You are on the way with starting up a business.
You have decided a private limited company is the right business vehicle, you have taken some time to choose a great company name and confirmed who the Directors and shareholders are going to be.
You are ready to form your limited company and finally take the exciting step to make your new venture official.
And then you are asked what types or classes of shares do you want the company to have and issue to the shareholders? Another decision to make.
You just want to get started – isn’t a share just that – a share and every shareholder gets one and that’s it.
Yes … and no. A limited company must have shares and at a minimum of one share per shareholder. These shares are commonly called ‘ordinary shares’ and are usually priced at £1.
And the majority of UK companies will indeed only ever have one type, or class, of share.
But this does not mean that the best share structure for all shareholders in every limited company with more than one shareholder is to issue one ordinary share each.
Many start-ups or early stage businesses will have more than one shareholder and it is possible to issue different types of shares depending on the circumstances and ambitions of the limited company’s founders.
Different amounts of resources can be put into the company by individuals and through share capital this can lead to different types of ownership, conditions and rights.
So we have written this article to explain the basics about the different types of shares a limited company can have along with the considerations for each option and the potential implications.
It is worth understanding this area of your business from day 1 because later alterations to the structure of your company can be time consuming and potentially expensive in terms of legal fees and tax.
WHAT different classes and types of shares are there?
In short, any class of shares may be created in a limited company.
And while there are a few practices which are best followed to avoid any misunderstandings a company, with the consent of shareholders, can have as many different classes of shares as necessary and call shares by whatever name it likes.
In general, however, if a company has more than one type of share the main differences between them will be found in one or more of the following areas:
- Rights to vote – It can be as simple as the shares carrying voting rights or not. It can also be more complex with different shares having different weights attached to them. This means some shares may carry more voting rights than others in specific circumstances.
- Rights to dividend – Again it can be very straightforward – certain shares can carry rights to dividends and others do not. Or certain shares could only have dividends distributed to them in certain specific circumstances.
- Rights to capital – Different classes of share may have different rights to any company assets which are left after debts have been paid off when the company is sold or dissolved. For example some shares may rank first for capital distribution with others only paid if sufficient assets are left after the first ranking shareholders have received their full share.
It is the Articles of Association which set out the division of shares into their different classes. The Articles will also detail the precise rights attaching to each class. Most classes of share though will fall into one of the below categories of types of share:
- Ordinary shares
Ordinary shares are the most common type of share.
They carry one vote per share and no special rights or restrictions.
They entitle the owner to participate equally in dividends and rights to capital if the business is wound up or sold.
They however rank after ‘preference’ shares in relation to dividends and the rights to capital.
- Preference shares
Preference shares as their name suggests have some form of ‘preferential’ rights over ordinary shares. This could be to 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 of the shares (i.e. the value of the shares when they were first issued).
For example, a £1, 7% preference share will carry a dividend of 7p each year. It is however still a dividend and therefore payable only out of profits.
Preference shares may also be given priority on the return of capital when a company is sold or dissolved and are often non-voting. They are further sometimes ‘redeemable’.
- Redeemable shares
Redeemable shares are issued on terms that the company will or may buy them back at a future date. Such an arrangement can either be fixed – e.g. the shares will be redeemed three years after they are issued – or at the directors’ discretion.
The redemption price is often the same as the issue price but does not have to be.
This can be a method of making a clear arrangement with an outside investor.
They are usually issued to employees so that if the member of staff leaves, the shares can be bought back at their nominal value (i.e. the value of the shares when they were first issued).
There are statutory restrictions on the redemption of shares.
For example, the company may only ‘redeem’ the shares out of profits or the proceeds of an issue of new shares.
- Deferred ordinary shares
Deferred shares are shares on which no dividend is paid until all other classes of shares have received a minimum dividend. After that they will usually be fully participating.
When a company is sold or dissolved deferred shares will only receive something once every other entitlement has been met.
- Non-voting ordinary shares
These are ordinary shares but they do not carry any right to vote or attend general meetings. You will find it commonplace for these shares to be issued to employees.
The reason for this is that they can then be paid out in dividends which could be more tax efficient for both the employer and the employee. Non-voting shares are also common where crowd funding is involved, mainly to try and reduce admin for company in dealing with a large number of shareholders.
Preference shares are often non-voting.
WHY use different classes of shares?
But why would a limited company typically bother having different share classes?
Typical reasons include:
- To attract investment
- To remove, or sometimes enhance, the voting powers of certain people
- To ensure dividends are paid in a specific way
- To encourage staff to stay at a company.
One common example of different share classes is “alphabet shares” which is the term used when the distinct shares are denominated by a letter (e.g. Ordinary A shares, Ordinary B shares, Ordinary C shares etc).
Frequently when these are used they have identical voting and capital rights, but they allow for dividends to be paid at different levels to the different shareholders, so individuals can be rewarded for their different contributions to the company.
A degree of caution needs to be exercised though when creating different classes of shares.
There have been numerous examples in the past where shares have been created in order to save tax without taking proper accounting advice.
That does not mean such schemes should be avoided but a limited company clearly needs to take care that the shares strategy it sets up is in line with HMRC rules.
Can a Limited Company Make Changes to Shares Later On?
Yes.
Provided it follows due process, and subject to any restrictions in its’ Articles of Association, a limited company can create new share classes at any time.
When it needs a new share class a company can choose to either create a new share class in addition to an existing class or convert an existing share class into one or more new share classes.
It is relatively straightforward to create a new share class.
Indeed, if the shareholders consent then a limited company can have as many different share classes as it likes, each representing a different type of share.
The rights that go with different classes of shares, which are at least in part described in the prescribed particulars for the class, can be whatever the shareholders are willing to accept.
There is no statutory procedure for converting shares from one class to another.
It may be done however with the consent of all the shareholders affected.
The safest course is to pass a resolution to which all the shareholders consent because, in practice, changing the rights on one person’s shares may well have an effect, at least in practice on the rights of all the other shareholders.
Such conversions are now relatively commonplace.
It is far easier though to make changes to share capital before company formation.
To alter a class of shares post company formation involves careful planning and drafting new articles of association after a special resolution.
That can take 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.
Key Takeaways
You can see therefore that you can not simply assume that ordinary shares for example in one limited company will have exactly the same rights as the ordinary shares in another company.
The only way to tell what rights go with a particular share class is to read the Articles of Association of that company.
Most companies start by just having one type of shares in the form of an ordinary share class. These will typically carry equal rights to voting, capital and dividends.
The issue of new shares after company incorporation will generally be allotments of these ordinary shares, unless circumstances suggest a need for flexibility or varied rights.
Just as a company may issue shares in multiple share classes, there is also nothing to stop a shareholder holding more than one class of share in the same company and thereby benefiting from the differing rights (e.g. voting or dividend entitlement) that each share class offers.
As a general rule therefore, think long and hard about your share capital prior to company incorporation in order to get it right based on your business needs and long term plans.
The reason simply being that changing types or classes of shares post company formation, although perfectly feasible, can take time and money.
Before You Go …
Another key question when setting up a limited company is how many shares it should start with.
So why not check out our video on this very topic below!
