One area that can cause real concern, either from the start or at a later date depending on your choices, is the types and class of shares you issue in your limited company.
Written by: Debbie Austin
So we’ve written this piece to explain the basics along with the considerations for each option and the potential implications. As you will read further on, it’s worth understanding this area of your business from day 1 because later alterations to the structure about how your company is run can be time consuming and expensive.
The paperwork related to your shares
When you start out there are several documents you will need to complete. For the purposes of this article the one we’re most interested in is the memorandum of association. This confirms that the shareholders in your business want to form a company under the Companies Act 2006. This document also explains that each shareholder must have shares at a minimum of one share per shareholder.
Of note, that’s the minimum each shareholder is expected to have. However, many businesses have more than one shareholder from the start, meaning you have the option of issuing different types of shares depending on your circumstances and what you’re trying to achieve.
After all different amounts of money and resources can be placed in your company by various individuals so distinctive forms of ownership, rights and conditions could well be preferable. Simply put, the types and classifications allow you to control exactly that by deciding matters such as voting rights and the distribution of profits to different investors.
1. Ordinary shares
There isn’t one set type of share that has to be used. Most businesses issue ‘ordinary shares’ which provide full rights to dividends, voting at board meetings and equal rights to the allocation of assets in the event of a sale or if the company goes into administration.
They carry one vote per share but rank after preference shares when it comes to rights to assets should the business be wound-up. Somewhat confusingly, you can categorise these shares into different classes which we cover a little later in this article.
2. Preference shares
Preference shares authorise the holder to receive a fixed amount of dividend every year and they are entitled to this payment ahead of individuals with ordinary shares. The dividend is usually, but not always, calculated as a percentage of the nominal value (the value of the shares when they were first issued).
3. Non-voting shares
These are ordinary shares but they often don’t carry any right to vote or attend general meetings. You will find it commonplace for these shares to be issued to employees. The reason being their remuneration can then be paid out in dividends which could be more tax efficient for both the employer and the member of staff.
4. Redeemable shares
These are issued based on terms stating the company will or may buy them back at a future date. Such an arrangement can either be fixed or, set at the director’s discretion. They are usually issued with non-voting shares given to employees so that if the member of staff leaves, the shares can be bought back at their nominal value.
Classes of shares
Ordinary shares can also be divided into different classes and this is commonly referred to as ‘Alphabet Shares’. With the consent of existing shareholders, a company can have as many different classes as necessary; they each represent a different type of share, namely A,B,C etc.
The different classes of share often apply conditions in the following areas:
Rights to vote – It may be as simple as the shares carrying voting rights or not, but this can become more complex whereby the votes are weighted. This means some shares may carry more voting rights than others concerning specific matters or circumstances.
Rights to dividends – These rights could be as follows, either no rights to dividends whatsoever, distribution of dividends only in certain specific circumstances, a preferential dividend paid prior to other share classes or finally, access to a normal dividend.
Rights to capital – Different classes of share may have different rights to capital distribution. If the company is sold or wound up, any assets left after all debts have been paid off can be distributed to shareholders.
Get your share capital right before incorporation
As a general rule, think long and hard about your share capital in order to get it right based on your business needs prior to incorporation. The reason being you want to be optimally set up from day 1 and altering types or class of shares means drafting new articles of association. This will likely require the help of a professional advisor at additional cost.
When issuing shares, plan carefully and think of the long term implications. There have been famous examples in the tech world for example, where particular types of private shares have been issued with specific guarantees. These have pledged an appreciation in share price to a specific level when the time came to list on the stock market.
Problems then arose when later valuations resulted in the price quoted per share being below what had been promised to original shareholders. Consequently clauses were activated that issued more shares to the original backers and thus diluted the holdings of other investors. So you can see how it can all get very complicated, quickly.