Plain Jane to Alphabet Soup in 5 Easy Steps
Readers will already be familiar with the concept of the “share capital” of a company and with seeing declarations (in the accounts and elsewhere) that the “issued share capital” of the company is, for example:
“10 Ordinary Shares of £1 each.”
Breaking down that statement a little:
First of all, what is meant by the phrase “the issued share capital of the company”? How does this differ from the also often seen expression “the allotted share capital of the company”?
- S.558 Companies Act 2006 (‘CA 2006’) says that shares are “allotted” when a person acquires an unconditional right to be entered into the register of members; whereas
- Case law establishes that shares are “issued” when the entire process of application, allotment and registration has been completed (so when the person actually has been entered into the register of members).
The value given to each of the shares (referred to as the “nominal value” of the shares – in this instance £1) is the amount which the member has contributed (or, for shares which have not been paid up, is liable to contribute) to the capital of the company. This is the amount which will be left behind (lost) if there is an insolvent winding up.
But what does the phrase “ordinary shares” mean? Why are these shares “ordinary”?
Shares are “ordinary” if they are not of another (more special) type, for example:
- Redeemable shares (which are issued on the basis that they can be re-purchased by the company); or
- Preference shares – which have prior entitlement to pay outs (from profits and/or on winding-up) and will frequently have a “fixed dividend” (making them closer in nature to borrowing or debt).
Many of you will also have seen the array of shares often created in the context of a private equity purchase –appearing in the accounts as “A Ordinary, B Ordinary, C Ordinary etc” (with different rights attached to each class). I have previously expressed concern about the use of complex share capital structures to give sellers a false impression of the level of control and/or the financial interest which they will retain after purchase (see my previous article: “St George and the Dragons”).
Such shares (“alphabet shares”) can however be a useful device. I will now explain one scenario in which they can be useful and then set out how, if you decide you want them, they can be created.
Imagine a father and mother team who are the sole shareholders of a trading company. They each have one ordinary share with a nominal value of £1.
Imagine, further, that they have, say, four children (all of adult age) and that (whether for reasons of tax efficiency or to recognise contributions made to the company) they wish to be able to pay dividends to the children. They also wish to retain the ability to pay dividends to themselves.
The first thing must then be to make the children members (shareholders) of the company. This can be achieved by simply sub-dividing each of the parent’s shares into three shares (nominal value 33 1/3p per share) and allotting one share to each of the children (with the remaining shares staying with the parents).
If, however, there is a need to be able pay different amounts of dividend to each of the members at different times (some of the children might, for example, still be students and need additional income; the parents may have no such immediate requirements) can this be done by simply deciding to pay different amounts to the different shareholders within the same class? The answer is no.
S.629 CA 2006 provides that “shares are of one class if the rights attached to them are in all aspects uniform.”
The rights referred to include any right to payment of dividend. The decision to pay differentially to members within the same class is therefore not lawful.
Creating “alphabet shares” (A Ordinary, B Ordinary, C Ordinary etc.) identical in every way but for their rights with respect to share in distributable profits (dividends) gets around this difficulty and can be a very effective tax planning tool.
Given the usefulness of such shares how then can they be easily created? How can we go from “plain Jane” (a company with 2 Ordinary Shares of £1 each held by two shareholders) to “alphabet soup” (a company with A Ordinary, B Ordinary etc held by a list of members)?
Thankfully this can be achieved through a series of simple steps:
Firstly: subdivide the existing share capital.
S.618 CA 2006 provides that (subject to this power being excluded by the Articles) a limited company may (on the passing of an ordinary resolution of its members) sub-divide its shares.
So, an ordinary resolution permitting subdivision needs to be passed, sub-division carried out and the relevant form (Form SH02) filed at Companies House. The 2 Ordinary Shares of £1 each will then have become 6 Ordinary shares of 33 1/3p each (I will refer to these as ‘the New Ordinary Shares’).
The New Ordinary Shares then need to be “re-designated.” (Please note that, for the purposes of CA 2006 this is not the same thing as “conversion” – which does not exist – or “re-denomination” – which is a change to the currency in which the shares are valued.)
The company has a power to re-designate its shares but must file the relevant notice – Form SH08 – at Companies House (s.636 CA 2006).
At the same time the company needs to vary the rights attached to the re-designated shares – specifically to provide that there shall be different entitlements to dividends between A Ordinary, B Ordinary etc.
Because this amounts to a variation of the class rights of the holders of the New Ordinary Shares (still at this point the mother and father) “class consent” (a Special Resolution from the mother and father) will be needed – s.630 CA 2006.
Once this has been obtained (and the relevant items – a copy of the Special Resolution/class consent and Form SH10 – filed at Companies House) the “alphabet shares” then need to be allotted. (Some people take the view that new Articles should be drafted and adopted when new classes of share are created however this is not a requirement and, where the only difference between the classes is in terms of entitlement to dividend, the need for new Articles can be questioned. If they are created copies of new Articles and the related Special Resolution also need to be filed.)
With due acknowledgement to Tanya Gass (legal trainer with MBL Seminars and other organisations) and Maxlex Ventures Limited, allotment can helpfully be viewed/summarised as a five step process:
- C: check for any cap on share capital;
- A: is there authority to allot?
- D: dis-apply pre-emption rights;
- C: consider class rights; and
- A: allot
In our case there has been no increase in share capital so the first stage is not relevant.
The general rule – under s.549 CA 2006 – is that directors need authority from the members to allot new shares. This does not apply if:
- The Articles grant authority to allot; or
- The members have previously authorised and that authority has not yet been (fully) used.
Otherwise the directors need to obtain an authority (ordinary resolution). This authority must state the date of expiry (maximum duration 5 years) and the number of shares covered.
Next s.561 CA 2006 gives existing shareholders, effectively, a “right of first refusal” when a company wishes to issue new shares – entitling them to acquire the items to be issued in proportion to their existing holdings (referred to as pre-emption rights). This is, of course, unless the relevant provision has been disapplied by the company’s Articles (s.570 CA 2006).
If pre-emption rights are not disapplied by the Articles, a Special Resolution must be obtained (and filed with Companies House).
Class rights also need to be considered. I have mentioned above that, where class rights are varied, consent from the relevant class of members is required. Thankfully in this instance this has already been dealt with at the re-designation stage.
Finally the directors need to pass a board resolution to allot the shares. Following this the process of issue will occur (which will require the return of existing Share Certificates together with Share Transfer Forms, the issue of new Certificates, appropriate entries in the Company Books – Register of Members etc – and the filing at Companies House of a revised Statement of Share Capital together with any updating necessary to the register of Persons with Significant Control.) All relevant board decisions should also be appropriately minuted.
This may all seem very long winded and complex. Please bear in mind, however:
- The above simply reflects legal requirements imposed by CA 2006; and
- As and when you come to sell your company the buyer’s advisers will require responses in due diligence which confirm that all of the above has been done. Not being able to produce the relevant documents is likely to delay the sale and/or adversely affect sale price (or even prejudice the entire transaction).
The Barrett & Co Property & Commercial Department will be happy to take on the burden of correctly carrying out the above process. This will help to ensure that, in due course, any future sale of your business will run smoothly.
Get in Touch
If you would like further information, Martin offers a one hour fixed fee meeting for £95 including VAT at our Reading office. Please contact Martin on 0118 958 9711 or email firstname.lastname@example.org.