You’ve decided to start-up by incorporating a company!
If you’re doing this for the first time you’ll be raring to go. If you’ve formed a company before you’ll still be raring to go, but perhaps this time painfully aware of the issues that can come with incorporation.
That's because the types and class of shares you can potentially issue may have significant long term implications. If you foresee the need to raise equity finance via investors and/or fundraising rounds then it will pay to understand the options with regards to issuing shares and what they mean for shareholder rights, conditions, and entitlement.
The consequences of these decisions can be far reaching in terms of the running and decision making in your business. They can also be complicated and expensive to amend later on. Be sure to read on to find out more.
Where a limited company has several shareholders with various amounts of money invested, different types of shares can be allocated with different ownership, conditions, and rights. These tend to be:
Subject to shareholders consent, a company can create many different classes of ordinary shares. Known as alphabet shares, (A, B, C etc.) this impacts on shareholders:
Many businesses in their early stages will have more than one shareholder and it's possible to issue different share types depending on the circumstances and ambitions of the founder and business.
In a limited company it's possible through different types and classifications, to weight shares in terms of what they can do for the owner. For example, in some cases to gain the most tax efficient remuneration whilst keeping the voting rights with the directors.
When setting up a business there isn’t a set type of share that has to be used. In most cases ‘ordinary shares’ are issued by small companies, which have full rights to dividends, voting at meetings and a right to the distribution of the companies assets in the event of winding-up or a sale.
If a company only has one shareholder then the simplest action would to be to award a single £1 share. However, in cases where there is more than one shareholder with different amounts of share capital, you may need to look at different options.
Ordinary shares are the most common type. They carry one vote per share and they entitle the owner to participate equally in the company’s dividends. If the organisation is wound up, the proceeds are again allocated equally.
Ordinary shares carry voting rights but rank after preference shares with regards to rights to capital, in the event that the business is wound-up. It’s possible to break these shares down into different classes, which will be explained later.
Non-voting ordinary shares usually carry no right to vote and no right to attend general meetings. These shares are usually given to employees so that remuneration can be paid as dividends for the purposes of tax efficiency for both parties.
Preference shares entitle the owner to receive a fixed amount of dividend every year. This is received ahead of individuals that hold ordinary shares. It is also usually as a percentage of the nominal value (the value stated when the shares were issued).
Redeemable shares are issued on the terms that the company will/may buy them back at a future date. This is either fixed or, set at the director’s discretion. It’s usually done with non-voting shares given to employees so that if the employee leaves, the shares can be taken back at their nominal value.
Whilst all documents are necessary for incorporation, it is the memorandum of association that confirms that the shareholders wish to form a company under the Companies Act 2006 and agree to become shareholders. In a case where the company is limited by shares, the memorandum of association states that shareholders must have shares, at a minimum of one share per shareholder which is usually priced at £1.
Whilst this means that all shareholders must have a minimum of one share, this doesn’t mean that the perfect share structure is for all shareholders to own one share each.
Entitlement to dividends
Shares can have a right to a normal dividend, a preferential dividend (to be paid before other share classes), a dividend to be distributed in certain circumstance, or no dividend at all.
Entitlement to vote
This can be as simple as shares either carrying voting rights or not, but sometimes weighted or tiered votes are possible in certain circumstances.
Entitlement to capital on winding up/disposal
If the company is wound up, any assets left after all debts have been paid off can be distributed to shareholders. Different classes of share may have different rights to capital distribution.
It’s far easier to make changes to share capital at the set up stage, before incorporation, but that doesn’t mean it’s impossible afterwards. That said to alter the class of shares involves careful planning and drafting new articles of association by a professional after the resolution. That takes time and money so you really want to be as optimally set up as possible from day 1 when it comes to share ownership in your business.
For an interesting read on how share structures can impact on a company read this post, why tech start-ups should forget insane valuations & being unicorns. It provides an example of the payments company Square and how some private investors in the business own particular types of shares with specific guarantees. These promised an appreciation in the value of those shares to a specific price when the time came to publicly list the business on the stock market.
The problem is when Square was subjected to the traditional valuation techniques of corporate finance advisors, the price per share was below what was originally promised to some of its backers. A clause in the guarantee then kicked in issuing those investors with more shares to make up for the deficit, but this in turn diluted the holdings of other stock holders.
When issuing shares be sure to plan for the long term because things can become very complicated quickly.
This post was created on 26/07/2016 and updated on 15/11/2019.
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