Every small business owner will have come across the concept of shares. A share refers to a unit of equity ownership in a business. They can be a financial asset ensuring equal distribution of profits in a company. The term "shares" is often used interchangeably with "stock". A company's share capital is the actual money invested into those shares which equal the total value of the company. These concepts can be a little overwhelming at first - this is why we've compiled this introductory guide to share capital in business.
Share Capital Definition
Share capital describes the nominal value (sum of each share's par value) of all shares of a company that have been sold to public investors. Shares are typically issued at what is called their nominal or par value.
Share capital is important for companies as it allows them to be divided up in regards to their ownership and control. It allows shareholders, depending on the percentage of shares they own, to have varying degrees of holding in a business.
Company A issues shares to public investors. The shares have a nominal, or par, value of GPB 500. In total, it issues 2,000 shares to public investors. This means that Company A's share capital amounts to GPB 1,250,000.
The Different Types of Share Capital
- Ordinary Shares: Ordinary shares are also referred to as "common stock" or "common shares". These stocks are sold on a public exchange and a share of stock typically gives its shareholder the right to vote at a company shareholder's meeting. However, the shareholder of an ordinary share is not guaranteed any dividends. Ordinary or common shares make up a large percentage of the share market.
- Preference Shares: Preference shares are also referred to as "shared stock". Dividends of preference shares get paid out to shareholders before any dividends for common shares get issued. The same principle applies to the business in question declaring bankruptcy - shareholders of preference shareholders are entitled to payment from the company's assets before the owners of a common share. However, preferred shareholders often do not hold voting rights.
- Cumulative Preference Shares: Cumulative preference shares ensure that shareholders are entitled to dividend payments that have been missed in the past. If the market value of a company goes up and down a lot, these shares can be a safer choice. Any monies owed must be paid to cumulative preference shareholders first (before other classes of shareholders). Cumulative preference shareholders are therefore less likely to miss out on capital gains.
- Redeemable Shares: Redeemable shares can be repurchased by the business issuing them. This is typically possible after a specific date or event. These shares also have a set call price, describing the price the company has to pay the shareholder upon redemption.
- Authorized Share Capital: This describes the number of shares a business can issue according to its memorandum of association or articles of incorporation. Often, a business's management will not issue all of the authorized share capital of a business in case the company needs to be paid in capital quickly later down the line.
- Issued Share Capital: This refers to the total amount of nominal value of stock that is held by existing shareholders. It represents the face value of what shareholders have invested in a company. The share capital of a business changes if new stocks get issued to existing or new shareholders or companies redeem or repurchase their shares.
Share Capital on a Balance Sheet
In its balance sheet, a company will report share capital in the "Shareholder's Equity" section. The information on shares is likely to be listed over several line items, including common stock, preferred stock, and additional paid-in capital.
Common and preferred stock are listed at their par value, but the "additional paid-in capital" line shows the real price paid over par for the shares.
Calculating Share Capital
There are several different formulas to calculate a company's share capital, depending on the business in question. For example:
- A company's share capital equals the issue price per share times the number of outstanding shares.
- A company's share capital equals the number of shares times the par value of stock plus the paid-in capital above par value.
Share Capital FAQs
- What is the purpose of share capital?
The purpose of share capital is for a business to be able to be divided up in regards to its ownership and control. It allows shareholders of that business, depending on the percentage of shares they own, to have varying degrees of holding.
- Is share capital an asset?
Share capital is not an asset. However, the shareholder purchasing the share does bring in capital in exchange, which then increases a company's assets.
- What are the advantages of share capital?
Share capital allows companies to raise capital without repayment requirements or interest payments. Depending on the type of share, dividend payments can also be halted by a company, which gives it additional flexibility. A business also has control over how many shares it issues, when to issue them, and what to charge for them. Shareholders, unlike creditors, can also not force the company into bankruptcy if it cannot make payments.
- What are the disadvantages of share capital?
With every share sold, ownership and control of the company seizes. Shareholders can vote on e.g., business deals and therefore substantially influence your company's future. If shareholders control a majority of the company, they may even be able to switch leadership of the business. Proportionally, shareholders also typically get a lot of stock for a low price due to the risk associated with a company halting dividends. There can also be considerable costs arising when a company first issues its shares (e.g., marketing or underwriting agreement).
- Is ordinary share capital an asset?
The ordinary shares capital can typically be found in the liability section of the balance sheet of a company.