In the intricate world of corporate finance, few moves are as revealing as the issuance of bonus shares. Imagine a company generously distributing additional shares to its existing shareholders, all at no extra cost. This isn’t merely a gesture of goodwill; it’s a strategic maneuver that can reflect a company’s financial health and strategic foresight. Major players like Infosys, Wipro, and ITC have demonstrated this practice, sending powerful signals to the market about their stability and growth prospects.
But what exactly is a bonus issue, and why should it matter to investors and companies alike?
Understanding Bonus Issues
At its core, a bonus issue is the process by which a company distributes extra shares to its shareholders based on their existing holdings. This allocation is made without requiring shareholders to make any additional payment, preserving the proportion of ownership each shareholder holds. In essence, bonus shares are issued to reward shareholders, affirm confidence in the company, and sometimes, to adjust the stock price to a more market-friendly level.
Why Do Companies Issue Bonus Shares?
Companies opt for bonus issue of shares for a number of reasons:
- Enhancing Liquidity: Companies with strong cash reserves might issue bonus shares to increase liquidity and make their shares more attractive to investors.
- Strategic Stock Option Grants: By lowering the share price through a bonus issue, companies can grant stock options at a more manageable price, aligning with regulatory requirements that prohibit fragmented shares.
- Anti-Dilution: Bonus shares can serve as a protective measure for existing shareholders, ensuring their ownership percentage remains stable even when new shares are issued.
- Substitute for Cash Dividends: Instead of paying out cash dividends, which depletes reserves, companies can issue bonus shares to reward shareholders without affecting their cash flow.
- IPO Preparations: Issuing bonus shares before an IPO can make the company appear larger and more appealing to investors, potentially leading to better returns post-listing.
- Capital Restructuring: By increasing the share capital, bonus issues can facilitate various corporate restructuring activities, capitalizing on accumulated profits.
Bonus Issue vs. Stock Split
- Stock Split: A stock split divides existing shares into smaller denominations, altering their face value but not the total value of an investment. For instance, a 1:10 stock split means a shareholder with one INR 100 share ends up with ten INR 10 shares. The total investment value remains unchanged, but the number of shares increases. The ownership percentage remains the same because the total market capitalization and the shareholder’s proportional ownership do not change.
- Bonus Issue: Conversely, a bonus issue adds new shares to existing holdings without changing the share’s face value or the shareholder’s relative ownership percentage. If a company declares a 1:1 bonus issue, a shareholder with one share will receive an additional share, resulting in a total of two shares. The total number of shares increases, but so does the total market capitalization, so the shareholder’s percentage ownership remains constant.
Funding a Bonus Issue
- Free Reserves: Companies may use accumulated profits kept in free reserves.
- Securities Premium Account: Funds from the premium on shares issued can be used for bonus shares.
- Capital Redemption Reserve: Used if redeemable preference shares are involved.
- Fresh Issuance of Shares: Issuing new shares at a premium to fund the bonus shares.
Prerequisites for Issuing Bonus Shares
Before issuing bonus shares, companies must:
- Settle all outstanding obligations and statutory dues.
- Ensure shareholders have fully paid for their shares.
- Issue bonus shares only from the same class of shares held by shareholders.
- Obtain board and shareholder approvals for the bonus issue.
Process for Issuing Bonus Shares
- Determine the Ratio: Decide how many bonus shares to issue per existing share.
- Obtain Consents: Secure necessary approvals from key investors.
- Review Capital Limits: Ensure the bonus issue does not exceed authorized share capital.
- Amend Articles: Update company articles if needed.
- File with ROC: Submit required forms to the Registrar of Companies.
- Allot Shares: Approve and allot the bonus shares, updating statutory registers accordingly.
Tax Implications
Shareholders receiving bonus shares do not pay tax upon receipt. However, capital gains tax may apply when the shares are sold, depending on the sale price and holding period.
Bonus Shares and Non-Resident Shareholders
Companies must ensure that issuing bonus shares to non-residents adheres to sectoral investment limits set by the government, such as those in insurance or mining sectors.
The issuance of bonus shares is more than a mere corporate gesture; it’s a strategic tool that reflects a company’s financial health and strategic intent. While it can enhance shareholder value and market perception, it’s crucial for both companies and investors to understand the underlying implications and ensure alignment with broader financial goals.
