What are Authorized Shares of Stock?
Definition: Authorized shares are the number of shares that a corporation is legally allowed to issue, while outstanding shares have already been issued. Thus, the number of outstanding shares is always equal to or less than the number of authorized shares. The number of authorized shares is initially set in a company’s articles of incorporation. The shareholders can increase the number of authorized shares at any time at a shareholders meeting, as long as a majority of shareholders vote in favor of the change. The number of authorized shares may be kept substantially higher than the number of outstanding shares, so that the organization has the flexibility to sell more shares at any time.
What Does Authorized Stock Mean?
Each corporate charter establishes the total number of shares that a corporation can issue. These shares are called authorized shares because this is the amount of stock that the company is legally authorized to issue. Once the corporate charter is complete, the number of authorized shares is set. It can’t be changed unless the charter is rewritten because an expansion, merger, or some other change of entity type.
This situation is common for many growing companies that want to take on new investors. After all of the authorized stocks have been issued, the company needs to get more authorized in order to take on new investors.
The number of authorized stock along with outstanding shares is listed on the financial statements or in the notes. This informs investors how many more shares can be issued by the company.
Several activities can increase the number of outstanding shares. For example, shares may be issued via a private placement, an initial public offering, a secondary offering, as a stock payment, or when someone exercises a warrant or option. The number of outstanding shares declines when a company buys back shares (which are then known as treasury stock).
Stewart Corp is a guitar manufacturer that produces high-end electric and acoustic guitars. Stewart is a family company and has been in business for 30 years. The corporate charter authorized Stewart to issue 50,000 shares, but there are only 30,000 shares currently issued to shareholders. Stewart owns 15,000. His wife owns 10,000 and his two children both own 2,500 shares. This means that if the company wanted to take on more investors, it could issue another 30,000 shares of common stock.
On the equity section of Stewart’s balance sheet, the total number of outstanding (30,000) and authorized (50,000) shares would be listed for external users to evaluate.
Why a Company Might Not Issue All of Its Authorized Shares
The number of authorized shares is typically higher than those actually issued, which allows the company to offer and sell more shares in the future if it needs to raise additional funds. For example, if a company has 1 million authorized shares, it might only sell 500,000 of the shares during its initial public offering (IPO). The company might reserve 50,000 of authorized stock as stock options to attract and retain employees. It might sell 150,000 more in a secondary offering to raise more money in the future. The unissued stock that will be retained in the company’s treasury account will be 1 million – 500,000 – 50,000 – 150,000 = 300,000.
Another reason a company might not want to issue all of its authorized shares is to maintain a controlling interest in the company and prevent the possibility of a hostile takeover.
Why Is Getting the Number of Authorized Shares Right Important?
Authorized shares can be issued when a company asks for financing. They may also be issued as a benefit for key employees. Usually, the number of shares that are authorized is much more than what is actually needed. This is to allow the company to issue stocks in the future when needed (as employee perks or perhaps as a secondary offering to raise more money). A company may refrain from issuing all of its authorized shares to maintain a controlling interest in the company and therefore prevent a hostile takeover.
The number of authorized shares can be changed by shareholder vote.
What Are the Dangers of Too Few Authorized Shares?
There is very little downside to not providing sufficient authorized shares; however, if you do have to increase the number of shares later, you will have to redraft and modify your articles of incorporation. Remember, there is not a limit of the number of shares you may authorize at the time of incorporation.
Issued Vs. Outstanding Shares
The number of issued shares is not necessarily the number in circulation – that is, available to be bought or sold. “Outstanding” stock refers to shares that have been issued and remain in the public’s hands. It’s simply the number of issued shares minus the number that the company has bought back and is currently holding. Shares held by the company itself are called treasury stock. Those shares have no voting rights.
Authorized stock is higher than issued and outstanding stock because companies need the flexibility of issuing additional shares without having to return to the regulatory authorities for approval. For example, a company may specify 10 million shares as the authorized number of shares in its incorporation documents. However, it may issue only 10 percent of the authorized amount when it lists on a stock market because the proceeds would be sufficient to fund operations. The accounting records would note the number of authorized shares but use the outstanding share count for calculating shareholders’ equity.
- Authorized stock refers to the maximum number of shares a publicly-traded company can issue, as specified in its articles of incorporation or charter.
- Those shares which have already been issued to the public, known as outstanding shares, make up some portion of a company’s authorized stock.
- The difference between a company’s authoroized shares and its outstanding shares is what the company retains in its treasury.