Increase in Authorized Capital vs External Funding: Which Is Better for Your Growth?

Introduction

Business growth is often the primary goal of every entrepreneur or organisation. Reaching sustainable development requires careful decision-making, particularly when it comes to financial options. Two popular methods used by businesses to finance their development are raising approved capital and securing outside investment. Companies must consider the distinct advantages and challenges of both approaches.

The main distinctions between acquiring outside finance and growing authorised capital will be discussed in this extensive text. In order to help you choose the approach that best suits your company’s growth goal, we will also evaluate the advantages and disadvantages of each one.

Understanding Authorised Capital

Authorised Capital: What is it?

Authorised capital, often referred to as nominal capital or registered capital, is the maximum amount of money that a company is legally allowed to obtain via the selling of shares. It is detailed in the company’s articles of formation or memorandum of association. Authorised capital is the most money that a company can give to shareholders without altering its original charter.

For example, a companyz may issue shares up to $1 million in authorised capital. The firm does not have to release the full amount at once; just the amount released will be considered “paid-up capital” on the balance sheet.

What options are there for increasing authorised capital?

It is necessary to change the company’s memorandum of association and approve a resolution at the annual general meeting (AGM) or special meeting in order to increase permitted capital. The rise is usually approved by shareholders before being presented to the relevant government or regulatory authority (e.g., Companies House or the Securities and Exchange Commission) for approval.

In many cases, the procedure requires:

• A board decision and consent from shareholder
• Sending the necessary documentation to the regulatory body
• Maintaining up-to-date legal and financial documentation for the company

Advantages of increase Authorised Capital

• Flexibility in Fundraising: By obtaining authorised capital, the company can issue more shares later on without having to go through the procedures of asking approval or altering the corporate structure.
• Maintain Control: Because the company offers shares domestically or to current shareholders, it has greater control over ownership and decision-making than it would with external funding sources.
• No Interest Payments: Increasing approved capital does not need interest payments, in contrast to debt financing. The company is free from paying interest on the funds raised since they are equity capital.
• Easy for Small or Growing Businesses: If a company lacks access to external funding sources or is not qualified for loans, increasing approved capital might be an easy way to inject funds into the business.

The drawbacks of increase authorised capital

• Diluting Ownership: When new shares are issued, existing shareholders’ ownership is diluted, which may lessen their ability to influence the company. This might be a huge issue for the founders who want to maintain a majority stake.
• Effect on Share Value: If the number of shares increases, the value of those shares may decrease. If the dilution is seen negatively by investors, stock prices of publicly traded companies may decline.
• Limited by Market Demand: The amount of money that may be raised through share sales depends on the demand for the company’s shares. If the market is struggling, there may not be much interest in purchasing further shares.
• Regulatory Approvals: Increasing authorised capital may require formal approval and filing with government authorities, which might lead to additional costs and delays.

Understanding External Funding

External Funding: What is it?

External money is capital that comes from outside the institution. Private equity, angel investors, venture capital, loans, and public share offerings are all ways to obtain this type of funding. In contrast to increasing permitted capital, external finance does not require changing the company’s capital structure or issuing more shares to existing shareholders.

External funds can be acquired in a number of ways, such as:

• Debt finance, or loans: Businesses borrow money from lenders and agree to pay it back over a certain period of time, plus interest. Bonds, bank loans, or credit lines are some examples of this.
• Equity financing: The process of selling shares to outside investors, such as venture capital firms, angel investors, and even initial public offerings (IPOs).
• Grants and Subsidies: Public and commercial organisations may offer grants to businesses that meet specific criteria or operate in specific industries.

Kinds of External Funding

• Debt financing: The business takes out a bank loan that it will eventually have to repay with interest. Working capital lines, bonds, and bank loans are a few examples.
  • Advantages: Interest costs are tax deductible, and ownership is not diluted.
  • Cons: Interest payments, the possibility of a credit rating reduction, and repayment requirements that are independent of business performance.
• Equity Financing: The company raises capital by selling shares to outside investors. This might come from an IPO, venture finance, or angel investors.
  • Advantages: Offers financing without adding to debt load and has no repayment obligations.
  • Cons: Sharing earnings with other investors, losing control, and diluting ownership.

Advantages of External Funding

• Increased Access to Capital: Increasing approved capital might not be sufficient to expand the pool of available capital; external financing could be able to help. Banks, venture capitalists, and other investors may be willing to provide substantial sums of money to help the business grow.
• No Dilution of Control through Debt Financing: When a company borrows capital through bonds or loans, it does not have to give up ownership, enabling its founders and current shareholders to keep control of the business.
• Networks and Expertise: Outside investors, particularly venture capitalists or angel investors, usually provide more than just financial support; they also bring in industry expertise, networks, and mentoring that might help the business grow.
• Flexible Terms: Depending on the source of funding, businesses may be able to negotiate more flexible terms, such as venture capital equity percentages or debt finance payback schemes.

The Cons of External Funding

• Repayment Obligation (Debt Financing): Businesses must pay back loans with interest regardless of how well they do as a company. This can put pressure on cash flow, especially during recessions or periods of poor profitability.
• Loss of Ownership and Influence (Equity Financing): Business owners that employ outside equity financing lose part of their control over the enterprise. In certain circumstances, they may even lose the majority of the company, especially if venture capitalists or other investors purchase a large portion of the company’s shares.
• Enhanced Expenses: When acquiring outside funding, there may be significant legal fees, interest rates, and equity dilution. The high returns that angel or venture capital investors occasionally demand on their investments may limit the original owners’ long-term profitability.
• Complex conversations: Equity finance and venture capital investment may entail intricate conversations on investor rights, board involvement, and governance. The funding procedure may drag on as a result of these lengthy negotiations.

Crucial Considerations for Choosing Between Authorised Capital and External Funding

Business Stage and Needs

• Early-Stage Companies: Startups and early-stage companies may find it challenging to obtain outside funding. In these cases, it could make more sense to issue shares to early investors, friends, or family in order to obtain approved capital.
• Growth and Expansion: External finance, especially debt or equity financing, may be a preferable choice for an established business looking to expand or grow rapidly.

Responsibility and Authority

• Desire to Retain Control: If an owner wants to maintain control over their company, they can avoid the dilution of ownership that occurs with external stock financing by obtaining approved capital internally (for instance, through close friends, family, or investors).
• Willingness to Dilute Control: On the other hand, if the company require significant funding or strategic assistance, it may be willing to relinquish some control in exchange for outside funding, particularly from venture capital or private equity investors.

Risk and monetary commitments

• Risk of Debt: If a business is financially stable and has consistent cash flows, debt financing could be a wise option because it does not lower ownership. Yet, companies with inconsistent revenue may want to escape the strain of loan payments.
• Investor Risk Sharing: Equity financing releases the company from the responsibility of repaying the funds by shifting the financial risk to investors. This might be advantageous for companies with erratic cash flows.

Goals for the Long Run and Exit Strategies

• Seeking Long-Term Independence: If long-term independence is the goal, increasing authorised capital may help ward off pressure from external investors who may demand exits or changes to the plan.
• Seeking Growth or Exit through Sale: External financing might provide the funds and expertise needed to achieve the goal of quickly growing the business in preparation for a sale or going public.

Conclusion

In summary, your organization’s development stage, financial needs, control choices, and risk tolerance all affect whether it is better to raise approved capital or seek outside investment.

• Increases in Authorised Capital are often suitable for smaller or more established businesses looking for an easy way to raise money without giving up control. However, due to the possibility of ownership dilution, it might not be the greatest choice for businesses seeking significant capital or extensive development.
• External finance is typically chosen by businesses who need large sums of money for growth or development and are prepared to take on debt or share ownership. Even while it may provide access to more money and experience, there are risks associated with repayment obligations, equity dilution, and potential loss of control.

The details of your company and your long-term objectives will ultimately determine which of these two options is best for you. In some stages of their development, companies may even decide to blend the two methods, changing their approach as the company grows.