What it means
At its core, a share issuance is how a company brings in outside money without taking on debt. Unlike a bank loan, which must be repaid with interest, money raised from selling shares does not need to be paid back.
Instead, the new investors become part-owners of the business. For non-finance managers, understanding this concept is vital because it directly impacts company ownership.
When new shares are created, the ownership percentage of existing shareholders is diluted. This means each current owner holds a slightly smaller slice of the total pie, even though the pie itself might grow larger with the new cash injection.
Businesses typically use share issuance when they want to fund major expansion projects, buy another company, or clear heavy debts. The process involves deciding how many shares to offer, setting a price per share, and offering them to private investors, existing shareholders, or the public on a stock exchange.
While avoiding monthly loan repayments helps cash flow, managing share issuance requires careful planning. Issuing too many shares too cheaply gives away too much control of the company to outsiders.
Managers must balance the immediate need for cash against the long-term value and control of the business. Imagine a pizza representing a company.
Initially, the pizza is cut into four slices, and four founders own one slice each. If the company needs money, it cuts the same pizza into eight slices.
The founders still have their original amount of pizza, but it is now a smaller percentage of the whole pie.
In practice
Real-world examples
Example 1
TechStart Ltd needs $50,000 to build a mobile app. The founders issue ten thousand new shares at $5 each, selling them to an angel investor. Because the founders hold 40,000 shares, the investor now owns 10,000 / 50,000 = 20% of the business.
Example 2
GreenLeaf Bakery wants to open a second cafe. It offers 2,000 new shares to its loyal regular customers at $10 each, raising $20,000 for kitchen equipment without borrowing from a bank. The customers become part-owners and have a stake in the cafe's success.
Example 3
A manufacturing firm with two hundred employees offers twenty key managers the chance to buy 1,000 new shares each at $5 as part of an incentive scheme. This raises 20 x 1,000 x $5 = $100,000 of working capital. It also aligns the managers' efforts directly with company growth.
Think of it
Imagine a pizza representing a company. Initially, the pizza is cut into four slices, and four founders own one slice each. If the company needs money, it cuts the same pizza into eight slices. The founders still have their original amount of pizza, but it is now a smaller percentage of the whole pie.
Formula
Calculation
Total Capital Raised = Share Price x Number of New Shares Issued
Worked example: a company issues 10,000 new shares at a price of $15 per share. The calculation is 10,000 x $15 = $150,000 of new capital added to the balance sheet.
The accounts then split that money. If each share has a nominal value of $1, share capital increases by 10,000 x $1 = $10,000, and the share premium account increases by 10,000 x ($15 - $1) = $140,000. The two amounts add back to $10,000 + $140,000 = $150,000.
You can also work out the dilution. If the existing owners held 40,000 shares before the issue, the total is now 50,000, so the new investors own 10,000 / 50,000 = 20% and the existing owners hold 80%.Case study
Seen in the real world
This is a fictional, illustrative scenario. BrightSpark Solar, a renewable energy firm, needed capital to purchase advanced testing equipment. The business was growing steadily, but taking on a traditional bank loan would have strained monthly cash flow with high interest payments. The leadership team decided on a share issuance. They created five thousand new ordinary shares and offered them to a syndicate of private green energy investors at a price of $40 per share.
This successful transaction raised 5,000 x $40 = $200,000 in cash instantly. On the balance sheet, cash increased by $200,000, and share capital plus share premium increased by the same amount. No debt was added, meaning the business kept its monthly repayments at zero. However, the existing founders, who held 20,000 shares, saw their collective ownership drop from 100% to 20,000 / 25,000 = 80%. The trade-off was clear: they owned a smaller share of a much better equipped and faster-growing company.
The finance manager compared the choice with borrowing. A $200,000 loan at an assumed 8% interest rate would have cost $16,000 a year before any repayment of the principal. The share issuance avoided that cost, but the new investors would also share in future dividends and any sale proceeds. Weighing both sides helped the board explain the decision to staff and lenders.
Watch out
Common mistakes
- Assuming that raising money by selling shares is free because there is no interest to pay.
- Failing to account for ownership dilution, which reduces the voting power of existing shareholders.
- Pricing new shares too low, which raises less money than needed and gives away too much equity.
Questions
People also ask
Do I have to pay back money raised from a share issuance?
No. Unlike a loan, investors give money in exchange for ownership rather than a promise of repayment.
What is dilution?
Dilution is the reduction in existing shareholders' ownership percentages caused by creating and selling new shares.
Who decides the price of the new shares?
Company directors, working with financial advisors, determine the price based on company valuation and market demand.