What Is Authorized Stock?
Authorized stock refers to the number of units of stock that a company or startup can issue to the general public. It is generally included in the capital accounts section of a company’s balance sheet. Authorized stock consists of issued stock, outstanding shares, and shares that are yet to be issued by the company. Companies are required to specify a figure for authorized stock in their article of incorporation. There is no limit on this figure and companies can change it by making another article of incorporation filing.
Why Should A Company Specify Authorized Stock Limits?
Entrepreneurs and established organizations can raise capital for expansion of their operations by issuing debt in public markets, taking out loans, or issuing equity. The first two options place limits on the raised amount and involve making periodic interest payments. The third option has no limits on the amount that can be raised but involves giving up equity stake in the company.
When a company founder registers their outfit with the state, he or she is required to file articles of incorporation and specify the number of authorized stock for their organization. This figure places limits on the number of equity shares that the company can issue to public markets. For example, a figure of 1,000 shares for authorized stock means that the company cannot issue more than 1,000 shares for all types of stock. A higher figure, say 5 billion, means that the company cannot issue more than 5 billion shares and has diluted its ownership interest further.
Apart from placing limits on the issue of public equity, authorized shares also have tax implications. For example, the annual franchise tax for corporations in the U.S. state of Delaware is calculated based on authorized capital specified in the articles of incorporation.
Details of Authorized Stock
Authorized stock includes Outstanding shares and Treasury stock. Outstanding shares is the common stock that has already been issued to the general public or disbursed to stakeholders and senior executives in the form of preferred stock. Even after they have issued stock, companies may purchase their own stock back from the general public to boost its price or take greater control of their strategy. This stock is known as Treasury stock. It is not common stock nor has it been distributed to stakeholders or senior executives. But it can be introduced for trading in the open markets without a public offering. The figure for authorized stock is generally a sum of these two figures. Treasury stock is equal to zero when the number of Outstanding Shares is equal to the number for Authorized Stock.
The share types that are eligible for inclusion in authorized stock include common, restricted, and preferred stock. The first type of stock is issued to the general public and provides voting rights and dividend payouts based on the company’s performance. Holders of preferred stock do not have voting rights but they are assured fixed dividend payouts, regardless of company performance. Finally, restricted stock is issued to senior executives in a company and have conditions attached to them. They provide voting rights and payouts based on company performance. For example, the CEO of a publicly-listed company may receive restricted stock that they are allowed to vest, if the company reaches a certain market capitalization or achieves a target earnings-per-share (EPS).
Making Changes to Authorized Stock
While it is always a good idea to specify a generous figure for authorized stock in the original articles of incorporation, entrepreneurs are not always eager to dilute their equity in a company because it could potentially mean giving up strategy control. Subsequent developments, such as growth in the market for the company’s products, can change their outlook and would require a revision of the authorized stock figure.
Consider, for example, the case of social media behemoth Facebook Inc. In 2004, when it was incorporated, the founder Mark Zuckerberg specified 100,000 authorized shares in the company’s articles of incorporation. During its IPO seven years later, Facebook offered 388 million shares to the public. By 2015, it had made 18 amendments to its articles of incorporations. As of this writing, it had 5,000 million Class A authorized shares, 4,141,000 Class B authorized shares, and 1 billion preferred shares listed.
The articles of incorporation can only be changed with shareholder approval and requires extensive refiling of documentation with authorities. In turn, this can involve considerable spending on legal fees and the like. To that extent, entrepreneurs should consider the future trajectory of their startups while specifying a figure in the original incorporation charter.
Authorized Stock and Stock Splits
For the most part, the numbers and issue of authorized stock is controlled by a company’s management and senior executives. However, there may be instances in which they may lose control over this process. For example, activist investors can force a company’s management to dilute their stake further and issue more stock in public markets. In such cases, the organization will have to change its articles of incorporation to make the change. A more interesting scenario occurs during a stock split. A stock split is a multiplication of a company’s issued stock based on a ration determined by its management.
Consider the example of company ABC which has stated a limit of 30,000 authorized shares in its charter of incorporation. Out of this number, it has issued 12,000 shares to the general public and senior executives, meaning it has 18,000 outstanding shares. ABC recently announced a 2:1 stock split. Thus, each publicly-issued share is now equal to two. The new number of issued shares now totals 24,000. The total number of authorized shares for ABC jumps to 42,000. But ABC is limited to 30,000 shares in its articles of incorporation. To ensure that it stays within that number, the company’s management will have to give up some of their shares to bring down the number of outstanding shares to 6,000.
Limits on Authorized Stock
Related to the topic of increase or decrease in authorized stock is the issue of placing limits on authorized stock. Proponents of the practice state that it protects shareholder interest by placing restrictions on management to dilute their equity. For example, senior management could engender takeover of a firm, against shareholder approval, by issuing new stock that allows the acquirer to take a controlling stake.
However, critics claim that the limits are a bureaucratic hassle that are time-consuming and expensive. This is especially the case for publicly-listed companies because changing the articles of incorporation is a laborious process. Besides, there are already several safeguards, such as oversight by a board of directors, to protect shareholder rights in a publicly-listed firm.
Limits might make sense for private companies because there are fewer stakeholders and they might need protection from a runaway management team intent on making a quick buck. But, changing articles of incorporation in closely-held or private companies is a shorter and relatively easy process.