What is Capital Increase? Definition of Capital Increase, Capital Increase Meaning and Concept
A capital increase is understood to be that financial operation aimed at increasing the own resources of a company in order to be able to undertake new investments or due to financing needs.
Companies can increase their equity in three different ways:
- Issuing new shares ;
- Increasing the nominal value of existing shares.
- Through the charge to the undistributed profits of the company - the reserves -, in which case the shareholders will not have to contribute money and will receive released shares (free).
Types of capital increases
The issuance of shares can be done at par, that is, for the par value of the new shares, although it can also be done at par, in such a way that those investors who wish to attend the extension must pay an additional amount, which it is added to the company's reserves and is called the share premium. The issuance of shares below par - with an amount less than the nominal value - is prohibited.
When a company increases its capital according to the first system -at par-, it increases the number of shares in circulation, which reduces the book value of each title -that is, the company is worth the same but is divided among more titles -. This is known as the dilution effect. To avoid this effect, an issue premium is usually required, so that the new shareholders also pay for the company's reserves, of which they also become owners.
The extensions released can be:
- Totally, in which case the shareholders do not have to make any disbursement - the money is obtained from the company's reserves.
- Partially, when the shareholder must make the disbursement of a part of the increase that is not covered with balance reserves.
The idea that fully released extensions are a way of rewarding the shareholder can be misleading, since although the shareholder receives a number of shares for free, the value of the company does not change and, therefore, the total value of the shares remains being the same, although there are now more titles in circulation.
Example of capital increase
A public limited company has 2,000,000 shares with a par value of 20 euros. And it has reserves amounting to 8,000,000 euros. The capital of the company is: 2,000,000 x 20 = 40,000,000 euros.
The notional value of a share will be equal to the amount of capital plus reserves, divided by the number of shares:
VTaction = (40,000,000 + 8,000,000) /2,000,000 = 48,000,000 / 2,000,000 = 24 euros.
If the company decides to increase its capital by 4,000,000 euros and does so at par, it would issue 200,000 new shares (4,000,000 / 20).
The new theoretical value of a share would be the following:
VTaction = (40,000,000 + 8,000,000 + 4,000,000) / (2,000,000 + 200,000) = 52,000,000 / 2,200,000 = 23.64 euros.
Therefore, the aforementioned dilution effect would occur.
To avoid this effect, it would be necessary to demand an issue premium from the new shareholders :
VTaction = (40,000,000 + 8,000,000 + 4,000,000 + issue premium) /2,200,000 = 24 euros.
It follows from the above that the total issue premium should be 800,000 euros, which implies 4 euros for each of the new shares issued.
The new value of the share would be:
Vaccination = 52,800,000 / 2,200,000 = 24 euros, the same that existed before the capital increase.