Authorized capital, often referred to as authorized share capital or nominal capital, represents the maximum number of shares, or the maximum amount of share capital, that a company is permitted to issue as stated in its corporate charter. This is a critical element of a corporation’s capital structure and is defined and governed by the corporate laws of the country where the company is incorporated.
Definition and Importance in Corporate Finance
Definition
Authorized capital can be formally defined as:
Where:
- Number of Shares is the total shares a company is allowed to issue.
- Par Value per Share is the nominal or face value assigned to each share.
Importance
- Capital Structuring: It plays a crucial role in the capital structuring of a company, determining the potential equity it can raise.
- Financial Flexibility: By setting a higher authorized capital, companies maintain flexibility to issue shares in the future without the need for corporate reorganization.
- Investor Confidence: Assures investors that the company has the capability to raise additional capital when required, thus supporting growth and stability.
Types of Share Capital Related to Authorized Capital
- Issued Capital: The portion of authorized capital that has been offered for subscription to investors.
- Subscribed Capital: The portion of issued capital that investors have agreed to purchase.
- Paid-up Capital: The actual amount received by the company from shareholders in exchange for shares.
Examples
- Example 1: A company is authorized to issue up to 1,000,000 shares with a par value of $10 each. Thus, its authorized capital is $10,000,000.
- Example 2: A startup may initially set a high authorized capital to allow for future expansion, such as $500,000 with shares valued at $1 each.
Historical Context
Historically, the concept of authorized capital originated to give clear legal boundaries within which companies could operate, preventing the dilution of shareholder value and protecting creditors’ interests. Over time, regulations have evolved to adapt to diverse corporate structures and financing needs.
Applicability in Business
Incorporation Process
When incorporating a company, it must declare its authorized capital in its articles of incorporation. This declaration sets a legal cap on the maximum capital that can be raised through equity issuance.
Regulatory Filings
Changes to authorized capital often require approval from the shareholders and must be filed with regulatory bodies, ensuring transparency and adherence to corporate governance standards.
Related Terms with Definitions
- Equity: The ownership interest held by shareholders in a corporation.
- Par Value: The nominal value of a share as set in the company’s charter.
- Shares Outstanding: The number of shares that have been issued and are currently held by investors.
- Stock Split: A corporate action that increases the number of the company’s shares by dividing each existing share.
- Shareholder’s Equity: The net value of a company, calculated as total assets minus total liabilities.
Frequently Asked Questions (FAQs)
1. Can a company exceed its authorized capital?
No, a company cannot issue shares beyond its authorized capital without amending its corporate charter, which usually requires shareholder approval.
2. How does authorized capital affect a company’s valuation?
Authorized capital does not directly impact a company’s valuation but provides the potential to raise additional funds and expand, influencing long-term valuation.
3. Is there a minimum or maximum limit for authorized capital?
Minimum and maximum limits may be dictated by the jurisdiction of incorporation and industry-specific regulations.
References
- Ross, S.A., Westerfield, R.W., & Jaffe, J. (2016). Corporate Finance. McGraw-Hill Education.
- Brealey, R.A., Myers, S.C., & Allen, F. (2017). Principles of Corporate Finance. McGraw-Hill Education.
- Companies Act [Specific Country’s Legislation] – Section [Relevant Sections Addressing Share Capital].
Summary
Authorized capital is a foundational element in corporate finance, outlining the maximum equity a company can issue as specified in its corporate charter. By understanding authorized capital, businesses can manage their capital structuring more effectively, maintain financial flexibility, and assure investor confidence while abiding by regulatory requirements.
