Share Capital Explained: The most misunderstood financial term
Share capital, an alluring figure sitting on your company balance sheet.
Often for the meagre value of $100, you are not sure what this allusive figure means.
Why does it even bother to show itself, if it’s for such a small value?
Good question.
That $100, is a really important $100.
Ryan, what is it? Can you just tell us?
Share capital is the value of the shares that have been issued to the companies shareholders.
But, the value of my company is way more than $100!
Yes, but at the time the company was incorporated, the company had no value. Hence, when the company was incorporated it was incorporated with a nominal share capital of $100. The $100 represents 100 ordinary shares.
This is extremely common in New Zealand. It’s how most companies are incorporated and setup.
Whether it’s $100, $500, or $1,000, each share is issued with a value of $1.
If this value is just nominal, why bother at all?
Share capital needs to be recorded because it’s a core component of a company. A company has shares, it issues those shares to shareholders when it begins its life, and the value of those shares needs to be recorded.
In more simple terms. It is a transaction, and that transaction needs to be recorded.
A more important, often unknown reason, is that if this initial issuance of shares is not recorded, the value of the company can be argued by a liquidator at a later point in the companies life when the value is greater than $100 and the company owes debts…
Let me explain…
When a company issues shares it’s saying ‘hey, buy my shares for X value.’
If that issuance is not recorded, then how can anyone know what the value of those shares were at that time? Or at any point in time?
If not recorded, it leaves the door wide open to interpretation.
Liquidators love interpretation.
And if they interpret the value of the shares to be significant, they can argue that the shareholders owe the company that amount. E.g. The value of the company is $400k, it’s shareholders need to stump up that sum to pay the company for it’s shares.
Remember, a liquidator is trying to recover as many dollars possible to repay the company’s creditors.
Ok, Ryan, that kinda makes sense….but my company is ACTUALLY worth more than $100, why does it still show $100 on my balance sheet?
Because, the $100 represents the value of the companies shares at the time that share capital was raised…which was at the time the company was incorporated, right at the beginning, and had no value…
Now, it doesn’t always have to stay at $100…
When the company has value, in the opinion of the directors, it can raise additional share capital.
For example. Company ‘X’ has $100 of share capital for 100 shares that were issued when the company was incorporated.
After five years of being in business, the directors believe the company is worth more like $900,000. This means they believe each of the 100 company shares is worth $9,000 each.
The directors would like to raise $100,000 to fund an expansion and the purchase of additional machinery. The therefore believe after raising the $100,000, the value of their company will be $1,000,000.
The directors will therefore need to issue and sell an additional 11.1 shares at $9,000 each, for a total value of $100,000.
Now for the fun part….the $100 on the balance sheet will increase to $100,100, being the initial $100 of share capital PLUS the $100,000 just issued.
So, in conclusion, the share capital balance on your balance sheet does change, it’s just that it’s rare for a New Zealand SME business to raise additional capital.
Most of the time SME’s in NZ are just sold as they represent the directors ‘job’ rather than a stand-alone company with a separate personality.
Public companies have shares and I can see the value of them at any time, how does this relate to share capital…?
When a company lists it’s shares on a stock exchange, it’s allowing people to trade in it’s shares on a daily basis.
This trading determines the value of the companies shares at a given point in time.
The value of something is as the adage goes ‘what someone else is willing to pay for it.’
When you look at the price chart of a public company, you are seeing the buying and selling data in a nice graph format. The current price is the last price that someone bought the companies shares at…
BUT
This doesn’t change the fact that the company issued these shares at a value…
This value is different to what you will see on the price chart…
It will be sitting on the companies balance sheet as well, just the same as a private company as I used in the examples above.
If their was a public market for the shares in your company, then you would also see the value of these shares on a daily basis, as with the public company…it’s just that your company is private…
So to get an actual value for the business you need to have a valuation prepared, or find out how much someone is willing to pay to buy it….