Which Is The Best Description Of Authorized Shares

Authorized shares represent the bedrock of a corporation's capital structure, defining the upper limit of stock it can legally issue. Understanding authorized shares is crucial for investors, corporate executives, and anyone involved in the financial aspects of a company.

Defining Authorized Shares: The Foundation of Corporate Stock

Authorized shares, sometimes referred to as authorized stock or the corporate charter, represent the maximum number of shares a company is legally permitted to issue. This number is established during the company's incorporation and is documented in its articles of incorporation or corporate charter. It's essential to distinguish authorized shares from other types of shares, such as issued shares (shares sold to investors) and outstanding shares (shares held by investors). Think of authorized shares as the "potential" shares a company could release into the market.

Why Do Authorized Shares Matter?

Flexibility in Fundraising: A higher number of authorized shares gives a company greater flexibility to raise capital in the future. This could involve issuing new shares to investors through public offerings or private placements.
Stock Splits and Dividends: Authorized shares provide the capacity for stock splits, making shares more affordable for investors. They also allow the company to distribute stock dividends, rewarding existing shareholders with additional shares.
Mergers and Acquisitions: Companies often use authorized shares as currency in mergers and acquisitions, issuing shares to acquire other companies.
Protection Against Hostile Takeovers: A large number of authorized shares can act as a deterrent to hostile takeovers, giving the company the option to issue new shares to friendly parties to dilute the ownership of the potential acquirer.

Key Concepts Related to Authorized Shares

Understanding authorized shares requires familiarity with related concepts:

Issued Shares: These are the shares that the company has actually sold or distributed to investors. Issued shares are always less than or equal to the number of authorized shares.
Outstanding Shares: These are the shares currently held by investors. The number of outstanding shares can fluctuate as the company buys back shares (treasury stock) or issues new shares.
Treasury Stock: These are shares that the company has repurchased from the market. Treasury stock is part of the issued shares but not part of the outstanding shares.
Par Value: This is a nominal value assigned to each share in the corporate charter. It's usually a very small amount (e.g., $0.01 per share). Par value has little practical significance in modern finance.
Shareholder Approval: Increasing the number of authorized shares usually requires approval from the company's shareholders.

The Process of Authorizing Shares

The process of authorizing shares is a fundamental step in establishing a corporation. Here's a breakdown of the key stages:

Initial Determination: During the formation of the corporation, the founders must determine the number of shares they wish to authorize. This decision should take into account both the company's immediate capital needs and its long-term growth plans.
Articles of Incorporation: The number of authorized shares is specified in the articles of incorporation (also known as the corporate charter). This document is filed with the relevant state authority.
Shareholder Approval (for Increases): If the company later decides to increase the number of authorized shares, it must typically obtain approval from its shareholders. This usually requires a vote at a shareholder meeting.
Amendment to Articles of Incorporation: Once shareholder approval is obtained, the company must amend its articles of incorporation to reflect the new number of authorized shares.
Filing with State Authority: The amended articles of incorporation are then filed with the state authority, making the change legally binding.

Factors to Consider When Determining the Number of Authorized Shares

Deciding on the appropriate number of authorized shares is a critical decision with long-term implications. Here are several factors to consider:

Current Capital Needs: The company should have enough authorized shares to meet its immediate capital needs, such as funding operations, expanding its business, or acquiring assets.
Future Growth Plans: The number of authorized shares should be sufficient to support the company's future growth plans. This includes potential future rounds of financing, stock splits, and acquisitions.
Investor Perception: A very large number of authorized shares could be viewed negatively by investors, who may worry about potential dilution of their ownership stake.
State Laws: State laws may impose restrictions on the number of authorized shares or the process for increasing them.
Cost of Authorization: There may be costs associated with authorizing shares, such as legal fees and filing fees.

How Authorized Shares Impact Shareholders

Authorized shares can directly and indirectly impact shareholders:

Dilution: Issuing new shares can dilute the ownership stake of existing shareholders, meaning each share represents a smaller percentage of the company. This can negatively impact earnings per share and voting power.
Value: While authorized shares themselves don't have inherent value, they give the company the option to raise capital, which can increase the company's value and, consequently, the value of the shares.
Voting Rights: Shareholders typically have the right to vote on important corporate matters, such as the election of directors and significant transactions. The number of authorized shares can influence the outcome of these votes.
Stock Splits: Authorized shares allow companies to perform stock splits, which can make the stock more accessible to individual investors and potentially increase its trading volume.

Understanding Authorized Shares in the Context of Financial Statements

While the number of authorized shares doesn't appear directly on the income statement or balance sheet, it is typically disclosed in the equity section of the balance sheet or in the notes to the financial statements. This information is important for investors to understand the company's capital structure and its potential for future stock issuance.

Increasing Authorized Shares: A Strategic Move

Companies may choose to increase their authorized shares for various reasons. Here are some common scenarios:

Raising Capital: The most common reason is to raise additional capital through the issuance of new shares. This capital can be used to fund growth initiatives, repay debt, or make acquisitions.
Stock Splits: To make their stock more affordable and attractive to a wider range of investors, companies may conduct stock splits. This requires a sufficient number of authorized shares.
Employee Stock Options: Companies often grant stock options to employees as part of their compensation packages. These options require a reserve of authorized shares.
Mergers and Acquisitions: As mentioned earlier, authorized shares can be used as currency in mergers and acquisitions.
Defensive Measure: In some cases, companies may increase their authorized shares as a defensive measure against hostile takeovers.

The Risks Associated with High Number of Authorized Shares

While having a sufficient number of authorized shares is beneficial, there are also potential risks associated with having too many:

Dilution Concerns: As mentioned earlier, a large number of authorized shares can raise concerns about potential dilution among existing shareholders. This can negatively impact the stock price.
Management Discretion: A large number of authorized shares gives management more discretion over the issuance of stock, which could potentially be used to entrench themselves or pursue actions that are not in the best interests of shareholders.
Takeover Vulnerability: While a large number of authorized shares can be used to defend against hostile takeovers, it can also make the company more vulnerable if management decides to issue shares to a friendly party at an unfavorable price.

Examples of Authorized Shares in Practice

To illustrate the concept of authorized shares, let's consider a few hypothetical examples:

Tech Startup: A tech startup might authorize 100 million shares at its inception. This provides ample room for future fundraising rounds, employee stock options, and potential acquisitions.
Established Corporation: An established corporation with a history of stock splits and acquisitions might have several billion authorized shares.
Small Business: A small, privately held business might authorize a relatively small number of shares, such as 1 million, as it has limited need for external capital.

Legal and Regulatory Aspects of Authorized Shares

The issuance and management of authorized shares are subject to various legal and regulatory requirements. These requirements vary depending on the jurisdiction but generally include:

Corporate Law: State corporate laws govern the authorization and issuance of shares. These laws typically require shareholder approval for increases in authorized shares and specify the procedures for amending the articles of incorporation.
Securities Laws: The issuance of new shares may be subject to federal and state securities laws, which require companies to register the offering with the Securities and Exchange Commission (SEC) and provide investors with detailed information about the company and the offering.
Listing Rules: Companies listed on stock exchanges are subject to the exchanges' listing rules, which may impose additional requirements on the issuance of shares.

The Role of Authorized Shares in Corporate Governance

Authorized shares play a significant role in corporate governance. They determine the number of potential votes that can be cast at shareholder meetings and can influence the balance of power between management and shareholders. A well-managed authorized share structure can promote transparency, accountability, and shareholder value.

Key Takeaways: Understanding Authorized Shares

Authorized shares represent the maximum number of shares a company can legally issue.
Understanding authorized shares is crucial for investors, corporate executives, and anyone involved in the financial aspects of a company.
Authorized shares provide flexibility in fundraising, stock splits, dividends, mergers, and acquisitions.
Increasing authorized shares requires shareholder approval and an amendment to the articles of incorporation.
A high number of authorized shares can raise concerns about potential dilution and management discretion.

Future Trends in Authorized Share Management

The management of authorized shares is an evolving area, with several trends shaping the future:

Increased Shareholder Activism: Shareholder activists are increasingly scrutinizing companies' authorized share structures and advocating for changes that they believe will enhance shareholder value.
Focus on Dilution Management: Companies are becoming more focused on managing dilution to protect the interests of existing shareholders. This includes carefully considering the timing and pricing of new share issuances.
Use of Technology: Technology is playing an increasing role in the management of authorized shares, with companies using software to track share issuance, manage shareholder records, and facilitate voting.

Conclusion: Authorized Shares - A Vital Component of Corporate Finance

Authorized shares are a fundamental aspect of corporate finance. They represent the potential for a company to raise capital, grow its business, and reward its shareholders. By understanding the concepts, processes, and implications associated with authorized shares, investors and corporate executives can make informed decisions that contribute to the long-term success of the company. While seemingly a simple concept, the careful management and strategic planning around authorized shares are crucial for navigating the complexities of the modern financial landscape.

Frequently Asked Questions (FAQ) about Authorized Shares

What happens if a company needs to issue more shares than it has authorized?

The company must obtain shareholder approval to increase the number of authorized shares by amending its articles of incorporation.
Are authorized shares the same as outstanding shares?

No. Authorized shares are the maximum number of shares a company can issue, while outstanding shares are the number of shares currently held by investors.
How do I find out how many authorized shares a company has?

This information is typically disclosed in the equity section of the balance sheet or in the notes to the financial statements. It can also be found in the company's articles of incorporation.
Does a high number of authorized shares always mean dilution is likely?

Not necessarily. It depends on whether the company actually issues those shares. However, a high number of authorized shares can raise concerns about potential dilution.
What is the difference between authorized shares and treasury stock?

Authorized shares are the maximum number of shares a company can issue. Treasury stock is shares that the company has repurchased from the market.
Can a company decrease the number of authorized shares?

Yes, a company can decrease the number of authorized shares, but this is less common than increasing them. It typically requires shareholder approval and an amendment to the articles of incorporation.
How do authorized shares affect the stock price?

Authorized shares themselves do not directly affect the stock price. However, the issuance of new shares can affect the stock price by diluting the ownership stake of existing shareholders or signaling the company's need for capital.
Why would a company authorize more shares than it needs?

To provide flexibility for future growth, acquisitions, stock splits, or other corporate purposes.
Who decides how many shares a company should authorize?

The initial decision is made by the founders of the company. Any subsequent increases require approval from the company's shareholders.
Are there any disadvantages to having a low number of authorized shares?

Yes. It can limit the company's ability to raise capital, make acquisitions, or conduct stock splits in the future.