Forfeiture of Shares - Meaning, How It Works & Example

Have you ever thought about what companies do when investors fail to fulfill IPO requirements? For instance, if you subscribe to an IPO, but when the shares are allotted to you, you fail to make the payment. What will happen to the shares in this scenario? Here comes the idea of forfeiture of shares.

This article will delve into the details of the forfeited share. Let's begin.

What is a Forfeiture of shares?

Share forfeiture can be defined as the process of a share-issuing company canceling the allotment of shares to the defaulting investors. The shares thus canceled, which were earlier allotted, are termed as forfeited shares.

These shares are either surrendered by the shareholders or given up, as they could not make payment for the shares. It is at the share issuing companies’ discretion whether they want to forfeit the shares or not.

Once the company forfeits the share, the investor/ shareholder does not owe any further amount to the company against the share/s. The potential gains and losses are also reverting to the issuing company.

The company can further reissue the forfeited share to new shareholders at any price set by them, however, it has been usually seen that these shares are reissued at a discounted price.

How Forfeited Shares Work?

An example can help you understand the meaning of the forfeiture of shares in the best possible manner and how this share works.

For instance, Rahul subscribed for 1000 shares in the IPO of Company A by paying a subscription charge of Rs. 10000. Each share price as per the issued price is Rs. 40, so he paid around 25% of the entire amount due that is Rs. 40000. Now when the shares allotment started, Rahul received allotment of all 1000 shares, but he failed to pay remaining Rs. 30000 within the due period.

The company has the right to cancel all these 1000 shares and forfeit them, which means the ownership transfers to the company again for these forfeited shares. Rahul will lose the amount he paid while subscribing to these shares.

Employee Share Forfeiture

While forfeiture of shares is common with investors, employees can also get their shares forfeited. If the company offers ESOP or employee stock option plan where the employees can invest in the company's stocks at a discounted price, but if they fail to pay the entire amount, or they resign before the stipulated time, then the company can forfeit their shares.

Example of Forfeited Shares

Let's understand the same with an example. Suppose, Akshay joined ABC Ltd. on 1 January 2024, and he is allotted 100 stocks of the company but he can only sell the shares after working in the company for at least three years. Therefore, if he resigns from ABC Ltd. before 1^st January 2027, then the company has all the rights to cancel his shares and this is the meaning of forfeiture of shares in case of an employee.

Reissue of Forfeited Shares

The shares forfeited become the asset of the issuing company until and unless they reissue those forfeited shares. Now, the company can reissue these shares at par, which is the value at which it issued the share during IPO, or at a discount, which means lower than the issued price, or at a price higher than the issue price which is known as a reissue at a premium.

However, as per company laws, any company reissuing shares that are forfeited cannot give any discount more than the amount of forfeiture. The maximum discount can be the amount forfeited.

The shares can be allocated to a third party but for allocating the forfeited shares to the defaulting shareholder, the articles of association of the company need to allow the same.

Effects of Share Forfeiture on Companies and Shareholders

The effects of forfeiture of shares are significant both on the company issuing the shares and the shareholders.

Effects on shareholders:

• Firstly, the shareholders/ investors lose the money they pay for the subscription of the shares.
• Forfeiture of shares leads to loss of ownership of the stakes of the company. Therefore, the shareholder ceases to remain a stakeholder in the company.
• This, in turn, leads to investors losing any potential gains from the shares provided if the company grows and offers great returns.

• The stock issuing companies’ financial ratios get affected as the number of outstanding shares reduces. The ratios, which get affected mainly, include return on equity (ROE) and Earnings per share (EPS).
• Share forfeiture also affects the equity structure of the company as the forfeited shares are added to the equity of the company as treasury stocks.
• Apart from these, the company has to deal with and adhere to tax compliances regarding the forfeiture of shares.

Conclusion

So, next time you subscribe for any stock or your employer issues you with any employee stock option plan, make sure before you subscribe. Forfeiture of shares can lead to potential loss of the investors.

FAQs on Forfeited share

1.What is forfeiture and reissue of shares?

Forfeiture of shares is the cancellation of shares allotted to the investors by the company upon non-payment of required capital or subscription fee or any other agreed amount.

Reissue of shares refers to the issue of the Forfeited shares to other shareholders or third parties at different prices.

2. Can forfeited shares be Cancelled?

Forfeiture of shares means cancellation of shares allotted. If the company decides to forfeit the shares, they cannot be cancelled. It is completely at the discretion of the company issuing the shares.

3. What is the entry of forfeited shares?

The accounting entry for share forfeiture varies –

• Shares issued at Par

Share Capital A/c ………………………………………………………………………….Dr

To Share Allotment A/c           

To Share Call A/c         

To Share Forfeiture A/c           

• Shares were issued at a Premium and the premium amount was received

Share Capital A/c …………………………………………………………………..…….Dr 

To Share Call (1,2,3) A/c          

To Share Forfeiture A/c           

• Shares were issued at Premium and the premium amount was not received

Particulars       

Share Capital A/c ……………………………………………………………………..….Dr 

Security Premium A/c ………………………………………………………………….Dr          

To Share Allotment A/c           

To Share Call (1,2,3) A/c          

To Share Forfeiture A/c