A Guide to Share Capital for Start-Ups

Last updated: 4 June 2019

Estimated reading time: 12 minutes

If you’re a start-up thinking of incorporating, or have incorporated, a private limited company, you might need to know more about the details of share capital. This guide may also be helpful for officers of existing companies who are considering altering or transferring their share capital.

Here, we’ll be discussing shares as they relate to private limited companies and not other types of entities such as partnerships or public limited companies.

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What is share capital?

The term ‘share capital’ refers to the funds that a company raises in exchange for issuing an ownership interest in the company in the form of shares.

Nominal value and limited liability

Each class of shares must have a fixed nominal value (for example, £1) which is the amount of money that the shareholder’s liability is limited to in the event that the company cannot pay its debts. This is the concept of ‘limited liability’, meaning that a shareholder’s liability is limited to the amount of their initial investment (being the nominal value of their shares). The nominal value is not the same as the market value of the shares which can be significantly higher.

Shareholders will not (except in very limited circumstances) be repaid the value of their share capital investment unless the company is sold, but they might receive a distribution from the company if the company is profitable. This is most commonly in the form of a dividend on their shares.

What is share premium?

When shares are issued at a price above their nominal value they are said to be issued at a ‘premium’. In this case, the company must credit the premium amount into a separate account known as a share premium account. The funds in this account are non-distributable reserves and can only be used in a limited number of circumstances.

Where is share capital on the balance sheet?

It’s listed under the ‘Capital and Reserves’ (sometimes called ‘Equity’) section of the balance sheet. If your company has shares issued at a premium you should also see a reference to ‘share premium’, ‘share premium account’ or similar under the Capital and Reserves section of your company’s balance sheet.

Allotted share capital

When we talk about ‘share capital’ it can be either

Shares are categorised as ‘allotted’ when a shareholder has the unconditional right to be included in the company’s register of members in relation to those shares (but has not actually been included in the register of members). This is thought to be when the prospective shareholder has requested shares from the company and the company has notified the prospective shareholder of the company’s acceptance.

Issued share capital

When a shareholder is entered in a company’s register of members, the shares have been issued. Thus, it is very important to write up your company’s register of members if you allot new shares to new or existing shareholders: until this is done the shares are allotted and not issued, meaning that the prospective shareholder is not a member of the company in respect of those shares.

Different types of share capital are not the same thing as different classes of shares. A company’s share capital can consist of different classes of shares with different rights and nominal values. If your company has external funding, it is possible that your investors will request preferential share classes.

Advantages and disadvantages of share capital financing

When a limited company is formed (incorporated) there must be at least one shareholder who holds the shares of the company. Thereafter, should the company wish to raise capital, the company’s directors can choose whether to issue more shares or whether to pursue an alternative source of financing such as a bank loan. There are advantages and disadvantages to share capital financing:

Advantages

  • No repayment requirement – a company does not have to repay share capital to shareholders
  • No obligation to pay dividends if it is not in the best interests of the company to do so
  • Shareholders cannot force a company into bankruptcy (unlike, for example, a bank if a company fails to pay its interest payments)
  • The company can use the funds raised for whichever purposes it wishes (a bank might specify that the funds can only be used for certain purposes)
  • New shareholders could provide helpful expertise for your business (for example, venture capital funds can provide both expertise and have a wide range of contacts that could help grow your business)

Disadvantages

  • If shares are issued to new shareholders there will be dilution of existing shareholders and some loss of control over the affairs of the company
  • Interest paid on a bank loan or other debt can be deducted from taxes, dividends cannot
  • Usually a higher premium is paid for equity – shareholders are the last to get paid in the event of bankruptcy and therefore have a higher risk than creditors. To compensate for this risk, investors often demand more shares at a lower price
  • Time, effort and potentially high advisor fees involved in issuing shares

Maintaining share capital

The rules around maintaining share capital are quite complex but the general principle is that it belongs to the company (not the shareholders) and can only be returned to the shareholders in very limited situations. In the case of a private company, as we have discussed, the amount is usually nominal in any event. However, the directors must consider and abide by the maintenance requirements should they wish to alter the company’s share capital.

Altering share capital

There are a number of ways in which a company can alter its share capital. We strongly advise that you seek legal advice when doing so, as the process can be complicated and entails several legal steps to be carried out for the alteration to be enforceable and in accordance with the law. We will discuss:

There are other ways in which a company can alter its share capital such as through the redemption of shares or the consolidation or sub-division of shares, but the above methods are what we will focus on here.

Reduction of share capital

What is the reduction of share capital? A reduction of share capital is when a company reduces the amount of its share capital. This could be a reduction in the number of shares, the nominal value of the issued shares or the amount paid up on the issued shares. A company can also reduce its share premium account, capital redemption reserve and certain other reserves. You will almost always require detailed legal advice on reducing share capital in these ways.
Why do companies do this? There are a number of reasons that a company may wish to reduce its share capital, including to:

  • Return surplus capital to shareholders
  • Reduce or eliminate accumulated realised losses (so the company can make distributions in the future)
  • Create distributable reserves (which could, for example, be used to pay a dividend)
How can a company reduce its share capital? Provided it is not prohibited by the company’s articles of association, a private company is able to reduce its share capital with the consent of its shareholders (by way of a special resolution with at least a 75% majority); and either (i) the consent of the court or (ii) a solvency statement. There are several requirements that must be documented when carrying out a reduction in this way and documents that must be filed with Companies House.

Redenomination of share capital

What is redenomination of share capital? Redenomination is when a company converts shares from having a fixed nominal value in one type of currency to having a fixed nominal value in another type of currency.
How can a company redenominate its share capital? Provided it is not prohibited by the company’s articles of association, a private company can redenominate its share capital by an ordinary resolution of its shareholders (a majority of more than 50%). Again, there are several requirements that must be documented when authorising a redenomination and documents that must be filed with Companies House.
Reduction of capital after a redenomination After a redenomination, a company may wish to cancel part of its share capital to ensure that the share values are suitable amounts in the new currency (for example, there could be fractions of shares in the new currency). A company is permitted to reduce capital in these circumstances by way of a special resolution of its shareholders so long as (i) the resolution is passed within three months of the ordinary shareholders resolution that authorised the redenomination and (ii) the share capital reduction does not exceed 10% of the company’s allotted share capital immediately following the reduction. If share capital is reduced following a redenomination, an amount equal to the value of the reduction must be transferred to a redenomination reserve (a non-distributable reserve). The redenomination reserve may be used by the company to pay up shares to be allowed to existing shareholders as fully paid bonus shares.

Buy-back of shares

What is a share buy-back? A share buy-back is when a company purchases its own shares. Share buy-backs are highly regulated and there are prescriptive requirements which must be carried out. If the requirements are not carried out it is possible that the buy-back can be void and that the company and its officers are in default. For a company’s officers this could mean an unlimited fine, a prison sentence of up to two years or both.
Why do companies buy back shares? Some of the reasons why companies buy back shares are to:

  • Increase earnings per share
  • Increase net assets per share
  • Return surplus cash to shareholders
  • Provide an exit route for shareholders
How can a company buy back its shares? The process relating to a share buy-back is complicated and should be carried out by a solicitor. The circumstances in which a private limited company may buy back shares are as follows: subject to any provisions in the company’s articles of association, a private limited company may only purchase its own shares if the shares are fully paid up and the purchase is funded out of (i) distributable profits, (ii) the proceeds of the issue of shares made for the purpose of financing the buy-back or (iii) out of capital (in certain circumstances).

Once the shares are bought back, they must either be cancelled and the amount of the company’s issued share capital reduced by the nominal value of the purchased shares, or, if the purchase was funded out of distributable profits, held as treasury shares.

Allotment of share capital

What is the allotment of share capital? The allotment  is the issue of new shares by a company which are then allotted to existing or new shareholders.
Why do companies allot share capital? Companies allot shares for a number of reasons: it could be to raise capital, take in new shareholders, issue more shares to existing shareholders or for many other reasons. We discussed some of the advantages and disadvantages here.
How can a company allot shares? The way in which a private limited company can allot shares differs from company to company depending on the company’s articles of association, the date of incorporation of the company and the number of share classes:

  • One class of share – company incorporated on or after 1 October 2009:
    There is a simplified procedure for allotment of shares for a private company that has only one class of shares. Unless the articles of association specify otherwise, the directors of such a company can allot shares without the approval of the company’s shareholders. This is known as the section 550 (Companies Act 2006) power.
  • One class of share – company incorporated before 1 October 2009:
    The directors of companies incorporated before 1 October 2009 do not have the section 550 power unless their members have specifically resolved that the directors should have this power.
  • More than one class of share:
    The directors of a company with more than one class of share cannot use section 550 to allot shares.

Should a company’s directors not have section 550 powers, they may only allot shares if they have been given the authority to do so by way of a prior authorisation by an ordinary resolution (a majority) of the company’s shareholders or if the company’s articles of association permit them to do so. The authority must specific the maximum number of shares to be allotted and the date of expiry of the authority (which cannot be more than five years).

Pre-emption rights

It is very important to be aware of existing shareholders’ rights of pre-emption when allotting new shares. Pre-emption rights are a right of first refusal for existing shareholders to purchase the new shares that are being allotted. This means that existing shareholders have the option to prevent themselves being diluted and maintain their current percentage of the company. The Companies Act 2006 conveys a general right of pre-emption for existing shareholders but this right can be excluded in a private company’s articles of association. It is also possible to disapply the statutory pre-emption rights in relation to specific allotments by way of a special resolution of the company’s shareholders or a provision in the articles of association.

The directors should also be aware that shares cannot be allotted at a discount to their nominal value.

There are several Companies House requirements for documentation and filing in relation to the allotment of shares.

Transfer of shares

Where shares are held in certified form (that is, the shareholder has a physical share certificate, which should be the case in a private limited company) it is usually possible for shareholders to freely transfer shares to another person or entity, subject to:

  • The company’s articles of association
    It is important to carefully check your company’s articles of association before carrying out a transfer of shares as there are often restrictions in place. This is because existing shareholders will want to have some control over any potential new shareholders. It’s important to remember that the articles of association of a company are automatically binding on all shareholders.
  • A shareholders’ agreement
    If your company’s shareholders have a shareholders’ agreement it is likely that this will restrict the transfer of shares but this will only apply to those shareholders party to the agreement.

The process for selling shares usually is usually carried out by a contractual agreement called a ‘share purchase agreement’ between the seller and the buyer. Depending on the complexity of the transaction and the value of the shares, this can be a very simple or very complicated document.

There are then several additional legal steps required to effect the transfer including the delivery of a stock transfer form, the payment of stamp duty and the ‘stamping’ of the stock transfer form, the issue of a new share certificate to the buyer, the filing of Companies House forms and the company’s register of members must be updated with the new shareholders details.

What next?

Should you wish to alter your company’s share capital or transfer shares it is important that this is done correctly, the experts in the Harper James corporate team can help. Please call us today on 0800 689 1700, email us at enquiries@hjsolicitors.co.uk or fill in the form below:

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