What are the risks & drawbacks of Increased Authorized Capital

Introduction

Authorized capital refers to the maximum amount of capital that a company is authorized to issue to its shareholders as per the Companies Act 2013. Increasing authorized capital can be useful for companies looking to expand their operations, but it also comes with certain risks and drawbacks that must be carefully considered before making the decision to raise authorized capital. In this blog, we will discuss the risks & drawbacks of increasing authorized capital.

What is increased authorized capital?

Authorized capital refers to the maximum amount of capital that a company is allowed to raise by issuing shares or debentures. This capital is stated in the company’s articles of association and it is determined at the time of its incorporation. However, as the company grows and its capital requirements evolve, there may arise a need to expand the authorized capital to tap into potential funding opportunities. By raising authorized capital, a company increases its capacity to raise additional funds by issuing new shares or debentures. In India, this is governed by the Companies Act, 2013, which sets out the procedures for increasing authorized capital.

What are the risks & drawbacks of increased authorized capital?

The following are the risks & drawbacks of increasing authorized capital:

1. Dilution of Ownership

One of the most significant risks associated with increasing authorized capital is the dilution of ownership. This happens when a company issues new shares, which can reduce the percentage of ownership for existing shareholders. This can be particularly problematic if the company does not have a clear plan for how it will use the new capital.

2. Difficulty in Finding Buyers

Increasing authorized capital can also make it more difficult to find buyers for new shares. Potential investors may be hesitant to invest in a company that has already issued a significant amount of new shares, as this can indicate that the company is not financially stable.

3. Increased Liability

Increasing the capital can lead to an increase in the company’s liability. This is because the company may be tempted to take on more debt or pursue more aggressive expansion plans. This can put the company at risk of defaulting on its loans or obligations.

4. Regulatory Compliance

Depending on the jurisdiction, there may be additional regulatory compliance requirements when increasing the authorized capital. These requirements can be time-consuming and costly to fulfill.

5. Shareholder Approval

Increasing authorized capital may require approval from the company’s shareholders. If the shareholders do not approve, the company may need to reconsider its plans for expansion or growth.

What are the features of Authorized Share Capital?

• The authorized capital is determined at the time of the company’s formation and incorporation.
• ROC fees will rise in accordance with the amount of approved capital.
• The authorized Capital of a company needs to be specified in the MOA and AOA of a Company.
• The authorized share capital is the maximum amount of capital that a company can have and is used to determine the nominal value of each share.
• It can be modified at any moment after the company’s establishment.
• The company’s net worth cannot be calculated using authorized capital.
• A firm does not have to issue shares up to its authorized capital; it can issue shares with a lower value.

Conclusion

While increasing authorized capital can offer certain advantages for companies seeking to expand their operations and raise additional funds, it is crucial to consider the associated risks and drawbacks. Dilution of ownership, difficulties in finding buyers for new shares, raise liability, regulatory compliance requirements, and the need for shareholder approval are factors that must be carefully evaluated before making the decision to increase authorized capital. It is essential for companies to have a clear plan and strategy in place to effectively utilize the increased capital and mitigate potential risks.