What Are Authorized Shares?
Authorized shares limit the Number of shares that a company can issue. It is mentioned in the article of incorporation. Usually, companies set a higher limit right from the start. Then, any consecutive increase is put to the vote. This cap prevents existing shareholders’ holdings from being too diluted.
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A limit on authorized shares keeps the power struggle between the shareholders and management in check, especially during mergers. If the number of authorized stocks is too high, the board of directors becomes too powerful. In such scenarios, the target firm management can initiate defensive strategies against hostile takeovers.
Table of contents
- What are Authorized Shares?
- Authorized Shares Explained
- How to Calculate?
- Authorized Shares Vs Issued Shares Vs Outstanding Shares
- Frequently Asked Questions (FAQs)
- Recommended Articles
Key Takeaways
- Authorized shares limit the number of shares that a company can issue. It is mentioned in the company’s article of incorporation.
- The corporate charter must contain information about classes of shares and the maximum number for each class.
- If more than one share class is permitted, the article of incorporation must specify distinguishing designation for each class.
- To increase the number of authorized stocks, the firm requires consent from the company shareholders. This change requires majority approval—at least two-thirds must favor this move.
Authorized Shares Explained
Authorized shares restrict the maximum number of shares a company can issue without shareholder approval. This number is mentioned in the corporate charter. In the short term, a company’s stock sale cannot surpass authorized stocks.
Before venturing further, let us quickly define a share. A company issues ordinary shares to raise funds from public and private investors. They carry voting rights. They are also called common shares; they represent an investor’s equity. An investor’s equity or ownership in a company is proportionate to the number of ordinary shares. Shareholders do not receive a dividend by default.
The article of incorporation (also known as corporate charter) contains details about the class of shares and the maximum number of shares issued (for each class). If more than one share class is permitted, the article of incorporation must specify it clearly; so that the designation for each class can be distinguished.
The article of incorporation authorizes the following:
- One or more classes of shares collectively with unlimited voting rights.
- One or more share classes, which may be the same class or classes of shares with voting rights, that collectively are eligible to receive net assets upon dissolution.
The article of incorporation is a legal document submitted to the government. This document is required when a business registers as a corporation or non-profit organization. This document contains the company’s name, type, nature, address, and number of authorized stocks.
Authorized stocks restrict the number of shares a company can issue without permission (from shareholders). Increasing this number is a tedious process; the firm drafts a proxy, the proposal is reviewed by the SEC, and the charter undergoes several changes. In addition, the firm requires the approval of majority shareholders (two-thirds). And this process can take several months. If successful, a shareholder’s meeting is scheduled. Sometimes, it is conducted to discuss the increase in shares.
Limiting authorized share capital balances the power struggle between the company’s management and its shareholders. This is especially crucial during a merger or tender. In hostile takeovers, target firm management could engage in certain defensive strategies. The poison pill is one such strategy. Firm owners use the poison pill to deter unwelcome investors, rivals, or potential buyers from acquiring a controlling stake in the business.
Alternatively, the target management could offer a top-up option to the acquirers to speed the deal completion (hostile takeovers). When the target company speeds up the process, it discourages competing bids. In both strategies, the target firm requires unissued authorized shares in excess.
Thus, the Board of Directors does not need shareholder approval if a company possesses enough shares. On the other end of the spectrum, limiting the authorized shares prevents unfair practices (curtails the board’s decision-making ability).
How To Calculate?
Let us discuss how to calculate authorized shares.
In most cases, the number of issued stocks is considerably fewer than that of authorized stocks. Here, the number of issues stocks refers to shares sold by the firm to shareholders.
Authorized stocks also comprise shares issued to the public. Thus, the following formula is used for calculation:
- Authorized Shares = Shares Issued + Yet to be Issued Shares
Authorized Shares vs Issued Shares vs Outstanding Shares
Let us look at authorized shares vs issued shares vs outstanding shares comparisons to distinguish between them:
| Key points | Authorized shares | Issued shares | Outstanding shares |
| Definition | These many shares can be issued to the public. The articles of incorporation document it. | It refers to shares issued to the general public; the buyers are termed: “shareholders.” | They are shares issued by a company after the deduction of “treasury”. |
| Difference | Subscribed capital represents a portion of the authorized capital. To purchase from the company’s treasury, shareholders’ consent is required. | It includes treasury stocks. | It does not include treasury stocks. |
| Status in financial statements | It is reported in the financial statements. | They are not reported in the financial statements. | They are reported in the financial statements. |
| Voting Rights | It includes various classes of shares. i.e., can contain shares with voting rights and without. | Includes treasury stocks that do not possess voting rights. | They may or may not have voting rights. |
| Quantity | The number of authorized shares always exceeds the number of issued and outstanding shares. | The number of issued stocks is fewer than the authorized stocks. | Fewer than authorized stocks. |
Frequently Asked Questions (FAQs)
Authorized stocks can be increased, but it requires consent from the company shareholders. Usually, such changes are proposed during the annual shareholder meeting. This change requires majority approval—at least two-thirds must favor this move. Consequently, the company’s corporate charter is amended. These changes need to reflect in the company’s article of incorporation.
The number is mentioned in the article of incorporation (also known as the corporate charter). The shares are estimated based on business goals, current and future funding needs, employee perks, etc. Any future increases can be accommodated by getting shareholders’ permission.
The shareholder’s consent and vote can change the number of authorized stocks (by the prescribed law). To increase this number, approval by two-thirds (majority) is required. These decisions are discussed in shareholder meetings.
Recommended Articles
This article has been a guide to what are Authorized Shares. We compare them with issued and outstanding shares and explain how to calculate them. You can learn more about it from the following articles –
- Transfer of Shares
- How To Buy Shares?
- Ordinary Shares Capital
This post first appeared on Free Investment Banking Tutorials |WallStreetMojo, please read the originial post: here
