Apr 25, 2016

Shares: What does it mean in a Company? PT 2 By Teingo Inko-Tariah

Credits  stepupmoney.com 

Ed's Note: You can begin by reading the first part of this blog series by Teingo on Shares and what they mean in a company  Here

Share Capital explained
In my last post [Shares: What does it mean in a Company? By Teingo Inko-Tariah] I attempted to explain what shares in a company mean and how they can be acquired. This post will explain some other related issues for a better appreciation of the subject.

Femi opted out of his paid job to set up his own company - Naija4Life Ltd. He registered the company at the CAC with a share capital of N1m. There was no N1m anywhere except on paper i.e. the CAC documentation. Femi took up 500,000 shares in the company and gave another 10,000 shares to his younger brother, Yemi who was also made a Director of the company.The operations of the block moulding and interlocking tiles company was largely funded by Femi but he realized that he needed additional funds to scale up the business and open branches in other locations. He began to consider how to raise money. If you are like Femi, please read on to understand the basics of equity funding.

Generally, companies get funding for their operations through debt or equity. Debt funding includes personal/family loans, bank loans, etc. This type of funding usually comes with the condition to pay interest on the loan amount though some loans could also be without interest. Equity funding on the other hand, is the kind of funding generated by sale of shares of the company to raise capital for its operations. The implication is that the person funding becomes a shareholder of the company and becomes entitled to share in the benefits thereof. The funds raised by a company by issuing shares for cash or other considerations is referred to as ‘share capital’.

At the time of incorporation of a company, the share capital would normally be stated in the Memorandum of Association and issued to the first subscribers. For e.g., Naija4Life share capital in our hypothetical case was N1million naira at incorporation. This does not mean that the sum of N1m has to be paid or has to be available at the bank. If the money is available, great. However even if it is not, what it would mean is that the value of the company at incorporation is stated to be N1m. It also means that every shareholder who has not actually paid any money to the company account for his shares owes the company. Shares could also be paid for by consideration other than cash so for instance, contributing office furniture, laptop, printer etc. The item contributed will be valued and the monetary value will be used to ascertain the amount of the shareholder’s contribution.

Using our hypothetical case, if Femi owns 500,000 shares of N1.00 each, he owes the company N500,000 while Yemi owes the company N10,000 for his 10,000 shares. As Femi contributes towards the operations of the company, the amount could be used to defray this debt such that his contribution becomes payment for his shares.However, If the company goes into liquidation, the shareholders who have unpaid shares would be liable for the debts of the company to the extent of the amount owed for the shares taken up by them. So, for e.g., if Femi had contributed N500,000 in exchange for his shares in Naija4Life Ltd, he will not be liable as he is no more indebted to the company. However, if he had only paid up N300,000 by way of contribution of same towards the operations of the company, he would have an outstanding N200,000. Therefore, if for instance, Naija4life is owing a supplier, Femi has to provide the money to defray that debt because he owns shares he has not paid for so his liability is not yet extinguished.
Credits - moneymorning.com 
The Authorised share capital of a company could be issued or unissued. Issued share capital is the portion of a company’s share capital that has been taken up by shareholders. The law requires a minimum of 25% of a companies authorized share capital to be allotted at the time of incorporation. So, in the case of Naija4Life, they are well above the specified minimum which would be 250,000 shares because they already allotted 510,000. The shares may have been paid for in full, in instalments or unpaid for. Unissued share capital is the portion of a company’s capital that has not been issued to any shareholder. Where shares are unpaid for, the shareholder could be called upon to pay for those shares in accordance with the terms stipulated in the articles of association of the company. This is referred to as a ‘call on shares’ which is a formal request by a company to the shareholders to pay for shares they have taken up.
Further issue of shares can be made by a company in future to raise more capital, provided it is within the stipulated maximum amount authorised by the articles of association. Thus the authorised share capital refers to the maximum value of the shares that a company can legally issue. For instance, Naija4Life has an authorised share capital of N1m. Femi has 500,000 units, his brother Yomi has 10,000 units. They have an outstanding 490,000 units which can raise N490,000 if they allow other people buy shares in the company. Naija4Life Ltd cannot sell any more than the balance of shares left which is 490,000 units to raise N490,000. If they need more capital, they need to increase the share capital from N1m.

Alteration of shares
The share capital of a company can be altered in various ways: cancellation, increase or decrease. Cancellation of shares is the process of annulling or extinguishing unissued i.e. shares that have not been taken up or shares that are yet to be issued. The effect is to reduce the authorised share capital by the amount of shares cancelled. Share capital could also be altered by an increase or decrease in the authorised share capital after the necessary amendments have been made to the articles of association of the company.
An increase in authorised share capital requires the creation of new shares which will normally be issued to rank in similar status i.e. paripassu as the shares already in existence. In the case of reduction, the issued share capital of a company is decreased by any of the following means: extinguishing liability on any unpaid shares so that the holder of the balance is excused from paying. For instance, if a company has issued 1,000,000 ordinary shares of N1 each of which N750,000 has been paid up, the balance of N250,000 could be extinguished thereby reducing the share capital to N750,000.
Reduction could also take place by cancellation of any paid up share capital which is lost or unrepresented by available assets. For instance if the value of net assets of the company is N1m and the share capital is N750,000, the share capital could be reduced to reflect the realistic value of assets but nothing is returned to shareholders who have paid N250,000 more. The third form of reduction in share capital is the cancellation of any paid up share capital in excess of the company’s needs in a manner similar to the second form of reduction above. In all cases of reduction, the share capital must have been issued. It may be paid up or unpaid. Reduction of share capital must be distinguished from cancellation of share capital earlier mentioned. A company can only cancel part of its unissued share capital while in the case of reduction; it is the issued share capital that is dealt with.
Reconstruction of shares
Company shares can be reconstructed and if this is done, it will affect the value of each share. Reconstruction of share capital is the process of reconstituting the shares such that the value of each share is either increased or decreased. However, this does not affect the total value of the share capital. Reconstruction could either be by way of consolidation or sub-division. Consolidation of shares is the process of reconstituting shares of a certain denomination to a greater denomination so that the value of each share is higher than the original value. For example existing 10,000 shares of 10k each can be reconstituted into 1000 shares of N1.00 each. The final value will be the same but the worth of each share has changed from 10k to 100k or N1.00. Consolidation is usually undertaken to reduce the number of shares in issue while increasing the nominal value. The purpose is to increase the share price of the company.Consolidation could also be undertaken to meet the minimum trading bid size to ensure its listing status on the stock exchange (in the case of a listed public company).
Subdivision is the opposite of consolidation where shares of a certain denomination are reconstituted into a lesser denomination. Example existing 10,000 ordinary shares of N1.00 each can be subdivided into 20,000 shares of 50k each. Subdivision is undertaken to increase the number of shares in issue while reducing the nominal value of each share .Subdivision would usually be embarked upon to improve liquidity and trading activity on the shares by making the shares more accessible and affordable and thereby increase shareholder base. Reconstruction applies to shares that have been issued.
In my next post, I will highlight some procedural steps on increasing share capital and transferring shares from one shareholder to another.