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Capital Increases

Capital increases are a key financial tool used by companies to obtain additional resources. They are a common strategy in financial markets and can significantly impact a company's structure and value. However, they can also bring risks and consequences for shareholders.

1. Definition of Capital Increase

A capital increase is a financial operation through which a company raises its share capital, either by issuing new shares or increasing the nominal value of existing shares. This strategy allows companies to raise additional funds for various business purposes.

Capital increases can be carried out in several ways:

  • With cash contributions: Shareholders or new investors buy new shares, providing liquidity to the company.
  • With non-cash contributions: Assets are incorporated into the company instead of cash.
  • Through the capitalization of reserves: Accumulated reserves are converted into capital, distributing new shares to shareholders without requiring additional contributions.

2. Uses of a Capital Increase

Capital increases serve various purposes, including:

  • Expansion and growth: Used to finance growth projects, acquisitions, or new developments.
  • Debt reduction: Helps improve the financial structure by reducing the company's liabilities.
  • Compliance with regulatory requirements: Some industries, such as banking, require a certain level of capitalization.
  • Financial rescue: In times of crisis, a capital increase can prevent a company from going bankrupt.

3. Advantages of Capital Increases

Capital increases offer benefits for both the company and investors:

  • ✅Greater liquidity for the company: It secures financing without incurring debt.
  • ✅Investment opportunity for shareholders: Current shareholders can buy shares at a preferential price.
  • ✅Improved company solvency: Reduces leverage and strengthens the financial balance sheet.
  • ✅Increased market visibility: Can attract new investors and enhance corporate reputation.

Example: Tesla, in 2020, took advantage of its stock price surge to issue shares and finance its expansion in electric vehicle production.

4. Disadvantages of Capital Increases

Despite their advantages, capital increases can have negative effects:

  • ❌Share dilution: If a shareholder does not subscribe to new shares, their ownership percentage decreases.
  • ❌Impact on stock price: It may lead to stock price declines due to the perception of oversupply.
  • ❌Administrative and operational costs: Issuing new shares requires legal and administrative processes.
  • ❌Possible loss of market confidence: If a company carries out too many capital increases, investors may see it as a sign of financial trouble.

Scrip Dividend

A Scrip Dividend is a form of shareholder compensation where a company offers the option to receive new shares instead of a cash dividend. This strategy allows companies to conserve liquidity while seemingly rewarding shareholders. However, in reality, it is a way to increase capital at the expense of dilution.

Purpose of Scrip Dividend

  • Avoiding cash outflow: Allows the company to retain cash instead of distributing it.
  • Providing flexibility to shareholders: Investors can choose between receiving cash or additional shares.
  • Strengthening capital structure: Increases share capital without issuing debt.

Example of Scrip Dividend

A notable case is Banco Santander, which frequently used this strategy. In 2014, it offered shareholders the option to receive new shares instead of a cash dividend, allowing it to conserve capital for future investments.

While Scrip Dividends can benefit the company, they often result in share dilution if most shareholders opt for new shares.

This practice is widely used in companies, particularly in Spain, where many shareholders lack financial literacy. Companies exploit this by "paying" dividends in shares, meaning either they do not have the cash to pay dividends or simply do not want to, yet they declare a dividend and compensate with stock instead. This leads to dilution of existing shares and, consequently, a loss in their value.

Why Scrip Dividend is Detrimental to Shareholders
  • In the best-case scenario, the net value of your holdings remains the same, as you receive new shares, but the old ones decrease in value.
  • In most cases, you will lose at least 20% in taxes for receiving the dividend.

Conclusion

Capital increases are a powerful tool for companies but require a clear strategy and effective execution to avoid negative impacts on stock prices and market confidence. Understanding their advantages, disadvantages, and real-world examples is essential for any investor seeking to maximize returns in the stock market.

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