You may have heard of companies issuing bonus shares. Essentially, it’s when a company gives out extra shares to its current shareholders. It’s a way for companies to show appreciation to their shareholders.
Big companies like Infosys, Wipro and ITC have done this in the past. Bonus share issues by financially strong companies can be a good sign and can boost investors’ confidence in the company. It shows that the company is committed to its shareholders and is in a good financial standing.
So, what is a bonus issue?
In a bonus issue, additional shares are handed out by the company to its current shareholders at no extra cost. These shares are given out to all or only a specific group of shareholders (of a specific class), as per the company’s discretion. Bonus shares are issued in proportion to the ownership that each shareholder has in the company. This results in the ultimate percentage holding of each shareholder remaining unchanged in the company with no dilution of shareholder stake across a specific class or the entire cap table.
Why do companies issue bonus shares?
Reasons for issuing bonus shares may be manifold. These may include – lack of cash to meet contractual obligations, a desire to conserve cash, a need to improve liquidity, enable capital restructuring and so on.
1. Enabling grant of stock options of lesser value: Issuing bonus shares can also be a strategic move by the company to enable grant of stock options of a lesser fair market value. Since in India, a company cannot issue fragmented shares (valued below the per share price), companies can opt to make a bonus issue to the existing shareholders, effectively reducing the price of each share, before granting options.
Let us look at an example.
Company Webb Private Limited has made a bonus issue announcement of 2:1, which means that for every 1 share held by a shareholder, 2 additional shares are issued without any additional subscription amount to be paid by the shareholders. This results in an increase in the total number of outstanding paid up shares. Since there is no change in the fair market value of the enterprise, the issue of additional shares under the bonus issue results in a decrease in the share price.
For example, if the company has a total paid up capital of INR 10,00,000 comprising of 10,000 paid up shares, and the fair market value is INR 20,00,000, the price per share before the bonus issue would be 20,00,000/10,000= INR 200. Post the bonus issue, the price per share would reduce to 20,00,000/15,000= INR 133.
2. An anti-dilution measure: Anti-dilution protection is used to protect current investors when the company’s stock price goes down and new investors come in at a lower price. Issuing bonus shares allows the company to compensate the existing shareholders by increasing the number of shares they hold thus maintaining their shareholding.
3. Substitute to dividend payout: Since dividends are paid from the cash reserves of the company, issuing bonus shares avoids depleting cash reserves.
4. Good returns from IPO: The company may have a commercial understanding with investors to issue additional shares right before the company goes for an IPO. Since bonus shares result in a reduction of share price, the shareholders can make good returns once the shares are listed for a higher value. The issue of bonus shares can also make a company appear larger and more attractive to investors by increasing its issued share capital. This can also decrease the stock price, making it more affordable for individual investors.
5. Capital restructuring: Issue of bonus shares increases issued shares and the company’s share capital. Further, bonus shares help to capitalise the profits of the company. Bonus issue of shares are often undertaken for various corporate restructuring activities.
How is a bonus issue different from stock split?
A bonus issue is often confused for a stock split. This is because, in both cases, the number of shares a shareholder holds increases. While this is true, both are different in their own aspects. Under stock split, the shares that a shareholder currently holds is split into smaller denominations. This means, if a share is valued at INR 100, and the company decides to split the shares in the ratio of 1: 10, then a shareholder holding one share of INR 100 will hold 10 shares of INR 10 post split.
Under bonus issue, the company issues additional shares to existing shareholders.
How is a bonus issue funded?
The company can use one or a combination of reserves mentioned below to fund its bonus issue.
Companies maintain a percentage of profit earned in a financial year in the free reserves account. This account may be debited to issue bonus shares.
Securities premium account:
The premium component of shares issued is credited to the securities premium account. When making the bonus issue, the securities premium account is debited, and the share capital account is credited.
Capital redemption reserve account:
If a company has issued any redeemable preference shares, it must transfer an amount equal to the face value of these shares to the capital redemption reserve account from its profits. Bonus shares can then be issued from this reserve account.
Fresh issuance of shares:
The issuance of bonus shares can be funded by issuing new shares at a premium and using the resulting funds.
Are there prerequisites to issue bonus shares?
- Before making the bonus issue, companies must fulfil any outstanding obligations to debtors such as interest or principal payments on fixed deposits or other debt instruments, as well make sure that all statutory dues to employees are met, such as provident fund contributions, gratuities, and bonuses.
- Only shareholders who have fully paid for their shares are eligible to receive bonus shares. If a shareholder has only paid part of the price for their shares, they must complete payment of the issue price to become qualified for bonus shares.
- Shareholders can only be issued bonus shares from the same class of shares they currently hold.
- Once the board of directors announce the bonus issue, the decision cannot be withdrawn. If the shareholders do not approve, then the bonus issue will be rejected.
What is the process to issue bonus shares?
If you are a private limited company considering to issue bonus shares, there are several steps you will need to follow to ensure a smooth and successful process. These may include:
- Determine the number of bonus shares to be issued: The number of bonus shares to be issued depends on the specific circumstances of the company, business considerations and the goals of issuance.
- Investors consent: Obtain necessary consents from investors in your company who have a significant stake.
- Check and ensure there is sufficient authorised capital buffer: The memorandum of the company sets a limit on the number of shares that can be issued to shareholders. Hence, before issuing bonus shares, a company must ensure that the issue does not exceed the limit. If necessary, the company can increase its authorized share capital by amending clause 5 (the capital clause) in its memorandum of association.
- Articles to authorise: The company’s articles of association must authorise the issue of bonus shares. If the articles do not have such a provision, then they must be amended in order to make the bonus issue.
- Filings with ROC: If there has been an increase in the authorised capital and an alteration in the articles of the company, e-Form SH-7 and e-Form MGT-14 has to be filed with the Registrar of Companies (ROC).
- Bonus issuance: The bonus issue needs to be approved by the board and existing shareholders of the company. The board decides the ratio in which the bonus shares will be issued. For example, if the ratio is 1:2, then for each share, two additional shares will be issued to a shareholder. Board approval must also be taken to allot the shares and issue duly stamped share certificates pursuant to the allotment of bonus shares. Form MGT-14 must be filed with the ROC intimating the special resolution passed with regard to the bonus issue.
- Allotment of shares: Once the shares are allotted, e-form PAS-3 (Return of allotment) has to be filed to the Registrar of Companies within 30 days from the date of allotment.
- Statutory registers: Lastly, the register of members must be updated, recording the bonus issue.
Tax and bonus shares
When shareholders receive bonus shares, they do not need to pay tax on the receipt of shares. However, they may need to pay capital gains tax when they sell the shares, depending on the price of the shares at the time of sale and when the sale takes place. Capital gains tax can be long term or short term.
Bonus shares and non-resident shareholders
A company often has shareholders who are non-residents. The government of India has set a limit on the percentage of shareholding that foreign shareholders are allowed to have in a company depending on certain industry sectors.
For instance, foreign investment in the insurance sector is allowed up to 49%, mining of precious stones up to 74% under automatic route. When issuing bonus shares, companies must be mindful of these cap limits and ensure that they are not exceeded.
With more and more companies issuing bonus shares, it’s essential to understand how they fit into the company’s financial plan and strategy. Companies may choose to distribute bonus shares as a way of thanking shareholders and potentially lowering the price per share. This decision requires approval from shareholders, who may be willing to accept a decrease in the price of individual shares as long as the overall value of the company is maintained. It’s worth noting, however, that receiving bonus shares does not guarantee a profit and the value of a company’s stock may still decrease even after bonus shares are issued.