What is a capital increase?

Definition of a capital increase

A capital increase is an operation aimed at the creation of new shares in order to strengthen the social capital of a company . It is a source of financing by the stock markets that allows the company to develop or overcome financial difficulties . A capital increase has the effect of increasing the company’s equity by allowing former shareholders to participate in the operation but also by attracting new investors. The equity is not intended to be repaid unlike a bank loan. On the other hand, it gives investors a right to vote and a right to dividends.

The different forms of capital increase

Increase in share capital : This type of capital increase is not intended to provide financing to the company but is simply an accounting entry game. Indeed, with this method, the undistributed reserves of the company are simply transformed into share capital. Free shares are then distributed to shareholders or the par value of the shares is increased so that there is no dilution for the shareholders. The value of the business remains the same.

– Capital increase by contribution in cash : The company issues new shares in order to obtain new financing. The former shareholders then receive preferential subscription rights in order to have priority over other investors for the acquisition of these new securities.

– Capital increase by contribution in kind : New shares are created by the company in return for contribution in kind that it receives from the various investors. A contribution in kind includes land, buildings, machine tools, patents or even an exchange of shares between two companies (public exchange offer).

– Capital increase by debt consolidation : This is an agreement between a creditor and the company. If the creditor wishes, he can decide to convert his debt into share capital. He will thus receive shares of the company in return for the cancellation of his debt. This can be done for example in the case of bonds convertible into shares or even which are exercised by its holder.

The motivations for a capital increase

Increase in guarantees for creditors : The increase in share capital is reassuring for creditors who, in the event of the company’s bankruptcy, will have a better chance of being reimbursed. In the event of the addition of new funds (cash contributions), the solvency (its ability to repay its debts) of the company is increased. The banks will then be less reluctant to grant new loans to the company.

– Financing new investment projects : A capital increase allows the company to obtain financing and continue its development with new investment projects. Ultimately, if the project is profitable, growth is generated.

– Better rating : The increase in equity reinforces the financial soundness of the company and therefore its solvency . Financial rating agencies attach great importance to this criterion and the capital increase is therefore a way for the company to stabilize its rating or increase it. Thus, the company will eventually be able to finance itself with lower borrowing rates on the markets.

– Debt reduction : When the company is too indebted, it can decide to carry out a capital increase which will allow it to repay part of its loans. The interest on the debt will therefore decrease and its financial flexibility will be increased. However, this maneuver is often badly perceived by the markets.

– Recapitalization : In the event of an economic and financial crisis, some companies have no other choice than to recapitalize if they do not want to disappear. The capital increase then allows it to cover its losses. Shareholders must subscribe if they do not want to lose their initial investment.

– Increase its cash flow : The company may want to buy out its competitors or better control its production costs by buying its suppliers or distributors. For this, it needs a lot of cash and the capital increase is a good way to dispose of it.

The misdeeds of a capital increase

Dilution : If the former shareholder of the company does not subscribe to the capital increase, he will not only see a dilution of his rights to dividends but also of his voting rights. This is mechanically explained by the increase in the number of shares. For larger shareholders, this can also mean a possible loss of influence over the company’s strategic decisions. However, it may happen that the new shares issued by the company are deprived of voting rights. Regarding dividends, the loss in the event of non-subscription for the former shareholder can be offset by the growth of the company the capital increase can be used to finance new investment projects and therefore to create additional  profitability. for the shareholder.

– Increase in WACC : WACC means weighted average cost of capital. It is more expensive for a company to finance itself by the stock markets than by a bank loan. In fact, in the markets, shareholders demand greater profitability than the cost of borrowing. However, the company cannot have too high a debt ratio and therefore markets are its only solution for obtaining new capital.

– Fall in the stock market price : Due to the issuance of new shares, the return per share will therefore decrease. Investors are going to be more reluctant to invest in the company. Some of the former shareholders will sell their shares, the prospect of short-term gains being reduced. The company’s future investments will only bear fruit (if the projects are profitable) in the long term. As a result, the stock price will therefore decrease in the short term.

– Risk of non-subscription : If the company’s communication has been bad over the past few years or if the reasons for the capital increase are considered bad by investors, there is a risk that the new shares issued will not be subscribed. The subscription will therefore reflect the confidence of investors in the company.

Leave a Reply

Your email address will not be published.

You May Also Like