8 mins readA Strategic Tool for Companies: What Are Paid and Bonus Capital Increases?
December 10, 2024We’ve gathered everything you need to know about the reasons for choosing capital increases, their advantages, and disadvantages, which can be executed through two methods: paid and bonus.
Barring exceptional cases, every company aims to grow. Among the most effective tools to achieve growth, repay debts, and make new investments is capital increase. This method allows companies to strengthen their financial structure and offer value to shareholders by increasing their existing capital. Capital increases can be executed in two forms: paid and bonus, each with significant advantages and disadvantages for both companies and shareholders. In this article, we’ll explore the concept of capital increase, its methods, and why it is such a critical tool for companies.
What Is a Capital Increase?
Typically, a fundamental part of companies' growth strategies, capital increase refers to a method whereby a company raises its existing capital to finance operations, seize growth opportunities, or pay off debts. Capital represents the resources pledged by partners during a company’s establishment or operations. Increasing this capital strengthens the financial structure of the company. Public companies execute capital increases through shareholders, while private companies rely on contributions from partners. Companies may choose capital increases to create resources for new investments, reduce existing debts, or enhance market value. Capital increases can be conducted via two methods: paid and bonus.
Why Do Companies Increase Capital?
Capital increase is a critical financing method that companies use to strengthen their financial structure and achieve strategic goals. Companies may decide on a capital increase to pursue financial growth, pay debts, make new investments, and adapt to market dynamics. A well-managed capital increase can effectively help a company achieve both its long- and short-term objectives. Here are the primary purposes for capital increases:
- Financial Growth and Expansion
- Debt Repayment and Financial Restructuring
- Financing New Investments
- Regulatory Compliance and Legal Requirements
- Enhancing Shareholder Confidence
- Increasing Company Value
- Strategic Partnerships and Acquisitions
Financial Growth and Expansion
A capital increase provides the financial support companies need to achieve their growth goals. Additional resources are required for strategies such as entering new markets, expanding products and services, or making technology investments. A capital increase offers the necessary funding for such strategic investments, enhancing the company’s competitive power. For instance, a globalizing firm may use it to finance international operations, or a tech company may use it to support R&D activities.
Debt Repayment and Financial Restructuring
Over time, companies may need to settle accumulated debts or reduce debt ratios. A company burdened by high debt may create resources through a capital increase to mitigate the impact on operational processes. This reduces financial risks with a lower debt ratio, boosting investor confidence. Additionally, companies using capital increases for debt repayment can reduce interest expenses, making their financial structure more sustainable.
Financing New Investments
Companies require significant financial resources for investments like building new facilities, acquiring equipment, or upgrading existing infrastructure. A capital increase is critical for funding such projects. For example, an energy company may use it to support renewable energy projects, or an e-commerce firm may use it to strengthen its digital infrastructure.
Regulatory Compliance and Legal Requirements
In some cases, companies increase capital to comply with specific legal regulations. This method is particularly crucial in sectors where expanding the capital base is mandatory. For instance, a banking institution may undertake a capital increase to meet legally mandated capital adequacy ratios.
Enhancing Shareholder Confidence
Capital increase is a significant step for publicly traded companies to enhance investor confidence. It can demonstrate the company’s commitment to its growth and financial goals. Paid capital increases offer shareholders an attractive opportunity to contribute more, while bonus capital increases may attract investor interest by offering free shares.
Increasing Company Value
Capital increase can enhance a company’s value and strengthen its market position over the long term. For instance, bonus capital increases can increase share liquidity, making the company more appealing to investors.
Strategic Partnerships and Acquisitions
Companies may also use capital increases to form strategic partnerships or acquire other firms. They can address substantial financial needs for such moves through a capital increase.
What Is a Paid Capital Increase?
A paid capital increase refers to the process by which a company raises its existing capital by requesting cash from its shareholders or new investors. This method allows companies to meet their financial needs without relying on external sources. During this process, companies issue new shares and offer them for sale at a specified price. When used strategically, paid capital increases can support both the company’s growth and the long-term interests of its shareholders.
Paid capital increase is a method used to address various financial and strategic needs of companies. Companies may decide on a paid capital increase to finance new investments, strengthen their financial structure by repaying debts, expand their shareholder base to improve share liquidity or comply with legal regulations and sectoral requirements.
What Is the Right of Preemption?
In a paid capital increase, shareholders have specific rights and responsibilities. One of these is the right of preemption. This right allows shareholders to purchase newly issued shares with priority, ensuring they maintain their ownership ratio in the company. Shareholders can exercise this right to buy new shares or transfer their rights. However, shareholders also have the responsibility to contribute additional capital during a paid capital increase. Those who fail to provide the required additional capital within the specified period may lose their preemption rights.
What Are the Advantages and Disadvantages of Paid Capital Increase?
Paid capital increase can be advantageous for both companies and shareholders. For companies, one key benefit is meeting their cash flow needs through contributions from shareholders, thus avoiding external borrowing costs. Additionally, reducing debt levels strengthens the company’s financial structure, while creating resources for new projects supports the company’s growth objectives.
For shareholders, a paid capital increase offers several advantages. Firstly, if the company grows after the increase, the value of its shares may appreciate. Secondly, existing shareholders can maintain their ownership percentage by purchasing new shares, ensuring their stake in the company remains intact.
Despite its advantages, a paid capital increase also comes with disadvantages. One drawback is that it may temporarily lower share prices. Moreover, the process could signal financial weakness, potentially undermining investor confidence. Shareholders must contribute additional capital to purchase new shares using their preemption rights, which may be a financial burden. Those who do not exercise their preemption rights risk losing their ownership ratio in the company, representing another disadvantage for shareholders.
What Is a Bonus Capital Increase?
A bonus capital increase is an essential tool for companies to strengthen their capital structure and create value for investors. It involves raising capital using internal resources without requiring payment from shareholders. During this process, companies allocate funds from capital reserves, retained earnings, or share premiums to capital and distribute new shares to existing shareholders free of charge. Companies may opt for a bonus capital increase to expand and strengthen their capital base, gain investor confidence, increase share liquidity, or comply with legal regulations.
What Are the Advantages and Disadvantages of Bonus Capital Increase?
A bonus capital increase provides various advantages for both companies and shareholders. For companies, it supports strengthening their financial structure, improving share liquidity, enhancing investor confidence, and reducing the need for borrowing. For shareholders, the primary advantage is acquiring new shares without any payment, thereby increasing the number of shares they own at no cost. While the market value of the company remains unchanged, shareholders maintain the value of their portfolio with the newly issued shares. Additionally, a bonus capital increase may reflect a strong financial structure, positively influencing market perception and boosting investor confidence.
However, despite its advantages, a bonus capital increase may also lead to disadvantages. It does not bring direct cash inflow to the company, making it insufficient to address liquidity needs. Furthermore, the process involves the consumption of internal resources, such as retained earnings or capital reserves. The increase in the number of shares following a bonus capital increase can reduce earnings per share (EPS), which investors may perceive as a decline in profitability, negatively affecting market sentiment.
FAQ:
What is a share premium?
A share premium is the difference obtained when a company sells new shares at a price above their nominal value. This surplus is added to the company’s equity and is typically used for capital increases, debt repayment, or new investments. For instance, if a share with a nominal value of 1 unit is sold at 1.5 units, a share premium of 0.5 units is created.
What is a capital reserve?
Capital reserve refers to a pool of funds derived from internal resources such as past profits, share premiums, or revaluation surpluses. These funds are used for future capital increases or other financial transactions.
What is liquidity?
Liquidity refers to the ease and speed with which an asset can be converted into cash without significant loss of value. In financial markets, liquidity indicates how easily an investment instrument can be bought or sold. For example, shares are generally more liquid, whereas real estate is less so.
The information presented in this blog is intended for general informational purposes only and does not constitute legal, financial, or investment advice. It is prepared to provide guidance and is not binding. For personalized recommendations, consult a professional advisor. All decisions made based on this content are at your own risk, and Papel Electronic Money and Payment Services Inc. assumes no responsibility in this regard.
