Whether you are incorporating your first start-up or are a seasoned entrepreneur with several successful businesses already, understanding the legalities around private company shares is essential if you are to meet your compliance requirements under the Companies Act 2006.
The World Bank’s 2020 report on the ease of doing business in a particular State ranked the UK eighth overall, ahead of all European countries with the exception of Denmark. One of the reasons for this high score is that UK regulations around setting up a company, including classifying, issuing, and transferring shares are extremely clear-cut.
When explaining how shares in a private company work, Julie Andrew’s immortal words from the Sound of Music – “let’s start at the very beginning, a very good place to start” is fitting – namely, what exactly is a ‘share’?
When you buy shares in a company you become an owner of that company and are therefore entitled to receive a share of the profits (known as a dividend) in relation to the number or value of the shares you have. A company can have one shareholder or several hundred.
Shareholders, also referred to as members, can be a person or an organisation. A minimum of one shareholder is required to incorporate a company at Companies House.
Shareholders can be directors and often are when the business is a start-up. However, as the company grows and attracts investment, either through seed funding and/or Series A, B, and C fundraising, shareholders become separate from the director (or Board).
As owners of the company, shareholders make decisions such as appointing or removing a director, changing the company’s Articles of Association, and authorising a director’s service contract if it provides security of tenure for two or more years. However, the day-to-day management and operational decisions remain in the hands of the director.
Shareholder decisions such as those mentioned above are made by way of a special resolution at a general meeting called by the company’s directors. Shareholders can also call for a general meeting. Those asking for the meeting must represent at least five per cent of the company’s paid-up share capital or, if there is no paid-up capital, five per cent of the voting rights.
Although most companies have one type of share, different classes of shares can be created. Each class can comprise of different voting, dividend, and/or capital rights.
Examples of different share classes include:
- Ordinary shares – these carry one vote per share and dividends are paid on the number of shares acquired. Ordinary shares can be divided up into different classes to allow, for example, the founders of the company to receive greater dividends than other shareholders.
- Non-voting shares – are often issued to employees, these shares carry no right to vote at general meetings.
- Redeemable shares – are issued with the knowledge that at some point the company will or may buy them back at the nominal price (or a stipulated amount). Legislation requires that the company can only redeem shares out of accumulated profits or the sale of new shares.
- Preference shares – are sold with the right for the owner to be paid a fixed dividend, stated as a percentage of the nominal value. Like with ordinary shares, any dividend can only be paid out of profit. There is a presumption that preference shares are cumulative, i.e. paid out the following year if one year is missed. In winding up proceedings, preference shares may be given a priority on any division of capital. The Articles of Association will set out the nature of preference shares and the rights attached to them.
- Management shares – to allow control of the company to remain in certain hands, extra voting rights can be assigned to a class of share. These types of shares are particularly important if you decide to take on venture capital investment.
- Freezer shares – these are often used by family businesses as a way to mitigate inheritance tax. For example, the older generation may have the right to sell their shares under a share buy back at a predetermined value and a preferential dividend that is enough to provide a pension and pay for any care costs. The incoming generation is entitled to what is left.
- Growth shares – are used as a way to incentivise managers, if the business is sold for more than a specified amount, the holders of these shares can receive preference share dividends or proceeds from the sale itself.
Variation of share class rights is governed by legislation and is outside the scope of this article. However, shares can be converted from one class to another, provided all affected shareholders agree.
A Share Certificate is a document issued by a company certifying that the person named is a member of that company and sets out the number and class of shares acquired.
It is a legal requirement that you keep a register of the:
- Name and address of each member.
- Number and class of shares held by each member.
- Amounts paid up (or credited as paid up) on the shares of each member.
The registrar of shareholders is open to anyone who wants to ascertain the names of shareholders and the details of the shares they hold. Therefore, you may wonder why you need to bother issuing Share Certificates at all. Considering the point in Re Bahia and San Francisco Railway Company Ltd v Trittin and others [1868] LR 3 QB 584, Chief Justice Cockburn reasoned:
“This power of granting certificates is to give the shareholders the opportunity of more easily dealing with their shares in the market, and to afford facilities to them of selling their shares by at once showing a marketable title, and the effect of this facility is to make the shares of greater value.”
In today’s digital world, a Share Certificate protects a shareholder if their name is mistakenly or fraudulently removed from the register.
Your company’s Articles of Association or Shareholders Agreement (see below) will set out when shares need to be paid for (known as consideration). Normally, consideration for shares will be required:
- Upon incorporation.
- When they are issued or transferred.
- At a specified or unspecified future date.
- When a ‘call’ on shares is issued by the director.
- Upon the winding-up of the company.
In most cases, shares are required to be paid for at the time they are issued, except for those issued when the company is formed.
Shares are unpaid if the person receiving them does not pay any of the nominal amount (and premium) to the company. If some of the nominal amount and premium is paid, the shares are partly paid for. In either circumstance, the shareholder is liable to the company for the outstanding amount; however, the rights attached to the shares are not affected.
Unpaid or partly paid for shares allows for flexibility, for example, a highly desirable investor may not have the means to pay for their shares in full straight away, or your company is yet to set up a bank account.
There is no legal requirement to have a Shareholders’ Agreement; however, it is extremely risky to forgo one. It provides a framework for dealing with everything relating to being a member of the company, how decisions will be made, the rights of shareholders (and different classes of shareholders), the payment of dividends, how and when general meetings will be called, and how disputes between shareholders and/or shareholders and directors will be resolved.
A well-drafted Shareholders’ Agreement will set out:
- The shareholders’ rights and responsibilities.
- How shares will be acquired and transferred.
- How the company will be run.
- Voting rights.
- The mechanisms in place to protect minority shareholders.
- Dilution Rights.
- Details regarding how dividends will be paid.
- Any intellectual property assignment.
- The disputes resolution process.
One of the advantages of having a Shareholders’ Agreement is it can be used to avoid a deadlock situation should your company have an even number of shareholders. Disagreements leading to deadlocks can result in costly litigation; by having a disputes resolution process that includes references to alternative dispute resolution methods such as negotiation and mediation, disastrous court action can be avoided.
A robust Shareholders’ Agreement can also lay down what happens if a shareholder dies or becomes incapacitated. These situations can cause endless complications, especially in the case of small businesses, if the deceased shareholder’s Executor refuses to relinquish shares and becomes involved in making company decisions.
Summing up
The rights and responsibilities of shareholders and compliance requirements around company shares are fairly straightforward in the UK. However, disputes can and do still arise, resulting in financial and reputational damage to the business concerned. Therefore, it is imperative to work with a professional organisation that will explain any matters relating to company shares when incorporating your company.
Uniwide Formations specialises in the registration of limited companies and LLPs. As professional business service providers we offer a wide range of related services including services relating to company shares. To discuss any of our services, please contact us.
