We have in the past, received numerous queries relating to the difference between the issued and authorised share capital of a company and more importantly, the relevance of this difference for Start-ups.
This blogpost will briefly explain the difference between authorised and issued share capital and will explain why, in some instances, more may sometimes just be better.
What are shares?
Shares, or a single share, as defined in terms of the Companies Act, 71 of 2008 (“the Companies Act“) refers to “one of the units into which the proprietary interest in a profit company is divided [into]”. In short, a company’s share capital is comprised of shares and the owners of these shares are referred to as shareholders.
What is the authorised share capital of a company?
Given the above, we now know that any ownership of a company is evidenced by the number of shares held by its shareholders. Shares can be divided into various classes and formats, each of them with various specific rights and obligations attached to them. Irrespective of the class of shares, the maximum total number of shares available for any potential shareholder to own are referred to as the authorised share capital of the company. The authorised share capital of the company is determined and stated in the company’s constitutional document known as the Memorandum of Incorporation (“MOI“) and can usually only be amended by way of a special shareholders’ resolution authorising such a change (if you want to see more on this please see our blog on shareholders resolutions here). The authorised share capital therefore is the maximum total number of shares available to the Company to distribute to potential future shareholders.
What is the issued share capital of a company?
If the authorised share capital is the maximum total number of shares available to be distributed to potential shareholders then, the issued share capital of the company is the actual number of shares already distributed to the shareholders. The shares are therefore issued and it’s not uncommon to find that the number of issued shares is significantly lower than the authorised share capital as the company does not want to find itself in a position where potential corporate actions are restricted due to the maximum number of authorised shares being exhausted.
Importance for start-ups?
So why is this important to start-ups? Although the above detail may be regarded as insignificant in the larger scheme of things, in terms of section 38 of the Companies Act, the board of directors of a company (usually the founders of a start-up) may not resolve to issue any shares in excess of the number of the authorised shares of any particular share class. If they do, they either have to authorise this share issue retroactively (section 38(2)) or, in the event that the resolution does not pass: return any funds (with interest as mandated by the Companies Act). Given the sometimes-precarious financial position of start-ups, returning vast amounts of funds could potentially be a daunting task. Not to mention the fact that board members who were privy to the decision to issue shares in excess of the authorised share capital (and who failed to vote against same) may be held liable in terms of section 77(3)(e)(i) of the Companies Act should the resolutions not pass. Finally, and in light of past experiences, implementing rectifying steps and correcting the previous processes after the fact can lead to delays and frustration when you may least need it. Especially, during that funding round or exit… Given this, we always recommend that start-ups consider having a substantial number of authorised shares (especially when incorporating a new company) reserved in their MOI and that the issued shares remain well below that.
If you require any assistance with getting your legal house in order, please contact us and we’ll gladly assist.