What are Authorized Shares?
Authorized Shares refers to the total number of shares that a company has the legal right to issue. This number is determined by the company's shareholders or board of directors and is stated in the by-laws or incorporation documents. Authorized shares are also known as authorized stock or authorized capital stock.
To incorporate as a company, a company must file its legal documents with the government. This is known as the articles of incorporation. The article of incorporation contains information about the company's stock structure, as well as the total number of shares it issues to owners and investors. The number of shares represents the authorized shares.
Shareholders of a company can increase the number of authorized shares at a shareholders meeting as long as there is a majority vote in favor.
In most cases, the number of authorized shares is higher than the number of outstanding shares. As a result, the company has greater flexibility to sell more shares if necessary in the future.
For example, if a company has 1 million authorized shares, it may sell 200,000 during its IPO. For retaining and attracting employees, the company may reserve 50,000 of the authorized stock as stock options. It may also sell 150,000 shares in a secondary offering to raise funds in the future.
Consequently, the unissued stock in the company's treasury account will be -
1 million (Authorized Shares) - 200,000 (IPO) - 50,000 (Stock Option) - 150,000 (Secondary Sale) = 600,000
Moreover, a company might not want to issue all of its authorized shares in order to have a controlling interest in the company and prevent the risk of a hostile takeover.
Outstanding shares vs Authorized shares
Authorized Shares are the maximum number of shares a company is allowed to issue to investors, as laid out in its articles of incorporation.
Outstanding shares are the shares issued or sold to investors from the available number of authorized shares. Several activities can increase the number of outstanding shares, including exercising a warrant or option, an initial public offering, a secondary offering, employee stock options, or a private placement.
However, when a company repurchases its own stock, the number of outstanding shares decreases.
The number of outstanding shares can be equal to or less than the number of authorized shares.
The difference between a company's authorized shares and its outstanding shares is what the company retains in its treasury.
Company’s Treasury = Authorized Shares - Outstanding Shares
Example of Authorized Shares
Payfriend is a fintech startup that makes it easy to send money to friends and family members. Payfriend's corporate charter states that the company is authorized to issue 100,000 shares.
However, only 60,000 shares have been issued to shareholders. Three of the company's co-founders own 20,000 shares each, totaling 60,000 shares.
Let's assume that the company wants to raise funds and attract more equity investors. It could then issue another 40,000 shares of common stock.
On the equity section of the company’s balance sheet, the total number of outstanding shares would be 60,000 and the total number of authorized shares would be 100,000.
Authorized shares are the number of shares that a company is allowed to issue. While outstanding shares are the number of shares that are actually held by shareholders.
By having a look at the outstanding shares and the authorized shares, investors can evaluate the potential for stock dilution. In general, the bigger the difference between authorized and outstanding shares, the greater the potential for dilution. Additionally, authorized and outstanding shares can also be used to accurately calculate financial ratios.