Share capital is one of the ways that some of the world’s largest businesses were able to raise money to reach their current market position.
What is share capital, and what is strategic finance for businesses?
Let's find out.
Understanding Share Capital
Share capital allows companies to raise money by issuing either preferred or common stock to an investor. Businesses report this figure on their balance sheets under the shareholder equity section on the sheet.
Multiple lines on the balance sheet may show share capital, including:
- Common stock
- Preferred stock
- Paid-in capital
While the stock may be sold in multiple ways, the only way that share capital is purchased is directly from the company itself. The company must receive the funds directly for it to count as share capital.
If, for example, you purchase 100 shares of Amazon today, this is not considered share capital if it’s purchased from another shareholder that bought the stock after the business’ IPO.
Definition and Types of Share Capital
A business share capital definition is: money a company raises by issuing its common or preferred stock. On an accounting basis, you’ll find a few types of share capital, by definition, that may be listed:
Authorized Share Capital
“Authorized share capital” is defined as the number of shares that can be sold off to raise money. Companies must seek permission to sell stock and outline:
- Total amount of equity that the company must raise
- Base share value
Authorized capital is the total capital a company can raise by selling its share capital. If you want to raise $10 million, you can, but it must be authorized. For example, if you have permission to raise this amount, it is irrespective of the value of the stock.
You would sell 1 million shares at $10 or 10 million at $1, but you cannot raise more than the $10 million of authorized share capital.
Issued Share Capital
On top of authorized capital, there is also “issued share capital.” What does this mean? This is the value of the shares the company agrees to sell to investors.
Share Capital on a Balance Sheet
Company balance sheets show a lot of information, and share capital is one of the items on your sheet, too. Share capital is also known as “par value” of your equity securities. Since the value may vary based on the definition, it’s crucial to see an example:
- Company A sells 10,000 shares of stock
- Stock par value is $1
You might assume that the share capital was $10,000, but this may not be the case. Par value, often $1 or less, doesn’t always reflect the actual value of the stock. The stock may have sold for $10 a share, raising $100,000 in the process.
On your balance sheet, your accountant may include the following line items:
- $10,000 in share capital
- $90,000 ($100,000 - $10,000) in paid-in capital
Reading through a company’s balance sheet will help you determine if the business has sold share capital or not. It will also show you how to calculate share capital, enabling accurate inferences regarding a company’s financial health.
Importance of Share Capital
While it’s essential to know the share capital meaning, it’s equally important why companies issue them.
Share capital is important if you want to raise money by selling shares in your business. You'll lose some equity and potentially need to pay dividends to shareholders. Here are the advantages of share capital for raising funds to your business:
- The business does not have to take out a loan to raise capital
- No lender requirements exist to raise funds
- Interest payments do not exist
- Funds raised through the sale of share capital can be used for anything
Raising Funds
Share capital allows companies to raise money to:
- Expand their operations, generating more revenue and the potential to attract a higher market share
- Invest in new opportunities, such as acquiring another company or funneling money into new products or services
- Maintain enough capital to keep operations running, raising working capital in the process
Many companies nowadays resort to share capital for their growth and expansion plans. Here are a few great examples:
Amazon - IPO in 1997
Amazon issued shares to the public, raising $54 million, which it used to enhance its operations and logistics network.
Facebook/Meta - IPO in 2012
The company raised $16 billion to enhance its platform and acquire other companies—solidifying its position in the market.
Tesla - Multiple Share Issuances
Tesla issued shares to raise capital on multiple occasions. One occurred in 2020 when it raised $5 billion to fund its production expansion and new Gigafactories. This share issuance enabled the company to scale its operations and stay ahead in the EV market.
However, raising capital using this method is not without its disadvantages. For example, you may give up some control in the company through issuance. Most owners and founders will not allow enough shares to be issued that they lose control over the company.
Shareholders will have rights within the company since they own a small portion of the company in stock.
If a single shareholder does accumulate a majority of the company’s shares, they can take a controlling vote in the company and dictate its future. Depending on the shares and agreements in place, you may have to pay dividends back to the shareholders.
You may also engage in stock buyback, which is a way to repurchase stock and regain control of the company, and not need to continue paying dividends to shareholders.
Shareholders do want to have higher value for their investments and will need to be updated on the company’s financials and operations.
Another risk lies in the market’s volatility and share price. Large share issuances may cause share prices to drop. Remember, the larger the supply, the lower the prices.
You can avoid this risk by strategically timing your share capital issuances, such as during a bullish market. This ensures strong investor confidence and maintains share price stability.
Financial Stability and Creditworthiness
Share capital is the money raised by a company by issuing preferred or common stock, so it directly impacts the business’s financial stability.
The money raised from the issuing of stock can be used to pay debts, cover expenses, pay staff and continue operations. In short, it contributes to the company's financial stability. Having more capital can also help improve the business’s creditworthiness.
Methods of Raising Share Capital
There are several methods of raising share capital, including:
- Initial Public Offering (IPO): Companies list their shares on a stock exchange, offering them to the public for the first time.
- Private Placements: Selling shares directly to select investors, like institutional investors and private equity firms, instead of the public.
- Follow-on Offerings: Publicly traded companies can issue new shares to raise more funds after their IPO.
- Employee Stock Options (ESOPs): Offering shares to employees as part of compensation raises capital while incentivizing staff.
These methods of raising share capital have unique benefits and risks. Always evaluate your needs and the market to determine which one best suits your business.
Advantages and Disadvantages of Share Capital
Using share capital as a financial strategy for business means you understand what it means to use it for raising capital. Let’s break them down below.
| Aspect | Pros | Cons |
|---|---|---|
| Debt Obligation | No repayment required; no interest burden | N/A |
| Fundraising Potential | Allows large-scale capital raising for expansion and innovation | Issuing shares at a low market price can reduce shareholder value. |
| Financial Risk | Spreads financial risk among shareholders | Market fluctuations may undervalue the company. |
| Control and Ownership | N/A | Dilutes ownership; investors may influence decisions. |
| Profit Sharing | N/A | Shareholders expect dividends or stock value appreciation. |
| Market and Regulatory Pressure | Enhances credibility and market presence. | Requires strict regulatory compliance and public disclosures. |
| Employee Incentives | Stock options attract and retain talent. | Dilutes existing shareholder stakes. |
| Cost and Time | N/A | IPOs and share issuances are expensive and time-consuming. |
Understanding share capital advantages and disadvantages allows you to make informed decisions regarding operations and growth.
Share Capital and Ownership
Share capital plays an integral role in a company’s ownership and decision-making. It’s important to understand the relationship between share capital and ownership.
Relationship Between Share Capital and Ownership
Share capital determines ownership and control within a company. When a stakeholder holds at least 50% of outstanding shares in a company, they gain controlling interest, or have the ability to control the corporation’s decisions.
Equity and Share Capital
Share capital is the portion of the company’s equity raised from issuing preferred or common shares. It differs from other types of equity.
Conclusion
Share capital plays an important role in business. The money raised from issuing preferred or common stock can help improve a company’s financial stability and creditworthiness, raise funds and more. It directly affects ownership and equity as well.
Because it plays such a crucial role in a business’s finances, share capital should be well-managed to support financial growth and health.
By fully understanding share capital and its concepts, you can create a new strategic finance meaning that enables you to grow your business without any hindrances.
Frequently Asked Questions (FAQs)
How is share capital calculated?
Share Capital = Number of Shares Issued x Par Value per Share
What are the advantages of share capital?
It includes no loan repayments or interest, helps raise funds for growth, and reduces financial risk, making it a great financial strategy for business.
What are the disadvantages?
Issuing share capital means losing some of the control you have with the company. Shareholders may also expect returns from their investments, and stock prices could fluctuate depending on market conditions and business performance.
What are the types of share capital?
The categories of share capital include authorized share capital, issued share capital, and paid-up capital.
How do companies raise share capital?
Raising share capital can involve IPOs, private placements, follow-on offerings, rights issues, and employee stock options.
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