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Understanding Capital Increase: Altering Company Bylaws and Managing the Operation

A capital increase allows a company to obtain fresh money for financing. However, it is a factor of dilution for existing associates.

Reading Time : 5 minut(s) - | Updated on 13-02-2024 23:15 | Published on 15-01-2024 11:15 

The share capital does not reflect a company's equity

To understand the ins and outs of a capital increase, let's revisit the creation of a company.

At the time of the company's creation, the partners make their initial contributions. These may, for example, be made in cash or in kind (assets other than money). Once they are fully released, these contributions form the share capital. This corresponds to a certain number of shares (in the case of LLCs, Single-member LLCs, SCI, etc.) or stock (for public companies such as Corporations, Joint-stock companies, LPs, etc.).

Thus, the share capital represents the par value of the shares or parts issued by a company and held by its partners. Each partner holds a participation in the share capital proportionate to their contributions. Each share confers rights, particularly in terms of voting at general meetings and profit distribution.

The concept of share capital is therefore based on the value of shares issued by a company and held by its partners. These partners invest money into the company in exchange for shares or parts. The total value of these shares at the time of issuance represents the company's share capital.

The term share capital should not be confused with the company's equity. While it represents the amounts that the partners or shareholders have decided to contribute at the time of creation or during a capital increase, equity also includes, in addition to share capital, the reserves and accumulated profit of the company.

One should not rely solely on a company's capital to assess its financial strength. Indeed, a company may choose to have a small share capital and rely on substantial reserves, or conversely, opt for a higher share capital depending on what is most relevant to its strategy and financial situation.

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Why carry out a capital increase

Several reasons may prompt a capital increase. The most common are the desire to strengthen a company's equity, finance a growth phase, or simply bring in a new partner without the existing partners having to sell their shares.

Multiple conditions must be met to successfully carry out this complex process. First, it involves, among other things, a modification of the company's bylaws. It should be noted that this indirectly changes the rights of pre-existing partners. Therefore, it is advisable to be assisted by a professional, with the most relevant being a lawyer specializing in business law.

How to carry out a capital increase? The main lines

The procedure to carry out a capital increase depends on the legal form of the company. For a LLC or a SAS, this operation begins with a capital increase decision, taken at an Extraordinary General Meeting (EGM). It will allow the modification of the company's statutes.

The operation continues with the issuance of new social shares or stocks. These can generate new rights, such as the preferential subscription right. In some cases, especially when the company has gained value, the existing partners and the issuance of new shares, the associates will also plan a premium issuance.

Premium issuances correspond to the difference between the price at which a stock is issued by a company and its nominal value. When a stock is issued at a price higher than its nominal value, the difference is considered a premium issuance. When investors pay an amount higher than the nominal value to acquire stocks, the company has additional resources to finance strategic projects, repay debts or strengthen its overall financial position.

From an accounting point of view, premium issuances are generally considered as the company's own capital.

Each new share or stock issued must be fully released at the time of subscription, especially if it has been decided to increase the capital by cash contribution (when the increase is made through a contribution in kind, an investment commissioner must be appointed).

Statutory modification will lead to a update of formalities with the INSEE and the Clerk of the Court. This whole procedure can now be carried out on the single window at the INPI. Note that the capital increase decision often needs to be updated in existing partners' agreements, or be the subject of a new pact.

Example of capital increase

Let's suppose a company named "ABC Company" decides to carry out a capital increase to finance its expansion. Originally, the company had issued 100,000 shares with a nominal value of 10 euros each. This means that the company's share capital before the capital increase was:

Initial Share Capital = 100,000 shares x 10 euros/share = 1,000,000 euros.

Now, the company wants to raise additional capital by issuing 50,000 new shares at an issuing price of 15 euros per share. This capital increase will provide the company with fresh money to finance certain projects and investments.

Calculation of the capital increase value:

Number of new shares issued = 50,000 shares
Issue price per share = 15 euros/share
Value of capital increase = 50,000 shares x 15 euros/share = 750,000 euros.

The new structure of the company's share capital after the capital increase would be as follows:

Share Capital after capital increase = Initial Share Capital + value of capital increase
Share Capital after capital increase = 1,000,000 euros + 750,000 euros = 1,750,000 euros

Therefore, ABC Company has successfully raised an additional 750,000 euros by issuing new shares at an issue price of 15 euros per share. These funds can be used to finance growth projects, repay debts, or for other company needs.

Existing shareholders will see their relative stake in the company diluted due to the issuance of new shares, but the company will now have additional financial resources to invest and expand.

Minimize the dilution effects on partners during a capital increase

For former partners, capital increase may lead to a dilution in capital ownership, thus reducing their share of the company's ownership. Some solutions can be considered to mitigate these effects.

A simple but effective strategy for existing partners is to actively participate in the capital increase by subscribing to new shares or units. By investing fresh funds in the company on the same level as new investors, existing partners can maintain their ownership percentage and protect their interests.

In some cases, the company's bylaws may offer existing partners preferential subscription rights. These rights allow them to purchase additional shares before they are offered to other investors. This option gives existing partners priority, which can greatly reduce the impact of dilution. Negotiation is a key skill in the business world. Existing partners can negotiate favorable conditions during the capital increase, such as reduced issue prices or specific benefits, to minimize the impact on their stake.

Instead of issuing common shares, the company might also consider issuing special shares for new investors. These can offer different benefits, notably in terms of dividend rights and voting rights. This can help existing partners maintain their control while raising funds.

Before the entry of new partners, the company should structure its operation in a way to minimize the effects on existing partners. A more modest capital increase or a limited number of new shares can be considered to reduce dilution. Again, using a lawyer specializing in these issues is strongly recommended, whether it's for the initial partners or the new ones.

Capital reduction is also possible

In contrast to an increase, a reduction in share capital is another operation that can be considered for various reasons, such as financial difficulties or the desire to restructure the company.

Like the increase, this operation requires a modification of the bylaws and should be carried out with caution. Also note that a capital can be both increased and reduced depending on the necessities of the company. At each of these stages, the capital transforms and evolves, becoming a true tool for the company's asset management.

Variable capital, the other solution

Even though they are less common, variable capital companies can be appealing in certain cases. These structures present unique benefits, including administrative and financial flexibility allowing companies to adjust their capital easily according to their needs without cumbersome legal formalities. Facilitating the integration of new entrants, it also implies an easier legal exit than fixed capital companies.

For founders, the main disadvantage of variable capital lies in the risk of dilution of their stake. Moreover, the value of the shares can be uncertain due to the fluctuation of the capital, making accurate evaluation of their investment difficult.

To limit these effects, strategies can be put in place. For example, setting a cap for variable capital can also help control the extent of the dilution. Finally, a wise dividend distribution policy can offset the loss of value due to dilution.