rights and sell them to another person who can exercise them. The company raises new money from a rights issue but must increase the number of authorised shares if the shares it proposes to offer to its shareholders exceed the difference between the existing authorised shares and issued shares.
More recently, listed companies have been making additional public offerings, which are invitations to their shareholders and other members of the public to buy their shares. If the new shares to be issued are more than the difference between the authorised shares and the issued shares, the company must increase its authorised shares sufficient to at least cover the gap, but it has to be voted by the shareholders at a duly constituted general meeting.
The shares may be offered to the public at a discount, and an application has to be made for them to be listed on the stock exchange. Additionally, the company is required to issue a prospectus to enable the public to evaluate the merits of the offer.
The funds a company raises from a rights issue and an additional public offering represent permanent capital, which it does not return to its shareholders.
The new capital can be used for several purposes, including to diversify its operations, to reduce debt, to finance acquisitions, and to expand its scale of operations. To the extent that the company becomes more profitable, the wealth of its shareholders increases as the price of the shares increases.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.