Last Updated on December 19, 2024 by admin
Every business owner can attest that raising sufficient funds to expand or achieve your business objectives can be challenging. Businesses can get finance through loans, investments, or share capital depending on the business funding requirement and business strategy. Understanding the advantages and disadvantages of share capital is crucial to making informed financial decisions for your business.
Does share capital affect the ownership of your business? In this article, we will highlight ways a company can utilise share capital in fundraising; the merits and demerits associated with share capital; and other effects on the firm and its members.
What is share capital?
Share capital is the total value of shares that a limited company has sold. It pertains to the portion of a company’s internal finance which consists of the total value of the shares distributed to all the shareholders.
Share capital can be used for many other purposes by the companies like, for instance, covering the costs that arise upon the registration of a new company, expansion of an already functioning enterprise, maintenance of its day-to-day operations, or even making purchases. This enables corporations to go about their activities without having to borrow money.
At the time of UK company incorporation, limited companies are obligated to assign an initial nominal value to each share. For example, if a company issues 100 shares at a nominal value of £1 per share, the cumulative nominal value would be £100.
In common practice, investors purchase shares in anticipation of the returns in the form of a rise in the share price, termed as appreciation of capital, and/or dividends. Thus, capital structure has an impact on ownership, control, and decision-making within the organisation. Shareholders have limited liability which extends only to the payment for the shares they own.
What are the different types of shares in a limited company?
In a private limited company, several types of shares can be issued, each with different rights and characteristics. The typologies of shares available and issued by privately held firms go further to include:
Ordinary shares (common shares):
Ordinary shareholders are considered the most basic form of ownership in the corporate structure. Generally, ordinary shareholders are given the right to vote and therefore can make decisions in matters like the election of directors or decisions that require majority approval such as mergers, acquisitions, and dissolution. They might also be entitled to some dividends although the payment of such dividends cannot be assured and often fluctuates with the business performance.
Preference shares:
Preference shares are a class of shares that give holders preferential rights over ordinary shareholders in certain aspects. Generally, a fixed amount of dividends is paid to the preference shareholders before any dividends are declared on the equity shares. They also generally rank above the equity shares in the event of a winding up of the company such that they are paid up their capital prior to ordinary equity shareholders being paid up their capital. Nonetheless, it is likely that preferred shares come with little to no rights to vote.
Redeemable shares:
Redeemable shares are a type of preference share that a company can buy back or redeem at certain times or under specific conditions. Shareholders may receive dividends, but the main characteristic is that the company has the option to repurchase the shares, typically at a predetermined price.
Non-redeemable shares:
These shares cannot be redeemed by the company, meaning the company retains them as permanent equity. Holders of non-redeemable shares have rights similar to ordinary shareholders but cannot compel the company to buy back their shares.
Cumulative preference shares:
Cumulative preference shares are a type of preferred share where unpaid dividends accumulate over time. If the company is unable to pay dividends in a particular year, those dividends will accumulate and must be paid in future years before dividends can be distributed to ordinary shareholders.
What are the advantages of share capital?
Fund availability: Capital generation can also happen for a firm through the issue of shares, and such a firm can raise considerable funds without borrowing. Such capital may be used for a variety of things including broadening current operations, rolling out new products, or investing in that firm’s technologies, among others.
Non-repayment constraint: As opposed to loans, share capital is a form of financing that does not attract an obligation of repayment. In other words, investors’ confidence in a business and its prospects leads them to buy shares expecting returns, but the business has no obligation to return any capital nor pay dividends or compound interest on the capital.
A great deal of financial options: Practically, any company can take common finance, and depending on how much cash is needed, the company can decide on whether to issue preference shares, common shares, redeemable shares, etc. This helps to attract various categories of investors.
Improved balance sheet: As opposed to borrowing, which has several constraints, a company seeks to recruit additional resources by issuing equity shares thus boosting the company’s net worth. A healthier equity base can also make it easier for the company to raise financing in the form of loans in the future when the company seeks to raise additional funds to support its operations.
Luring the investors: Issuing additional shares may encourage more investors including retail and institutional investors who wish to buy a part of the company. This may further enhance the company’s profile in the market.
Possibilities for growth and development: The funds raised from the sale of the shares can be plowed back into the business for growth and expansion which will in turn lead to an increase in revenues, market share, and possibly the stock price.
Capability to motivate staff: Companies are availed with the option of utilizing share capital to promote employee stock options or employee share ownership plans (ESOP). This is useful in ensuring motivation and retention of employees, as it makes them part owners and consequently aligns their interests with those of the shareholders.
Limited liability: A person that has purchased shares in a company and is a member is normally a person with limited liability and for this reason, he is only liable for any debts incurred by the company to the extent he subscribed to the shares. This ensures that people’s belongings are not drawn into and minimises risks associated with capitalists.
Widespread stock ownership: Share issuing enables companies to widen ownership which helps to mitigate risks and also enables the company to tap into skills and knowledge from different and varied shareholders.
Promotes patience capital: Share capital is likely to promote a patient form of capital since capital investors in shares are known to look for appreciation of the value of the shares and dividends after some time. This helps in creating a stable base of investors.
Enables firms to engage in acquisition: Share capital can also work as a means for acquisition whereby a firm can offer its own share to the target company in its payment for the acquisition of the said target entity.
What are the disadvantages of share capital?
Dilution of ownership: Issuing additional shares can dilute the ownership percentage of existing shareholders, reducing their influence over company decisions and their proportional share of dividends.
Loss of control: The control of the company by the original owners or founders may be jeopardized as the company releases more shares, especially to outside investors. This is even more accurate if new shareholders attain voting rights that allow them to participate in making critical decisions regarding the business.
Costs of issuance: The process of raising funds through share capital may incur direct costs such as legal expenses, underwriting, and administrative costs that may be significant. These kinds of expenses tend to reduce the net capital that is mobilised.
Anticipated dividends: When an individual purchases or holds shares, he or she, in some instances, may get used to the notion of receiving dividends, which raises the chances of the management choosing cash transfer to the shareholders rather than reinvesting the funds for the expansion of the operations. In instances where dividends are not paid out to shareholders’ satisfaction, discontent may prevail among them and consequently lead to a fall in the price of the company’s shares.
Difficult statutes: Issuance and selling of shares of certain private and public corporations are governed by a complex regulatory structure. This may add to the administrative costs and make it difficult to meet the regulatory requirements.
Market fluctuations: For public companies, share prices are subject to market conditions and investor sentiment, which can lead to negativity that doesn’t necessarily reflect the company’s actual performance. This erratic nature of the business can have implications on the finances of the firm and the trust of the stakeholders. Causes for Conflicts of Interests: Different aims are pursued by new classes of shareholders as compared to the existing ones as well as management and this creates a conflict of interest. Hence animosity between stakeholders becomes inevitable.
Conclusion
In conclusion, even though share capital could be a handy tool for financing growth and implementing strategic plans, several disadvantages should be factored in for business aims and the importance of shareholders. Businesses need to analyze the advantages and disadvantages of share capital against the requirements of the business and its objectives in the long run to ensure decisions made serve the best interest of all parties involved.
FAQs
Q: What is called up share capital?
Ans: Called-up share capital refers to the portion of issued share capital that a company has requested shareholders to pay. When a company issues shares, they can ask for the payment to be made immediately or in installments.
Q: What is ordinary share capital?
Ans: Ordinary share capital is essentially the backbone of a company’s funding. These shares grant shareholders part-ownership of the company, voting rights at shareholder meetings, and the potential to earn dividends. Unlike preferred shares, ordinary shares don’t guarantee dividend payouts, but they come with the perk of having a say in the company’s direction.
Q: Do you pay capital gains on shares?
Ans: Yes, you do. When you sell shares for more than you paid for them, the profit is called a capital gain, and it’s generally subject to capital gains tax. The specifics depend on your country’s tax laws, so the rules can vary.
Q: Is share capital an asset?
Ans: Nope, share capital itself isn’t considered an asset. It’s recorded as equity on the company’s balance sheet. When investors buy shares, the money they pay increases the company’s assets (cash, etc.), but the share capital reflects the ownership stake of the shareholders in the company.
Q: How to check the share capital of a company?
Ans: To check a company’s share capital, you can follow these steps:
- Company’s Financial Statements: Look at the company’s balance sheet, which is part of its financial statements. Share capital is usually listed under the shareholders’ equity section.
- Company’s Annual Report: Publicly traded companies publish annual reports that include detailed financial information, including share capital.
- Securities and Exchange Commission (SEC) Filings: For companies in the U.S., you can check their filings with the SEC, such as the 10-K or 10-Q reports.
- Company’s Website: Some companies provide financial information directly on their websites, including their share capital.
- Financial Databases: Use financial databases like Bloomberg, Yahoo Finance, or Morningstar, which provide detailed company financials.
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