If you are thinking about setting up a company, it’s important to understand the basics of company shares before getting started. This knowledge will enable you to devise the most appropriate share structure for your new company.
In this post, we explain the essential things you need to know about company shares, including:
- What shares are and what it means to own them
- The rights and responsibilities of shareholders
- The nominal value vs the market value of shares
- Deciding how many shares to issue when you register a new company
- Paying for your company shares
- Keeping a record of shareholdings
- Making changes to your company share structure after incorporation
The information in this post relates to a private company limited by shares with ‘ordinary’ shares and ‘model’ articles of association. This is the most popular company structure and the standard class of share used by the majority of startups and small firms. The model articles is the default governing document that UK companies can use.
Toward the end of the post, we provide a brief summary of some of the other share classes you can create. This might be something that you’ll want to consider in the future if you decide to grow your company, bring in new investors, or introduce an employee share scheme.
What are company shares?
Company shares are simply units of equity ownership or interest in a company. Each share represents a portion of the business, relative to the total number of shares the company issues. For example, if a company has 10 Ordinary Shares, each share represents a 10% ownership stake in the company.
The people who own shares are known as Shareholders. They are the members of the company and, by virtue of holding shares, they ultimately own and control the business.
As a shareholder, your rights and responsibilities in a company depend on the number and types of shares that you own, as well as the value of those shareholdings. Specifically, your shares determine:
- The percentage of the company you own or control
- The degree of influence or control you have over company decisions
- How much of the company’s profit you are entitled to
- The amount you have to pay for your shares, and when
- Your liability for business debts – essentially, how much of your own money is at risk if the company fails
When you set up a company, you must take all of these things into account to ensure that your share structure is appropriate for your needs. This will help you to decide who should get what, and why.
Shareholder rights attached to ordinary shares
Ordinary shares provide full rights in the company, which means that each share carries the right to dividends, the right to cast one vote at general meetings, and the right to capital distributions. They do not confer any special or preferred rights on the shareholders.
Dividend rights
Dividends are distributions of company profits. The percentage of shares that you own determines the percentage of company profits you are entitled to receive as dividend payments.
So, if you own 75% of the shares and another shareholder owns 25%, you have the right to 75% of any available profits, whilst the other shareholder has the right to a 25% portion of the profits.
With ordinary shares, all shareholders have the right to receive dividends if the company has available profits and chooses to declare this surplus income for distribution.
Voting rights
By virtue of being a shareholder, you are entitled to receive notice of and attend any general meetings that take place. If there are any proposed resolutions (motions) put to the shareholders, you also have the right to participate in the decision by voting for or against the resolution.
Whilst routine company decisions are made by the directors, the most important and exceptional issues are reserved for the shareholders. These include matters such as altering the articles of association, changing the company name, and approving substantial financial transactions
Every share that you own provides you with one vote on such decisions. So, your percentage of ownership determines how much weight your votes carry, thus how much control you have over the business.
Capital distributions
Capital distributions are distributions of assets (including cash payments) from a company that are treated as income for Income Tax purposes (i.e. they are not dividend distributions). Instead, they are subject to Capital Gains Tax.
When a company becomes insolvent or is wound up, its assets are first used to settle any outstanding liabilities it may have. If there is anything left after doing so, the remaining capital is shared between the shareholders (relative to their ownership stakes) as a distribution of capital.
Your responsibilities as a shareholder
Shareholders do not have many responsibilities in a day-to-day sense. It is the directors of a company who make most of the routine decisions about the business.
Even if you are both a shareholder and director of your company, it’s important not to confuse the different obligations associated with these two separate roles. They are completely different.
As a shareholder, your main responsibilities are to assume limited liability for the debts of the business and make certain decisions on behalf of the company.
Limited liability
With ordinary shares, your biggest responsibility as a shareholder is the liability that you take on. However, your liability is limited to the issue price of your shares. This is the amount that you agree to pay for each share that you take.
In the vast majority of companies, the issue price is the Nominal value of the shares. Every share has a nominal value, which is the minimum amount that the share can be sold for. It also reflects the liability of the shareholder if the company fails or ends up in financial distress.
If you pay for your shares when you take them, you won’t have any further liability to the company. However, if you don’t pay for your shares straight away (which some companies allow), you’ll have a legal obligation to do so when the company requests payment.
Most private companies assign a nominal value of £1 to ordinary shares, but you can set a higher or lower amount if you like. So, you’re not going to have an excessive liability unless your shares have an exceptionally high nominal value or you own an inordinate number of shares.
Sometimes, however, companies choose to issue shares at a premium – an amount higher than the nominal value. In this situation, the shareholder’s liability would be the total issue price of their shares, which would be the nominal value plus the premium.
Of course, you may also choose to invest other money and assets in the company as well, or perhaps act as a guarantor for business loans or leases. However, these additional liabilities are not associated with your shares.
Decision making
The other main responsibility that you have is making certain decisions on behalf and for the benefit of the company. As mentioned previously, ordinary shares provide voting rights to shareholders. So, you will be required to participate in any proposed resolutions put to you and the other shareholders.
This means that you are responsible for exercising your shareholder decision-making powers when shareholder approval is required. When doing so, you have a legal obligation to base your decisions on what is best for the company as a whole.
Nominal value vs market value of company shares
One of the most important things to understand about the nominal value is that it has nothing to do with the market value (the real, actual value) of those shares or the company’s worth as a whole. As the name suggests, it is simply a nominal, token sum.
For example, a company could be worth a million pounds whilst having a total of only one or two issued shares with a nominal value of £1 each.
The nominal value forms the share capital of the company. It is a fixed amount that never changes, regardless of the value of the company. Whereas, the market value of those shares will fluctuate over time, depending on how successful the business is and the impact of various internal and external factors.
Choosing a nominal value
When choosing a nominal value for your ordinary shares, you should not base your decision on how much your company is worth when it is set up (or what you think it may be worth in the future). By doing so, you’d be saddling yourself with a large liability for no good reason.
If you’re planning to issue a conservative number of shares, setting the nominal value at £1 is a perfectly reasonable choice. This is what most companies do.
However, if you’re going to have a much larger quantity of shares (e.g. 10,000), you may want to set the nominal value at a more modest sum (e.g. £0.01) to minimise the liability of the shareholders.
You don’t need to give too much thought to this aspect of your company shares, other than the key points we’ve mentioned here. If and when your shares do increase in value, you can simply sell them at a premium to reflect their market value at that time. The nominal value will stay the same.
How many shares should I issue in my new company?
You must issue at least one share to every shareholder. That’s the only hard and fast rule. Therefore, if you are going to be the sole shareholder, you only need to issue one share to yourself. If there are two shareholders, you must issue at least two shares (one per person), and so on.
There is no maximum number. You can issue as many shares as you like to yourself and other shareholders. Every company has different requirements, and there is no right or wrong amount, so it’s entirely up to you.
However, you should be strategic and base your decision on what is best for you and your company. To do this, the first thing you need to consider is whether you want to own and control the company by yourself or with other people
If you’re setting up a company with one shareholder
If you are setting up a company by yourself and you’re going to be the only shareholder, your share structure can be pretty straightforward. Legally, you only need to issue one share to yourself.
That single share will represent 100% ownership of the company. This means that you will be entitled to all of the profit and you’ll have the power to make important company decisions singlehandedly.
However, perhaps you’d like to bring in additional shareholders in the future. If this is the case, you may want to issue more shares to yourself in preparation for selling some of them to new investors further down the line.
Alternatively, you can wait to issue more shares until they’re needed. You can create more shares at any time after incorporation. There is no need to issue all of the shares you might need in the future, so there is no rush if you are unsure.
More than one shareholder
If you are setting up a company with more than one shareholder (or you’re planning to bring in new shareholders at a later date) more consideration is required. You need to think very carefully about what percentage of the business each person will own.
Do you want to divide ownership equally, or will some shareholders own and control more of the company than others? It really depends on what each person brings to the table (e.g. money, expertise, clients, reputation) and what percentage of shareholdings best reflects their contribution or value to the business.
Many novice company owners give insufficient thought to this and instead make decisions on gut instinct. You may be setting up a company with trusted friends or family, so why not share everything equally, regardless of what each person brings? This is a nice idea and it might work out well, but it is generally unwise.
Company shares should be allocated based on the contributions and commitments that each person makes to the company at that moment in time. The value they bring to the company, whether in the form of cash investment or soft assets, should then be reflected in their ownership stake. This is the best way to protect yourself and your business.
Issue a total number of shares that is easily divisible
When you’ve determined what percentage of the company each shareholder will have, you then have to factor in the practical consideration of how many shares to issue overall.
Ideally, you should pick a number that is simple to divide and visualise. So, it is usually best to stick to quantities that can be easily divided by 100 (or those that divide 100) without resulting in fractions. For example, two shares, 10 shares, 100 shares, 1000 shares.
With these types of quantities, assigning equal or different percentages to shareholders is far simpler. You will have greater flexibility to tailor each person’s ownership stake, profit entitlement, and decision-making powers accordingly.
For example, if you set up a company with two shareholders and you’re going to be equal partners, you could issue two shares. This would mean that you would both own and control 50% of the company.
A popular option is to issue a total of 100 shares. Each share will represent 1% of the company, so you can apportion ownership to multiple shareholders in a variety of different ways.
You could split those 100 shares equally, or give more shares to certain individuals who are making bigger contributions to the company. And whichever way they are apportioned, you can quickly and easily visualise what percentage of the company everyone owns.
However, as a general rule, it doesn’t matter how many shares you issue overall. It’s all about the percentages of ownership – how much of the company each person actually owns with their shares.
Paying for your company shares
Shareholders normally pay the nominal value amount to the company as soon as they take their shares. This is often preferred because most shares are issued to raise capital for the business.
It may seem like an odd concept to pay your own company for shares that you have chosen to issue to yourself. However, as we mentioned earlier, the money that your company raises from the nominal value of issued shares forms its ‘share capital’. And this share capital is the limited liability of the shareholders.
Some companies allow shares to be taken unpaid (nil-paid) or partly paid, with the outstanding nominal value remaining due at the company’s request. In these instances, if the company becomes insolvent, the shareholders are legally required to settle the outstanding nominal sums when the company requests payment.
Recording your company shares
When you issue shares during the company formation process, your share information is recorded on the application form that you send to Companies House. Once incorporated, Companies House records this information and makes it publicly available on the register of companies.
You need to issue a share certificate to every shareholder as evidence of the shares they own and the date they became the owner of those shares. Your company should keep copies of all share certificates that it issues.
Legally, you must also keep a statutory register of members at your registered office address. This shows who the shareholders are and what shares they own. It is incredibly important because you are not legally considered a shareholder of the company if you are not entered into the register of members,
If any shareholder owns more than a 25% stake in the company, you will also need to record their details and percentage of ownership in the register of people with significant control (the PSC register).
If your company’s shareholdings change at any time, you must update the relevant company registers and report the changes to Companies House.
Keeping a capitalisation table
Whilst not a legal requirement, it can be worthwhile keeping a capitalisation (cap) table, particularly if you plan to grow your business, attract new investors, or seek funding.
In contrast to the register of members, a cap table is more of a working, practical document that provides a snapshot of a company’s shareholdings at each stage of the business journey.
It can be of great benefit when important decisions need to be made because it will tell you which shareholders have the power to make certain decisions.
If you’re thinking about selling some of your shares or issuing new shares in the future, it will also show you what impact these decisions will have on each shareholder’s current ownership stake.
Potential lenders and investors will expect to see an accurate cap table before signing off on loans or investing in your business. So, this is something that you should consider putting in place as soon as you set up your company.
Can I change my company share structure after incorporation?
Your company share structure is not set in stone, so it is common for companies to make changes after incorporation. It usually evolves over time, reflecting the changing nature and needs of the business.
Provided that you have the necessary approvals from a majority of the directors or shareholders, you can alter your company share structure in any number of ways, such as:
- issuing additional ordinary shares
- transferring shares to other people
- creating new share classes
- varying the rights attached to an existing share class
- redesignating share (converting from one type to another)
- changing the nominal value
- reducing the number of shares in issue if, for example, you issued too many during incorporation
Any changes to company shares will impact all shareholders to varying degrees. Also, some of the procedures can be time-consuming and costly, so it’s always best to seek professional advice beforehand.
What other types of company shares can you issue?
There are many share classes available other than ordinary shares. So, some of these might be worth considering if you want to vary the rights of different shareholders in your company, set up an employee share scheme, or issue shares to family members.
Alphabet shares
Alphabet shares are ordinary shares separated into different classes, such as “A” ordinary, “B” ordinary, and “C” ordinary shares. The benefit of this share structure is that it allows companies to vary the voting rights, dividend rights, and capital rights within each share class on a non-pro-rata basis.
Management shares
Typically, management shares carry multiple voting rights (for example, two votes per share) but no dividend rights. They are often held by the founding members as a way to retain greater control of the company than newer investors who join the company at a later date.
Growth shares
Growth shares are a special share class that you can issue to both employees and non-employees at a low acquisition value. This allows them to benefit from any future growth of the company’s value above a nominal valuation hurdle.
Non-voting shares
As the name suggests, non-voting shares do not carry voting rights, but they usually provide dividend rights. They are typically issued to family members of the main shareholders, or to employees as part of an employee share scheme.
Preference shares
Preference shares carry the preferential right to receive a fixed percentage of profits before dividends are issued to other shareholders.
Redeemable shares
With redeemable shares, the company has the right to buy back the shares after a fixed period. These shares are usually non-voting and are often issued to employees, with the proviso that they are taken back if the employee leaves the company.
Deferred ordinary shares
This share class provides dividends to shareholders only when certain conditions are met. This may be after dividends have been paid to other share classes, or after a particular date or event.
Thanks for reading
Our team of company formation experts is here to answer any questions you may have about setting up and running a limited company. We can also provide advice on the most appropriate share structure for your startup or SME and guide you through the incorporation process.
Visit the 1st Formations Blog homepage for more limited company guidance and small business advice.
The post Company shares for startups appeared first on 1st Formations Blog.
This post first appeared on 1st Formations Blog - Company Registration Inform, please read the originial post: here
