Deciding between raising authorized capital and external funding? Understand their benefits, costs, and impact to choose the right approach for growth.
As business grows, the requirement for finance becomes one of the important growth factors. Companies have two major alternatives: increasing their authorized capital or opting for external capital. Each alternative has its merits and demerits, and therefore, the goals of a company, its financial health, and long-term vision play a decisive role in choosing between the alternatives.
But choosing the right business financing isn’t just about raising funds; it’s about matching your growth strategy with the right capital structure. From scaling operations and entering new markets to launching new products, understanding what these funding options entail can be an essential part of sustainable growth.
This article compares how increasing authorized capital differs from seeking external funding and explores which avenue is best to meet the unique needs of your business.
What Is Authorized Capital?
The authorized capital is the highest amount of share capital a company is legally allowed to issue to its shareholders, according to the structure of its Memorandum of Association. It represents the highest limit of the financial capability of a company to raise equity through the issuance of shares. Such capital, although pre-determined at the time of incorporation, can be increased at later stages depending upon requirement and fulfillment of legal requirements.
For example, if a company is authorized to have an issued and paid-up capital of ₹1 crore, it can issue shares only up to ₹1 crore but not beyond, without increasing its authorized capital with due formality. That becomes the threshold within which the company has to operate its capital structure.
Process of increasing authorized capital
Increasing authorized capital has many steps, and every such step involves a series of legal and procedural requirements within the Companies Act, 2013, in India. A breakdown of the procedure is represented as follows:
Board Approval
- Hold a board meeting and propose increasing authorized capital.
- Pass a resolution by the board approving such a proposal and convening a general meeting of the shareholders.
Shareholder Approval
Hold a general meeting and pass a special resolution for increasing the authorized capital with shareholder approval.
Amendment of MoA
The capital clause in the MoA should be modified in order to raise the authorized capital.
Filing with RoC
The company should file Form-SH-7, together with the amended Memorandum and resolution copy with prescribed fees within 30 days from the passing of the resolution.
Registrar Approval
In case of approval by the RoC, the increased authorized capital comes into effect.
Benefits of increasing authorized capital
More Financial Flexibility
By increasing the authorized capital, the company will be able to issue more shares and raise capital for its expansion, operations, or new projects.
Growth Strategy
Increased financial scope will facilitate new market explorations, R&D investments, and scaling up of operations.
Strengthened Credibility
Increasing authorized capital reflects financial stability, which may help attract investors and other partners.
No Financial Burden
Unlike loans, raising authorized capital doesn’t mean repayment or paying interest. It is debt-free finance.
Limitations of increasing authorized capital
Share Dilution
This may dilute the percentage ownership of the existing owners, possibly affecting their voting powers.
Compliance Requirements
There is a lot of legal administrative and regulatory compliance involved, which may be time-consuming and costly as well.
Possible Misuse of Funds
Poor utilization of capital may amount to financial distress or discontent among stakeholders.
Increased Scrutiny
Regulatory authorities may scrutinize companies with higher authorized capital more closely with regard to their finances.
What Is External Funding?
Definition and types
External funding is the generation of capital outside the company for financing its operation, expansion, or any other business activity. Unlike internal funding, which depends on retained earnings or reserves, external funding means resorting to third-party investments. The major types of external funding include:
Equity Financing
- It involves raising capital by issuing ownership of the company to external investors such as venture capitalists, angel investors, or the public through IPOs.
- Equity financing does not need to be repaid, but ownership is diluted in the process.
Debt Financing
- Borrowing from financial institutions or corporate bond issuance.
- Must be repaid with interest added; however, it does not affect ownership.
Venture Capital
- The investment of capital by venture capitalists in return for equity.
- Normally targets the startups and high-growth businesses that have huge potential.
Grants and Subsidies
- Non-repayable finance provided by governments or organizations for certain purposes.
- These are very limited and often come with strict conditions.
Crowdfunding
This means raising small amounts of capital from many people over online platforms. It is more effective for startups and niche products.
Advantages of External Funding
Access to Large Pools of Capital
Businesses are able to raise huge amounts with external funding, and sometimes this is much faster compared to internal methods.
Diversified Financing Options
Equity, debt, or hybrid model-businesses can choose an option that best suits their goals and risk tolerance.
Expertise and Networking
Equity investors, such as venture capitalists, typically bring invaluable industry experience, mentorship, and valuable networks.
Preservation of Internal Resources
External funding ensures the business’s internal reserve is used for operational stability.
Disadvantages of External Funding
Loss of Control
Equity finance represents partial ownership and thus the reduction of control of existing owners.
Repayment Liabilities:
Debt financing repayment liabilities along with interest cost, increase the cash flow burden.
Time-Consuming Process
The process of external funding generally involves huge due diligence, negotiation, and compliance checking.
Investor Expectations
There may be certain performance targets or substantial returns which have been demanded by the investors, which management is supposed to cope with.
Key Differences Between Increasing Authorized Capital and External Funding
Ownership and control implications
Increasing Authorized Capital
Issuing more shares dilutes the ownership percentage of the already existing shareholders, which means less voting power. On the other hand, issuing internally keeps complete ownership with the company.
External Funding
Equity financing reduces ownership and possibly changes the strategic direction of a company, while debt financing entails financial obligations without diluting ownership.
Risk and liability factors
Increasing Authorized Capital
It does not involve financial risk since it does not create any repayment obligations. The risk is, however, in the dilution of shares and possible misuse of funds.
External Funding
Debt financing amplifies financial liability through repayments and interest obligations. Equity funding shares risks with investors but may be associated with pressure to achieve aggressive growth targets.
Long-term financial impact
Increasing Authorized Capital
It is a permanent solution to raising debt-free funds, but the financial implication on shareholder value depends upon how well the raised capital is utilized.
External Funding
Debt financing can eventually squeeze cash flow due to repayment schedules, while equity financing means the business must share its future profits with its external investors.
When to Choose Increasing Authorized Capital
Situations favoring authorized capital increase
The authorized capital shall be increased in a situation when the company wants to avail internal financing and also want to have better control over the ownership structure. The circumstances supporting such a decision include:
Internal Expansion
Companies who intend to fund new projects, scale up operations, or launch other products using their internally available shareholding capacity.
Equity Retention Purposes
When businesses need to raise funds without diluting ownership beyond the existing shareholder group.
Reinvestment of Retained Earnings
Companies with high retained earnings that prefer internal financing rather than opting external debt or equity dilution.
Long-Term Capital Needs
Businesses needing to create financial flexibility in the future without any immediate liabilities.
Private Companies Needing Investor Comfort
The increase in authorized capital proves financial preparedness and transparency in the business, thus making it attractive for future investment.
Examples of businesses that benefit from increasing authorized capital
Family-owned companies: To retain ownership control while raising funds for growth.
Companies with a Stable Shareholder Base: To fund expansions without changing ownership dynamics significantly.
Companies expecting IPOs: Increasing share issuance capacity in preparation for public listing.
Startups with Existing Investors: When the business has committed investors and wants to issue additional shares to the same group.
When to Opt for External Funding
Scenarios where external funding is ideal
External funding is best used when the companies need huge inflows of capital, rapid-scale expansion, or require very specialized expertise. Key scenarios include:
High-Growth Startups
Startups planning for high-scale growth find more feasibility with venture capital investment or angel investors, which, along with providing capital, offers strategic guidance.
Capital-Intensive Industries
These are businesses in industries like real estate, manufacturing, or technology that involve huge upfront investments.
Short-Term Liquidity Needs
Companies having immediate cash flow problems often resort to debt financing for immediate relief.
Market Entry
Diversification into new geographical locations or industries often requires external funding due to the generally more obstacles to enter the market.
Innovative Projects
Externally funded projects dealing in innovative products or services also arise when such investors perceive the possibility of high growth.
Types of businesses suited for external funding
Start-ups and Early-Stage Companies:
Mostly dependent upon equity investors, such as venture capitalists, to finance early activities and product development.
Scalable Tech Businesses:
These businesses have potentially very high growth and often raise finance externally to try and outrun their competitors.
Companies with Low Debt Tolerance:
Where companies do not wish to borrow, external equity can be raised to fund growth.
High-Risk, High-Reward Ventures:
The potential for high returns in innovative or disruptive businesses often attracts external finance.
Comparative Analysis: Authorized Capital vs. External Funding
Criteria |
Increasing Authorized Capital |
External Funding |
| Cost Implications | – Stamp duty and filing fees based on capital increase. | – Equity financing involves profit sharing and dilution. |
| – Legal and administrative costs for resolutions and filings. | – Debt financing includes interest payments and loan fees. | |
| – No repayment obligations after issuance. | – Additional costs for due diligence, legal services, and investor relations. | |
| Time and Complexity | – Typically completed in 3-4 weeks. | – Equity financing can take months due to due diligence and negotiations. |
| – Involves board and shareholder approvals, MoA amendments. | – Debt financing is faster but involves collateral agreements. | |
| – Simpler for internal operations. | – Higher complexity with external stakeholder involvement. | |
| Impact on Valuation | – Neutral impact directly; depends on fund utilization. | – Equity funding can enhance valuation through investor confidence and growth potential. |
| – Perceived financial stability may improve market perception. | – Debt financing may negatively impact valuation if liabilities increase. | |
| Ownership and Control | – Dilutes ownership only if external investors are involved. | – Equity financing dilutes ownership and may reduce decision-making control. |
| – Retains ownership within existing shareholder group. | – Debt financing retains ownership but adds financial obligations. | |
| Risk Factors | – Minimal financial risk; main risk is shareholder dilution. | – Debt financing carries financial risk due to repayment obligations. |
| – Funds must be utilized effectively to avoid dissatisfaction. | – Equity financing may involve performance pressure from investors. | |
| Strategic Fit | – Suitable for companies prioritizing internal growth and reinvestment. | – Ideal for high-growth businesses, startups, or those needing large capital inflows. |
| – Works well for long-term flexibility and planning. | – Best for companies requiring expertise, networking, or immediate capital. |
Conclusion
A decision to increase authorized capital or go for external funding proves very important often and shapes a company’s future growth. It has its own merits and drawbacks, and hence, which option is viable depends upon the financial goal, growth strategy, and long-term vision of a company.
Increased authorized capital is ideal for businesses seeking to maintain ownership control, internally prioritize finance, and build flexibility in favor of gradual and sustained growth. It is particularly suited for companies that are focused on internal reinvestment and those with a stable shareholder base.
External funding is a strong tool for high-growth companies, startups, or businesses that need a large capital base on a wide scale for rapid expansion or entering new markets. While external funding gives access to resources, expertise, and networks, ownership dilution and financial obligations are almost part of the package that comes with it.
In other words, your choice between authorized capital and external funding should fall in line with your business vision and needs to have a full and sustained path toward growth.
