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What’s the difference between authorised and issued shares?
What are share buybacks and treasury shares?
It might sound like lots of jargon, but as is often the case, these are important terms that are simple to understand.
Let’s start right at the beginning. When a company is formed (whether private or listed) the founders will decide on an initial number of shares.
These are the authorised shares, in other words those that have been authorised by the owners.
However, the owners may elect not to issue all the authorised shares, keeping some in reserve for later use.
So, for example a new company starts life with 1 200 authorised shares but only issues 900 of them.
These 900 shares are the ones that are tradable on the exchange and will be used to determine the market capitalisation of the business. (Market cap is calculated as follows: the number of issued shares x share price = value of company.)
The remaining 300 shares can only be used (issued) with shareholder approval and could be used to raise cash (sell the shares into the market and the company receives the money).
Alternatively, they could be used (again only with shareholder approval) in lieu of money when buying assets or paying debts or even to pay director bonuses.
For example, the company wants to buy out a competitor and, instead of using cash it uses 100 of the un-issued shares.
It means the people who sold their company now own 100 of the now 1 000 issued shares – the initial 900 plus the newly issued 100.
The potential concern here is that you will have essentially given away a part of the company whereas if you pay cash for the competitor you just bought, it is a one-off payment.
The shares would be an everlasting payment.
How this works is that at the annual general meeting (AGM) the directors will request authority from shareholders to use a specific number of the un-issued shares for transactions, even if they have no immediate plans for them.
This means that they have the authority to use the shares and don’t have to get shareholder approval every time they want to transact.
Authority is generally given for a limited number of shares so that directors can do medium-sized deals but would require additional approval for huge deals.
A company can, of course, again with shareholder approval, increase the number of authorised shares in order to issue a larger number to investors.
Then we have share buybacks. If the directors feel that the company’s share price is well below their perceived fair value and they have free cash that they don’t see any immediate use for, they can start a share buyback programme.
They would once again need shareholder approval and if it is granted, they would buy back the shares in the open market.
These purchased shares become treasury shares until such time as they are “destroyed” – effectively meaning they will no longer exist.
The net result here is to increase the value of the remaining shares in the market.
Let’s go back to our example of the above company that now has1 000 issued shares. Let’s say they’re trading at R100 each. That would give the company a value (market cap) of R100 000.
If the company now buys back 200 shares there would be 800 issued shares left. Assuming all else is equal, the company is still worth R100 000 but each share would have a value of R125 as there are 200 fewer shares with rights to the company’s value of R100 000. Of course, it doesn’t always work as smoothly as that.
The company has spent money to buy back the shares, meaning that it has less cash and as such the value of the company would have decreased, but in the longer term it can add value to the remaining shares.
This article originally appeared in the 24 August edition of finweek. Buy and download the magazine here.
