In Short
- Share capital represents the money a company raises by issuing shares to its owners.
- It limits shareholders' liability to the amount unpaid on their shares.
- Share capital helps build trust with creditors by showing the company's financial backing.
Tips for Businesses
Use share capital as a tool to raise funds and grow your business without increasing debt. Keep your company records accurate and follow legal requirements when issuing shares. Regularly review your share structure to ensure it meets your business goals and supports future investment opportunities.
Share capital can mean different things in different contexts. Broadly speaking, it refers to ownership in a limited company. Each share reflects a portion of ownership in the company. All shares in existence in aggregate refer to the company's share capital. This article will discuss the purpose and advantages of share capital.
What is Share Capital?
In the broader sense, share capital describes the value of a company's equity and the number of shares the company has issued. This helps you determine the value of each share. In turn, this makes it easier for investors to determine how much they are willing to pay to purchase shares:
- in your company; or
- from existing shareholders.
Only companies have share capital. Accordingly, a sole trader and a partnership cannot have share capital. While partnerships often issue partnership shares, investors do not generally treat partnership shares as favourably as they do shares in a company. A partnership share is only available to a partner who is involved in a partnership. However, an investor can buy shares in a company without having to work for the company.
1. Shareholders Enjoy Limited Liability
A company limited by shares means that ownership in the company is measured by the number of shares in that company relative to the entire shares in existence. The vast majority of companies in existence are companies limited by shares.
The reference to 'limited' refers to the fact that the law limits each shareholder's liability to the amount they owe for the value of their shares. For instance, if you own 100,000 shares issued to you at £1 each, the extent of your liability does not exceed £100,000 as payment for your shares. Sometimes, a company may issue these shares at a discount or not demand immediate payment. In this case, the company can usually demand payment at any point. If the company enters insolvency, an insolvency practitioner can require all shareholders to pay the full value of their shares if they have not already done so.
2. Share Capital Facilitates Creditor Certainty
The law requires that a company's creditors, including its trade suppliers, have some assurance that the company has sufficient assets. Otherwise, a company could incur considerable liabilities relative to its asset value. This would place its creditors in a compromised position.
Companies must make certain public disclosures. This includes the value of its share capital, the number and classes of shares it has and details of its shareholders. A company's share value is equal to the value of all the shares the company has issued (at their fully paid-up nominal value).
Suppose your company has issued 1 million shares at £1 each. The value of the company's share capital is £1m. This figure is further reflected on your company's balance sheet and confirmation statements. Supposing the company has not yet started trading, has no liabilities, and all shares have been fully paid for, the net asset value of the company is £1 million. This indicates that the company has issued 1 million shares, and the shareholders have paid the company £1 million in cash.
3. Share Capital Can Help Raise More Capital
The nature of share capital means that valuing an individual shareholder's interest in the company is relatively straightforward. You simply calculate the value of each individual's shares and divide them by the value of the share capital. As a result, it is straightforward to raise additional equity financing. A prospective investor can calculate what portion of financing it will contribute to the company. The company can then determine the number of shares it should issue.
For instance, suppose your company has started trading. After a year, its net asset value has grown from £1 million (the initial share capital value) to £1.5 million. You approach a prospective investor to raise an additional £500,000. This amount would equal 25% of the total net asset value after the investment is made. Accordingly, a starting place for negotiations may be to issue the investor with shares equivalent to 25% of the total share capital. Whilst this may be one starting point, the company and the investor would also factor in the investor's contribution relative to the company's total value in their negotiations. For example, the company may cap the amount of shares it is willing to issue at a value of £500,000, or 10%, rather than 25%, if it does not want to give away too much equity in the next investment round.
On the other hand, banks are more keen to lend to companies compared to other business structures. This is because it is more straightforward to secure the loan on the company's assets and the shares themselves.
Key Takeaways
There are many advantages to share capital. For one, the law facilitates the approximation of the company's asset value based on the value of its share capital. Share capital also facilitates the easier raising of debt and equity financing.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
