A company can legally issue up to a maximum number of shares, known as authorized stock or authorized shares. The company sets this when it forms and typically outlines it in its articles of incorporation. Authorized stock differs from outstanding shares already issued and held by shareholders.

Why does this matter? When a company sets its authorized stock, it decides how much room it has to grow in issuing shares to raise money. Let’s dive into why companies don’t issue all their authorized shares and how this plays out in business.

Why Authorized Stock Matters

When companies start, they often decide on the maximum number of shares they might need. These shares are known as authorized stock. The company might not issue all these shares immediately; instead, they leave some unissued for future growth or needs.

The shares they issue become outstanding, which investors buy and sell on the stock market. The company needs to understand the difference between authorized and outstanding shares because it shows how much more stock it can issue later.

For example, if a company has 1 million shares authorized but only 500,000 shares issued (outstanding), they still have 500,000 shares available to issue in the future. These unissued shares give the company flexibility for growth or emergencies.

Why Don’t Companies Issue All Their Authorized Stock?

Companies keep some shares unissued for several reasons:

1. Raising Capital for Future Growth

If the company grows and needs extra cash, it can issue more shares without a complicated process. Unissued shares allow the company to raise funds quickly without immediate shareholder approval. This flexibility is crucial for businesses aiming to expand or navigate uncertain financial times.

2. Employee Stock Options

Companies often use shares to attract and retain top talent. The company keeps unissued stock in reserve to offer employees stock options or shares as part of their pay package. It is a common practice in tech companies and startups.

3. Preventing Hostile Takeovers

By not issuing all available shares, companies can maintain control and prevent the possibility of a hostile takeover. Issuing too many shares can dilute the power of existing shareholders, making the company vulnerable to outside parties gaining too much influence.

Increasing Authorized Stock

If a company needs more shares than initially set, it can increase its authorized stock but requires shareholder approval. The authorized stock limit protects shareholders from excessive dilution, which would decrease the value of their shares.

For example, Amazon’s corporate charter allows 5 billion common shares and 500 million preferred shares. If they ever need to increase this, they must get their shareholders to vote on the change. It ensures transparency and protects shareholders from unexpected company moves.

How Authorized Stock Affects Investors

One of the biggest concerns for investors regarding authorized stock is dilution. When a company issues new shares, the value of existing shares can decrease because the total number of shares has increased, meaning each represents a smaller piece of the company.

For example, let’s say a company has 500,000 outstanding shares, each worth $10. If the company issues 500,000 more shares, suddenly, there are 1 million shares on the market. In theory, the value of each share could decrease because the company splits its total value among more shares. This reduction in value is called dilution, and investors need to watch for it.

Another impact is on earnings per share (EPS). Issuing more shares without increasing profits decreases the EPS, making the company appear less profitable on paper. That’s why companies often balance the number of shares they issue carefully to avoid over-diluting their stock and losing investor confidence.

What Unissued Stock Is Used For

Many companies reserve a portion of their shares to prepare for future needs. Here’s why this matters:

• Issuing New Shares Quickly: Companies may need to raise capital quickly to cover a big investment or stay afloat during tough financial times. Having unissued shares ready allows them to do this without delay.
• Stock Buybacks: Some companies use their extra capital to buy back shares. The company cuts the number of outstanding shares, raising the value of the remaining shares by reducing supply. It’s a way for companies to reward investors and make their stock more valuable.

Costs of Increasing Authorized Stock

Increasing the number of authorized shares in some regions comes with a cost. For example, in India, companies pay a stamp duty of 0.15% to 0.20% of the increase in authorized stock. It might not sound like much, but it can add up quickly for large companies.

Besides stamp duty, there are administrative costs, such as holding shareholder meetings to vote on the increase. While not every company will face high costs, they’re something to consider when increasing authorized stock.

Conclusion

In summary, authorized stock is a powerful tool for companies to manage their growth and maintain flexibility. Not issuing all their shares upfront allows companies to raise capital when needed, reward employees, and protect themselves from hostile takeovers. For investors, it’s important to keep an eye on a company’s authorized stock, as it can affect share value and dilution.

FAQs 

What is authorized stock?

Authorized stock is the maximum shares a company can legally issue, as stated in its corporate charter.

Why don’t companies issue all their authorized stock? 

Companies keep some shares unissued for future growth, employee stock options, or to avoid hostile takeovers.

Can a company increase its authorized stock? 

Yes, but shareholder approval is required to increase the authorized number of shares.

How does issuing new shares affect investors? 

When a company issues new shares, it can lower the value of existing shares and reduce earnings per share (EPS).

Why do companies do stock buybacks? 

Companies repurchase shares to cut the number of outstanding shares, which can boost the value of the remaining shares.