Forfeited shares: The untold story of investing and corporate finance

In the dynamic world of investing and corporate finance, understanding the nuances of share trading is crucial. One such nuance, often overlooked but of significant importance, is the concept of forfeited shares. Though complicated, this term is crucial to corporate financial strategies and shareholder investment decisions.

So, what are shares forfeited exactly? How do they function? How do they influence you as an investor or a business? This article unravels the concept of forfeited shares, illuminating its workings, consequences, and pertinence in the current financial environment.

What are forfeited shares?

As the name implies, shares forfeited are shares that a shareholder gives up (or forfeits) when they do not follow the rules the company has set. It usually happens when a shareholder does not pay the calls on shares, which are the company’s requests for additional payment. 

The corporation can reclaim the shares if the shareholder fails to fulfil these payment requirements within the specified time. Companies use this forfeiture process to ensure they get enough money and that the shareholders pay their bills. Investors must grasp this idea thoroughly since it affects their shareholding in the business.

How does the forfeiture of shares work?

Companies can enforce shareholder payment discipline by forfeiting shares. It all starts when a shareholder does not pay their share payment by the due date. After that, the corporation gives the shareholder who has defaulted another chance to pay by serving them with a notice. The company can seize the shares if the shareholder refuses to pay.

The right to receive dividends and vote at meetings, among other rights and benefits, are immediately forfeited upon default by the shareholder. Following forfeiture, the shares are considered the company’s property and can be reissued or cancelled at the discretion of the company.

Note that companies usually only choose to forfeit shares as a last resort to recover unpaid capital; it is a serious action. Thus, shareholders must know and pay their calls to avoid forfeiture.

Consider a hypothetical example to illustrate the process of share forfeiture:

Company A issues 1,000 shares to investor B at ₹10 each, payable in two instalments. B pays the initial ₹5 per share, totalling ₹5,000. After three months, a call is made for the remaining ₹5,000, but B fails to pay despite a notice. Consequently, Company A forfeits B’s shares, revoking all associated rights and benefits, including the initial ₹5,000 payment.

The journal entry in the books of Company A would be:

Debit: Share capital ₹10,000

Credit: Calls in arrears ₹5,000

Credit: Forfeited shares ₹5,000

This entry removes the liability of investor B’s unpaid amount from the company’s books and records the amount initially paid as forfeited shares. This will be the treatment of forfeited shares in the balance sheet. 

Reissue of forfeited shares

When shares are forfeited, they become the company’s property and can be reissued to new investors. The procedure for the reissue of forfeited shares involves several steps:

Decision to reissue: The board of directors decides to reissue forfeited shares. The reissue terms and price depend on this decision.

Announcement: The company issues a prospectus or stock exchange announcement to reissue forfeited shares.

Sale of shares: Under company terms, forfeited shares are sold to new investors.

Registration: The company registers and issues share certificates to new shareholders.

The reissue of forfeited shares must adhere to the company’s articles of association and the laws of the jurisdiction in which the company operates, in terms of legal considerations. The amount that the defaulting shareholder owes on the shares must be greater than or equal to the reissue price. For instance, in the above example, if Company A decides to reissue the shares to investor C, the reissue price should be more than equal to ₹5,000, which were the calls in arrears of investor B.

The securities premium account is utilised to transfer any excess received over the unpaid amount if the shares are reissued at a premium.

Journal entry for reissue of forfeited shares:

Debit: Bank (Amount received on reissue)

Debit: Forfeited shares (To the extent of the amount originally paid)

Credit: Share capital (Nominal value of shares reissued)

Credit: Securities premium (If reissue is at a premium)

Impact of share forfeiture

Forfeiture of shares has significant implications for both the shareholder and the company.

For the shareholder, forfeiture means losing their investment along with any rights that come with it, like the ability to vote and receive dividends. It may also hurt their credibility as a potential investor.

For the company, forfeiture can aid in the recovery of unpaid capital and the upkeep of shareholder financial discipline. The company’s image in the market could take a hit if it indicates financial trouble. Fortunately, if the forfeited shares are reissued at a premium, they can generate more capital.

Bottomline

Forfeited shares are not just about lost opportunities; they are about the resilience of companies to recover unpaid capital and the potential for new investors to step in. 

So, whether you are an investor eyeing the horizon or a company charting its course, knowing the ins and outs of share forfeiture is more than a compass, it is your guide to making informed decisions in the dynamic world of investing.

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