When forming a corporation, its charter must specify the maximum number of shares it is authorized to issue, although the company does not have to issue all the shares at once. It usually issues enough shares to meet its current capital needs. The shares issued and in the hands of investors are called outstanding. The number of shares outstanding can never exceed the number of authorized shares.
A company can issue shares in an initial public offering, or IPO, or a secondary offering. In an IPO, the shares are issued for the first time to raise capital and establish the share price. All subsequent issues of shares are called secondary offerings. Once issued, shares start trading on an exchange. The proceeds from a stock issuance go to the company or sometimes to the selling shareholders; all subsequent share trading is by and among investors and does not involve the company or affect the number of shares outstanding.
In certain instances a company may find it advantageous to buy back on the open market some of the previously issued stock. Shares just repurchased reduce the number of shares outstanding and become treasury stock that the company can reissue later should the need arise.
Changing the Number of Authorized Shares
Once a company issues all the shares it is authorized to issue, it cannot issue any more shares unless its shareholders vote at an annual meeting to increase the number of authorized shares. A company may have simply grown too big and need to sell more shares to satisfy its capital needs, or it may decide to effect a stock split.
In the most common 2-for-1 stock split, an investor who owns 100 shares will receive another 100 shares, but the stock price will drop by 50 percent. If a company is authorized to issue 100 million shares and has 85 million shares outstanding, it cannot do a 2-for-1 stock split without first increasing the number of authorized shares because 85 million pre-split shares will become 170 million shares post-split, exceeding the maximum authorized number of shares by 70 million.
- “PassTrak Series 7: General Securities Representative License Exam”; Dearborn Financial Services; 2003