What defines a capital increase ?
Any corporate action, that has an increasing effect on the share capital of the company can be considered a capital increase.
What makes the share capital increases ?
Let’s define the share capital first. This is a key information to take:
Share capital = Par value (Nominal value) of the company’s ordinary shares x Shares outstanding
You should also keep in mind, that we have what we call “Authorized capital”. This one includes the shares authorized for the issue, but not issued yet.
– Authorized capital
Indeed, the company may have authorized shares for the issue, but not issued yet. Like the case for Stock Warrants
– – Stock Warrants
A Stock warrant is a security that can be traded in the stock exchange, similarly to the shares. The warrants represent an option for their holders to subscribe for new shares, at a specific price (Strike price), during a specific period of time (Exercise period).
Here is a dummy illustration of the warrant security:
In contrast to the “Stock Options” (To be discussed later). Warrants are issued by the company, for its shareholders or bondholders, as a sweeteners (Like candies), in certain events. For example, the company may issue Bonds with Stock warrants attached to them for free.
– – – Benefits of Stock Warrants to the holders and the company
The company gets more cash when the owner of the warrant exercises them.
The holder benefits from a possible price discount when they exercise the warrants, to get more shares. let’s take an example:
As you can see, in the illustration above, the warrant holder can exercise the warrants as of July, when the share price has gone above 10 USD, Anything above that is a profit, so we call it the profit zone. The warrant holder, has the ability, to buy newly issued shares for 10 USD, when they are traded in the market for 12, 13 or 14 USD.
What happens to the warrants after the exercise period ?
They become worthless, as they get delisted from the exchange, and you can’t use them anymore. We call it expiration.
As a result of the warrant exercise, and the issue of shares, the share capital would then increase. Consequently, the authorized capital would decrease.
Illustrations boy !
So that was the definition of the authorized capital and its relation to the issued capital or the share capital, i hope you got the point. Now let’s go back to the capital increase.
– More methods to do a capital increase
As the share capital equals the number of shares outstanding multiplied by the Par value we can increase it using two methods
– – By Increasing the number of shares
– – – Capitalization of Reserves
This is another method that’s used mostly, when the company is doing really well. This operation consists of transferring funds from the reserves account into the share capital account resulting in new issue of shares.
You may ask, and who takes these shares ? Good question!
The shares are mostly distributed freely to shareholders. This is what we call a Bonus issue.
– – – – Bonus issue
The Bonus issue, which is a corporate action by itself, is the action of capitalization of funds coming from other accounts mainly “Profit accounts” or “Reserves accounts” that were previously funded from profits. The funds gets transfered and the equivalent number of shares is distributed freely to share holders.
Let’s take an example:
- Company: SFBT
- Market: Tunisian Exchange
The source document says the following:
On March 19, 2019, the Board of Directors of the Tunisian Beverage Manufacturing Company – SFBT – decided to propose to the next Extraordinary General Meeting a capital increase of 33,000,000 dinars, by incorporation of the special investment reserves (investments within the company) for an amount of 29,980,000 dinars and withdrawal of 3,020,000 dinars from the special investment account that became available.Source in french: HERE
This increase will result in the issue of 33,000,000 shares of one dinar each, for one new free share for five old ones.
Hence: 33 000 000 TND will be withdrawn from the “Special Investment Reserves” account, and transferred to the “Share capital” account, resulting in the issue of 33 000 000 new shares, as the Par value for this company’s share is (1 TND).
TND is Tunisia Dinar
Let’s now check the second way of increasing the capital by increasing the Par value
– – By Increasing the Par value
The action of changing the par value, via increase or decrease is called, “Par value re-denomination“, this is a corporate action by itself.
Similarly to the Bonus issue, the company can incorporate a part of its reserves money into the share capital account. Rather than issuing new free shares, it will increase the Par value of the existing ones. So the Shares outstanding figure stays the same.
The key details to extract capital increases are:
- Type of the increase or method
- Amount to be incorporated
- Share capital change
- Par value change
- Shares outstanding change
- Effective date
- Ratio of distribution in case of Bonus shares
It would be nice, if we complement this section, with a Bonus Rights explanation.
That’s it for the capital increase. As always, understand the logic and be flexible with the details provided in the source document for any specific country.