Key Takeaways:

  • Authorized stock is the maximum number of shares a corporation can issue as specified in its articles of incorporation.
  • Not all authorized shares are issued; companies may reserve shares for future use, providing flexibility for capital raising, employee compensation, and corporate transactions.
  • Issued shares are those that have been sold to shareholders, while outstanding shares refer to those available for trading on the market.
  • Stock options are typically used as employee incentives, while stock warrants are often issued to investors as part of financing deals.
  • Authorized stock plays a crucial role in mergers, acquisitions, and IPOs, offering companies flexibility in managing their capital structure.
  • Increasing authorized stock requires amending the articles of incorporation and shareholder approval.
  • Legal considerations, including shareholder rights and state regulations, play a significant role in the management of authorized stock.

What is Authorized Stock?

Authorized stock is the number of shares a company is allowed to give away to shareholders. This number is stated in the company's charter. In the United States, this is called the Articles of Incorporation.

Authorized Stock is also called authorized capital stock, authorized shares, or authorized share capital. This number can only be changed if the current shareholders approve it. This is done with a vote (and a lot of paperwork). Due to this, many companies have a higher authorized stock number than the number of stocks they plan to issue.

Authorized stock represents the maximum number of shares that a corporation is legally allowed to issue as specified in its articles of incorporation. It's important to note that not all authorized shares are issued or outstanding at any given time. The company can choose to reserve some shares for future use, such as for raising additional capital, employee stock options, or mergers and acquisitions. These reserved shares offer flexibility for the corporation to meet future needs without having to go through the legal process of amending its charter to increase the number of authorized shares.

In addition to the total number of shares, the articles of incorporation may specify different classes of shares with distinct rights, such as voting rights, dividend entitlements, and liquidation preferences. This setup allows companies to structure their capital in a way that aligns with their strategic goals and governance structures.

Why Are Authorized Shares Important?

  • Many states and international articles of incorporation, called memorandums of association in some countries, require companies to authorize shares.
  • This number will have a direct effect on how much you will pay in fees when you incorporate. This amount will vary depending on what state you incorporate in.
  • It gives corporations the option to raise money in the future by selling shares of their company to investors. The more authorized shares you have, the more opportunity you have to raise money.

The importance of authorized shares lies in their role as a strategic tool for corporate management. By having a large number of authorized but unissued shares, a corporation can raise capital quickly when needed, issue stock options or other equity incentives to attract and retain employees, and respond to opportunities for acquisitions or other strategic transactions.

Authorized shares also play a critical role in corporate governance. For example, issuing new shares can dilute the ownership percentage of existing shareholders, which can impact voting control and shareholder value. Therefore, the decision to issue new shares is often a matter of significant deliberation by the board of directors and may require shareholder approval, especially in cases where the issuance would result in substantial dilution.

Moreover, the number of authorized shares can be a factor in preventing hostile takeovers. Companies can issue new shares to friendly parties, making it more difficult for an unwanted party to gain control. This is known as a "poison pill" strategy.

The Difference between Authorized, Issued, and Outstanding Shares

1. Authorized shares are the total number of shares allowed for the company to issue. For instance, a company puts in their charter that the authorized shares will be 50,000. That is the maximum number of shares they can give away or sell. The only way to change this is with a vote of all of the shareholders. This number is usually higher than issued shares.

2. Issued shares are the number of shares that have been given to or sold to investors to raise money for the company. If the authorized shares are 50,000, the issued shares can be anywhere between 0 and 50,000. This number can never be larger than the authorized shares.

Whenever a company issues new stock, the value of all issued stock is lowered or diluted.

3. Outstanding shares are the number of shares that shareholders own. It is owned by members of the public and not the company. It generally does not come with votes or any control over the company. This number can be the same as issued shares. If the company "issues" 10,000 shares to investors, then they have 10,000 shares outstanding. If they then decide to buy back 1,000 of those shares, the outstanding shares are now only 9,000 (but "issued shares" is still 10,000). This is often done to return money to the shareholders.

  • The stock that has been repurchased is known as Treasury stock. Outstanding shares are equal to issued shares minus treasury stock.

While authorized shares represent the total potential shares a company can issue, issued shares are those that have actually been sold to and are held by shareholders. Outstanding shares, a subset of issued shares, refer to those shares currently held by shareholders and available for trading on the market. The difference between issued shares and outstanding shares typically includes treasury stock—shares that the company has repurchased and holds in its own treasury.

Understanding the relationship between these three types of shares is crucial for evaluating a company's capital structure and its potential impact on shareholder value. For instance, when a company repurchases its shares, it reduces the number of outstanding shares, which can increase earnings per share (EPS) and potentially the stock price. Conversely, if the company issues new shares, it can dilute the EPS, depending on how the additional capital is used.

Stock Options Versus Stock Warrants

  • A Stock Option is a contract between a buyer and seller of a stock. The two parties agree that the buyer can buy a certain amount of stocks at a specific price from the seller. The contract has a fixed time period. The buyer does not have to buy the stocks if he or she does not want to. Stock options are generally between one investor and another.
  • A Stock Warrant is similar to a stock option. The main difference is that the seller is the company and the shares in questions are newly issued stocks (they have never been sold before). This means the value of all the other shares will be diluted. Stock warrants are usually issued at a lower price than what the value is expected to be in the future.
  • While stock options are generally only for two-three years, stock warrants can be valid for many years.

Stock options and stock warrants are financial instruments that give the holder the right to purchase shares of the company at a predetermined price. However, they differ in their origin and purpose:

  • Stock Options: Typically granted as part of employee compensation packages, stock options are a right given by the company to its employees or executives to buy shares at a set price, known as the exercise price, within a certain timeframe. Stock options are a powerful tool for aligning the interests of employees with those of shareholders, as they provide an incentive for employees to contribute to the company's success, which in turn can increase the stock price.
  • Stock Warrants: Warrants are similar to options but are generally issued directly by the company and often to investors or financial institutions. They are frequently attached to bonds or preferred stock as an incentive to buy the underlying securities. Unlike options, when warrants are exercised, the company issues new shares, which can dilute existing shareholders.

Both instruments play a significant role in the company’s financial strategy, providing flexibility in raising capital and rewarding stakeholders.

Frequently Asked Questions

  • How Many Shares Should I Authorize?

You should authorize enough shares to accommodate growth within the company. There should be enough for all the initial shareholders. You should think about the sort of future investment you will want as your company grows. It is best to be generous with this number. You can have 100 million authorized stock but only issue 1 million. However, if you only have 10,000 authorized shares, you can only issue 10,000 shares. The recommended starting number is 10 million.

Preferred stock is also a number that is decided during the company's incorporation. Authorized stock consists of both Common Stock and Preferred Stock. The two together are also called Capital stock. Common stocks are normal shares. Preferred stocks will give the owner special rights. Someone who owns preferred stock may have more voting power than someone who owns the same amount of common stock. Owners of preferred stock will also likely receive more dividends than an owner of a common stock.

An option pool is a number of shares than have been set aside for employees. It is an incentive created by companies to bring talented workers to a new company. It is basically a promise to a new employee that when the company "goes public" and begins issuing shares, he or she will receive a certain number of those shares.

  • What is Par Value?

Par value is the number the company decides is the base value of the stock. Simply, it means the company can never sell a stock or share for less than the par value.

  • What is a stock split?

A stock split is when a company issues more stock. This increases the number of shares in a company while reducing (diluting) the share price.

The Impact of Authorized Stock on Corporate Transactions

Authorized stock plays a pivotal role in various corporate transactions, including mergers, acquisitions, and initial public offerings (IPOs). For instance, in an acquisition, a company might use authorized but unissued shares as part of the purchase price, offering the shares to the target company's shareholders. This can be a cost-effective way to finance the acquisition without requiring immediate cash outflows.

During an IPO, a company might authorize a large number of shares to provide flexibility for future capital raising and to meet the potential demand from investors. The number of shares offered in the IPO will be a portion of the authorized stock, and the remaining shares will be held in reserve for future needs.

How to Increase Authorized Stock

A corporation may decide to increase its authorized stock to raise additional capital, offer more stock options to employees, or for other strategic purposes. To do this, the company must typically amend its articles of incorporation, a process that usually requires board approval and a vote by the shareholders.

The process involves filing the amendment with the state in which the corporation is registered and paying the required fees. It’s important for companies to communicate clearly with shareholders about the reasons for increasing the authorized stock, as it can affect the value of their holdings through potential dilution.

The management and issuance of authorized stock are subject to various legal considerations, including state corporate laws, securities regulations, and shareholder rights. Shareholders have the right to approve certain actions that could affect their ownership, such as the issuance of additional shares, especially if it results in significant dilution.

In some cases, shareholders might have preemptive rights, allowing them to purchase additional shares before the company offers them to the public, ensuring they can maintain their proportional ownership. Understanding these rights and the legal framework surrounding authorized stock is essential for both corporate management and investors.

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