Capital reduction is defined as the process of decreasing a company’s shareholding equity through share cancellations and share repurchases. Companies may undertake capital reduction for various reasons, including restructuring, mergers and acquisitions, and increasing shareholder value. In India, capital reduction falls under the purview of the Companies Act of 2013. If you have just started investing in stock market, it's crucial to understand the meaning of capital reduction, its rationale, and its impact.
Capital Reduction, also known as reduction of share capital, is a process where a company lowers its total issued capital. This doesn't require approval from every individual shareholder. A common way to do this is through a share buy-back, where the company purchases its own shares from existing shareholders. This helps reduce the number of shares in circulation and can be used to return excess funds to investors or improve the company's financial structure.
Key takeaways
- Capital reduction involves decreasing a company's shareholder equity, which can be executed through measures such as share cancellations, paid-back capital, or share buybacks.
- Companies undertake capital reductions for various reasons, including increasing shareholder value, improving earnings per share (EPS), or streamlining their capital structure for better efficiency.
- The process of capital reduction must adhere to legal requirements, ensuring the company completes all necessary procedural steps to lawfully implement the reduction.
How does capital reduction work?
Companies can undertake capital reduction in one of two ways:
- Pay back the amount the shareholders paid in acquiring the company’s shares.
- Cancelling a certain number of shares.
The decision for capital reduction does not require permission from each shareholder. In other words, the company can return the capital to shareholders without their consent. That said, companies are required to comply with certain regulations and follow a set process when implementing capital reduction. Here’s a step-by-step guide on how capital reduction works:
- The company must send a notice to its creditors outlining the capital reduction resolution.
- Next, the company must submit an application for the decrease in share capital within a stipulated period after the publication of the initial notice.
- Once the share capital reduction decision is noted in the commercial register, the company has to disburse the capital amount to its shareholders within a few months.
Note: While these are the general steps to capital reduction, the specifics may vary depending on the country in question. Different countries may have different sets of rules and compliance regulations vis-a-vis share capital reduction.
