What is Capital Stock?
Before a company goes public, it needs to create a corporate charter. Within that corporate charter is a wealth of governance information that the company must abide by, including the maximum number of shares it’s allowed to issue. This figure represents the company’s capital stock offering.
For most public companies, their total capital stock ranges in the hundreds of millions of shares, as dictated by the charter. It’s important to realize that this doesn’t reflect the number of outstanding shares. Rather, it’s how many total shares the company can issue. As a result, most companies distribute a portion of total capital stock and reserve the rest. Total outstanding shares appear as the sum of all common and preferred shares on the company’s balance sheet.
Capital stock plays an important role in both the formation of a company and the continued governance of that company once it’s public. Here’s what investors need to understand about capital stock.
Understanding Capital Stock
To better-understand the concept of capital stock, it’s important to look at stock within the context of a company’s total equity offering:
- Capital stock refers to all shares of stock. It’s also called authorized shares.
- Outstanding shares are the number of authorized shares distributed to shareholders.
- Restricted shares represent authorized shares not yet owned by corporate directors.
- Float shares are all authorized shares available to general investors.
It’s also important to think about capital stock in real terms: equity. Authorized shares represent 100% of a company’s capital stock. Therefore, anyone who owns 51% or more of those shares owns a controlling stake in the company. For this reason, public companies only make a certain percentage of capital shares available.
There’s no limit to how much capital stock a company can authorize in its corporate charter. That said, companies need to keep in mind the per-share value and the number of shares they plan to make outstanding. For example, Amazon (NASDAQ: AMZN) has a corporate charter that allows it to authorize up to five billion shares of common stock. Currently, the company only has 507.15 million outstanding shares.
Capital Stock Sales and Buybacks
Because the company charter puts a cap on the total number of shares a company can distribute, most companies will leave a substantial portion of capital stock in reserve. For example, ABC Company’s charter might allow for 500 million shares of stock; however, the company may choose to hold 300 million in reserve. The company would then only have 200 million shares of outstanding stock.
As a company grows and seeks new sources of funding, it might choose to tap into its capital stock reserves. Releasing more stock involves a sale, which has ramifications on the current pool of outstanding shares. Namely, it can involve a level of share dilution on the part of current shareholders. For companies, it means giving up more of the company’s equity. Companies typically release more capital stock in small increments, and only with approval from the board of directors.
Opposite the issuance of additional capital stock is a process known as stock buybacks. In this scenario, a company pays the face value (or a premium) to shareholders who want to divest themselves of shares. That stock goes back into the company’s reserves (treasury shares), lowering the total number of outstanding shares.
Raising the Cap on Capital Stock
A company’s outstanding shares can’t exceed the amount of capital stock stipulated in the charter. If, for some reason, a company needs to issue more shares of stock than allowed, it needs to amend its charter to reflect the higher value. This process involves disclosing the newly updated charter to the SEC and other financial and legal organizations for approval. Only after the amended charter is accepted can the company proceed with the sale of additional stock, not to exceed the new cap.
The Benefits of Issuing Capital Stock
Companies choose to issue stock because it connects them to investors. This means an inflow of investment money, without incurring debt. Loans are expensive, especially when interest rates are high. Moreover, a company has full control of how much money it wants to raise based on the amount of capital stock it releases into the public markets. Through a stock offering, a company is in control over its equity and how it chooses to raise money.
As they think about capital stock, companies need to be mindful of the implications that come with it. As mentioned, stock is equity: the more outstanding shares, the more a company distributes its equity amongst shareholders. More outstanding shares could also mean the obligation to pay dividends to more shareholders, which can get expensive. The company is also subject to investor sentiment and scrutiny, which can dictate its market capitalization based on positive or negative price action.
A Gateway to Public Funds
If a company wants to raise money in the public markets, it needs to have a stock offering. Companies can offer the amount of stock up to the amount outlined in the organization’s charter. Many times, the company will issue a small fraction of this, to gain access to only the investor dollars it needs, without opening itself to equity risk. Capital stock is what makes the markets go round, but it needs to stay in balance to prevent dilution. It’s why there’s a hard cap on authorized shares.