Bonus Issue of Shares: A Detailed Explanation
Created on 06 Oct 2020
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Are you also a shopping enthusiast? Do you love buying new things in your free time? Obviously, yes, right! New clothes, accessories, shoes, furniture, electronics, utensils, artistic pieces, etc. are the things which are never enough and there is always a craving for more, and this is what leads people towards shopping malls.
These shopping experiences become more fun and immersing when there are offers prevailing in the market. The booming market with super exciting offers like buy 1 get 1 free, 50% off, cashback, buyback all seem more engaging and captivating during this exciting period, thus inducing all the buyers as well as non-buyers wanting to take everything with them.
These exciting offers are not only a successful sales-boosting move in normal markets but also in the share markets. Various companies use such offers very strategically for getting benefits at their end. One such offer is known as Bonus issue.
So, what are bonus issues of shares?
What is a Bonus Issue?
A bonus issue is an offer in which free additional shares are given to the already existing shareholders. A bonus issue is also known as a scrip issue or capitalization issue. These additional shares which are offered are known as Bonus Shares.
The bonus shares are issued as an alternative to the increasing payout of dividend. It's like; one company could offer an additional bonus share for every three shares held by the existing shareholder. So, as said above, this offer is similar to the buy 1 get 1 free or buy 3 get 1 free offer.
With the issue of bonus shares, the share capital of the company increases but the net assets of the company remain constant. The lieu of cash dividends is the reason why bonus shares are issued.
Shareholders of the company could sell their shares in order to meet the liquidity needs as well. Let's have an in-depth understanding of the reason behind the bonus issues of shares.
What are the Reasons for Bonus Issues?
As mentioned above, bonus shares are issued for meeting the liquidity needs. When there are situations where the company is running out of cash, and shareholders are expecting their regular dividends, then bonus issues are given to shareholders. By selling these bonus shares, the shareholders can meet their liquidity needs.
Restructuring the company's reserves is another reason why bonus shares are issued. But there is a system on how bonus issues take place.
Bonus shares are issued in accordance with each shareholder's stake in the company. There is a constant ratio in which these shares are issued to the already existing shareholders of the company. The reason for the same is to keep the relative equity of every shareholder the same as before the issue of bonus shares.
For example, a six-for-three bonus issue entitles existing shareholders five shares for every three shares they hold before the bonus issue. Now, if you have 1000 shares, then 2000 bonus shares will be issued to you. (1000*6/3).
Lastly, a bonus issue of shares is done to convert the share premium account.
However, simply having these reasons is not enough for issuing bonus shares, there are several conditions to it as well. So let us now put some light on the conditions under which we can practice bonus issues.
What are the Conditions for Issuing Bonus Share?
Unlike the normal markets, where the sales-boosting offers are not required to meet any conditions, offers in the share market have to oblige to some conditions.
These conditions are as follows:
- The very first and an important condition for bonus issues of shares is that the company must abide by the guidelines issued by SEBI.
- Bonus shares could only be issued if the Articles of Association of the company authorizes such an issue.
- Another condition is that the shares must be released on recommendations of the BOD of the Company, and they should also be sanctioned by the shareholders themselves.
- This condition is for the good sake of the shareholders. It requires only fully paid-up bonus shares to issue; if partially paid-ups are released, then shareholders will become liable to pay the part value of the share, which would be unfair.
How are Investors Benefited from Bonus Issue of shares?
Bonus issues of shares are successful not only because they are beneficial for the company offering it, but also because they are equally beneficial for the investors. It's just like a normal market where the person giving offers and the person availing offers are both at an advantageous end.
So, let us just have a quick look into the benefits of bonus shares to investors:
- The investors are not required to pay any extra amount on bonus shares.
- There are various investors who believe in the long-term growth of the company. For them, it is a merit that they are exempted from the tax payments.
- Another big advantage comes to the investors when the company announces cash dividends on the shares. In such scenarios, the investors receive more profits as they hold extra shares because of the previous distribution of bonus shares by the company.
- Last but not least; the investor is most benefited from the bonus shares when the stock price of the company moves up in the long run. Due to the increased stock price, the wealth of the shareholder also booms.
What is the Difference Between Stock Splits and Bonus Shares?
It happens many times that the non-market players have confusion in the understanding of Bonus shares and Stock Splits. For them, stock split and bonus shares are almost the same concepts. However, there is some significant difference between bonus and split.
The basic meaning of the stock split is dividing the existing outstanding shares into multiple smaller shares. The objective of this stock splits is to increase the affordability of stocks for small retail investors for enhancing the liquidity in the market.
The biggest difference between bonus and split is the face value of the share. In bonus shares, as discussed, there is no change in the face value. But in the case of stock splits, the face value reduces in proportion to split the ratio.
The result of the stock split is that the future per share dividend also reduces as the face value reduces. Unlike in bonus shares, a stock split is beneficial for both existing shareholders as well as the new potential investors.
Example of stock split- A stock split of 1:10 means that the shareholder will have 10 shares for every 1 share he holds.
So, contrary to the famous saying 'opportunities don't knock twice', bonus issues of shares come with an additional chance to maximize the wealth of the shareholders.
They are as amazing and exciting as the Diwali offers. So if you are an investor and in the future, your company comes out with such amazing bonus shares, then don't just let it go.
Grab this opportunity in the same way you jump in the malls or markets after hearing those buy 1 get 1 offer.
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