What are Authorized Stocks?

Key Highlights

• Authorized stock is the maximum number of shares a publicly traded company is permitted to issue, as detailed in its articles of incorporation or charter.
• Outstanding shares represent the portion of authorized stock already issued to the public. Investors actively hold these shares.
• The company's treasury stock refers to the authorized shares that the company keeps. It helps to clarify the difference between authorized and outstanding shares.
• Issued shares encompass both outstanding shares held by investors and the shares the company has in its treasury.

Understanding of Authorized Stocks

The share market is influenced by various factors, including the number of authorized stocks a company can issue, a key determinant of its potential equity impact on the market. Authorized shares represent the maximum number of a company can legally issue shares to investors, a limit set by its legal formation documents, typically known as the articles of incorporation. These documents, sometimes referred to as authorized stock or authorized capital stock, impose no restrictions on the total number of shares for larger corporations. However, smaller companies, especially those with predetermined shareholders or no plans for expansion, have a designated limit on their authorized shares.

The actual tradable shares in the market are known as the float, while there are also restricted shares set aside for employee compensation and incentives. These restricted shares contribute to the overall count of a company's authorized shares. The total outstanding shares, as reflected on the balance sheet, combine both the float and restricted shares.

Understanding authorized shares is crucial for investors as it provides insights into a company's growth strategy and potential. Companies with a high number of authorized shares might have plans for future expansions or mergers, while those with limited authorized shares may be indicating a more conservative approach. Investors also assess the interplay between authorized shares, float, and restricted shares to gauge the company's flexibility and commitment to employee incentives, contributing to an evaluation of the company's financial health and strategic direction.

What are Outstanding Shares?

Outstanding shares are the shares that a company has issued or sold to investors from its authorized shares. The initial determination of the number of outstanding shares is typically made during a company's Initial Public Offering (IPO) by the investment bank. However, this number can change due to factors such as secondary stock market offerings or the exercise of employee stock options (ESOs). Conversely, a company's repurchase of its own stock results in a decrease in outstanding shares. It's important to note that the total number of outstanding shares cannot exceed the total number of authorized shares outlined in a company's articles of incorporation.

For investors, distinguishing between authorized and outstanding shares is crucial for accurate financial calculations. For example, using outstanding shares to calculate earnings per share (EPS) might lead to inflated gains, while relying on authorized shares could significantly offset a realized loss. A solid understanding of these distinctions is essential for investors to make accurate assessments of a company's financial stability and performance.

Investors benefit from this understanding as it allows them to navigate financial ratios with precision. The careful consideration of outstanding shares provides a more nuanced view of a company's financial health, enabling investors to make informed decisions based on accurate calculations.

Authorized Stock Vs Issued Stock

Authorized stock denotes the maximum number of shares a company is legally allowed to issue, a limit specified in its corporate charter or articles of incorporation. In contrast, issued stock refers to the tangible shares the company has allocated or sold to stakeholders, including employees, shareholders, and investors. While authorized stock serves as a regulatory boundary, determining the upper cap of potential shares, the company retains control over issued stock, deciding when and to whom these shares are distributed. This strategic approach enables the company to manage its equity structure deliberately. Importantly, not all authorized shares need to be immediately issued, allowing flexibility for future allocations and reflecting the company's foresight in navigating its ownership dynamics.

Example of Authorized Shares

Suppose you are a founder of Company XYZ aiming to enhance manufacturing operations through the establishment of a new factory plant. After thorough research, you and your fellow founders conclude that setting up a new plant is the optimal choice, requiring a capital infusion of Rs. 10 crores.

Upon assessment, you realize that out of the total authorized shares amounting to 100,000, each priced at Rs. 10,000, only 60,000 shares have been issued. To raise the additional Rs. 10 crores, you decide to issue an additional 10,000 shares. Following a unanimous vote with the directors, you opt to sell 10,000 of the remaining 40,000 shares. Consequently, your authorized shares remain unchanged at 100,000, but the number of issued shares has increased by 10,000 to 70,000, generating an additional Rs. 10 crores for the planned business expansion.

Factors to Consider for Selecting Authorized Stocks

Here are some of the factors you can check for selecting authorized stocks:

Limiting Issued Shares:

• The total number of authorized shares is a cap on the potential issuance of shares.
• Issued shares are always less than or equal to the authorized shares, ensuring control over the company's ownership structure.

Future Financing Capability:

• Companies intentionally keep unissued authorized shares to have the flexibility to raise capital in the future.
• This strategic reserve allows them to issue new shares when needed, supporting financial growth and stability.

Defense Against Takeovers:

• Unissued authorized shares act as a defense mechanism against hostile takeover attempts.
• By holding back on issuing all authorized shares, companies maintain control and prevent dilution of ownership.

Reserved Shares for Strategic Planning:

• Unissued authorized shares are often designated as reserved shares for various purposes.
• These reserves can be incorporated into future stock option plans, providing flexibility for employee incentives.

Stock Option Plans and Reserved Shares:

• Companies may reserve shares for stock option plans to attract and retain talent.
• The issuance of these reserved shares is typically tied to the implementation of stock option plans.

Strategic Issuance through Warrants:

• Unissued authorized shares can be strategically issued through stock warrants.
• It provides companies with a tactical avenue to engage with third parties and facilitates controlled equity distribution.

Understanding the intricacies of authorized shares is essential for investors to comprehend a company's financial strategy and potential future developments.

Conclusion

Authorized stocks are like a limit set for a company on how many shares it can give out. This limit is written in legal papers, and it guides the company's important decisions. The company decides when and to whom it gives these shares. This control not only helps in planning for the future but also protects the company from being taken over by others who might not have its best interests in mind. By managing the balance between the allowed and given-out shares, companies show that they understand what they need now and have a plan for growing in the future.