A company limited by shares usually has the option to divide its share capital (the shares that the company has issued to its members) into different types, or classes. Your limited company can create different classes of shares according to the benefits, voting rights and other conditions you want to assign to different groups of shareholders.
Why have different classes of shares?
Under the Companies Act 2006 (the ‘Act’), a class of shares is a group of shares that all have the same uniform characteristics and rights. Common share classes used by limited companies include ordinary shares, preference shares, alphabet shares and deferred shares and we’ll discuss more about these in this article. The Act regulates a company’s share capital and distinguishes between how the share capital of public and private companies can be treated. This article focuses primarily on private companies limited by shares.
There are strategic as well as financial and operational reasons for introducing different share classes to a company and a lot will depend on the stage of establishment of your company and its business. For example, the more complex the business and operations of your company, or the more funding rounds your company goes through, the more likely it is that having multiple classes of shares will be beneficial to your company and its shareholders. Popular reasons for creating different share classes include:
- To attract investors by giving them enhanced rights above other shareholders, such as the right of veto over certain financial or operational decisions of the company to enable them to protect or capitalise on their investment
- To give certain members, such as founding members, enhanced voting rights so that they can continue to exercise a high degree of control over the company as it grows, including influencing whether decisions made by way of resolutions are passed or not
- To prefer certain shareholders over others because they contribute in a different way to the running or funding of the company
- For tax reasons
- To allow shareholders the right to share in company profits, but not have a say in the way the company is run by having voting rights
It’s particularly common to see different classes of shares when companies offer employees shares as an incentive to work hard and participate in any increase in the value of the company as a result. However, you might not want these employees to receive dividends or have any say in the way the company is run and so employee share schemes often offer a class of shares that do not carry voting rights.
A guide to the different classes of shares
|Ordinary shares||These usually have no particular rights associated with them over and above the right to receive dividends, vote and to a return of capital on a winding up. Their ranking in terms of these rights may drop below those of other shareholders if different classes of shares are issued.|
|Dividend rights||This class of shareholder may have the right to receive normal dividends, a dividend before other classes of shareholder, a set amount or enhanced dividend or a dividend only in certain circumstances. If a shareholder has preferred right to receive a dividend, this is usually expressed as a percentage of the nominal value, for example a £1 5% preference share will get 5p per share ahead of holders of ordinary £1 shareholders. Sometimes dividend payments are missed or reduced, and if you want to give some shareholders the right to ‘roll’ up their rights to missed dividends so they are paid before others when dividend payments return to normal, these are called ‘cumulative preference’ shares.|
|Right to share in the company’s capital on winding up||If a company is wound up (closed down), and its assets are sold, any funds are first paid to creditors and then the shareholders. If you create different share classes, certain shareholders may have the right to be paid before others.|
|Voting rights||Certain classes of shareholder may not be able to vote in company meetings, or alternatively may have extra votes. It’s also possible to give weighted voting rights on certain matters affecting the company.|
|Redemption rights||Shares with redemption rights can be bought back by the company in the future, for example at a certain date or during a certain period, either at the price they were sold or at a different price. If a company issues redeemable shares, it must retain some share capital as non-redeemable shares.|
|Pre-emption rights||The right of pre-emption is a right of first refusal for the existing members of a company for the issue of new shares. A company’s constitutional documents can also state that sellers of shares in the company must first offer those shares to existing shareholders with rights of pre-emption. These shareholders will then be able to decide whether to buy the shares before they are offered to a third party. Often private companies can exclude the statutory pre-emption rights and in private sale or purchase transactions, rights of pre-emption over a transfer of shares can be waived by the shareholders holding such rights to allow the sale to go through.|
Many companies have a type of share class known as ‘ordinary’ shares and it is likely that you will be familiar with this share class. These ordinary shares are created when the company is first incorporated, and the rights attaching to the ordinary shares are usually described in the company’s constitutional documents, such as the articles of association of the company or the shareholders’ agreement between the shareholders of the company.
These ordinary shares will usually set out the standard rights attaching to the shares of the company. Ordinary shares often carry the right to vote on resolutions of the company, a right to receive dividends granted by the company and a right to receive a share in the assets of the company when it is wound up.
When shares are attached to rights that are held back in relation to the rights of other shareholders, for example the right to receive dividends, these are referred to as ‘deferred shares’. Deferred shares usually rank lower than standard ordinary shares. When shares with certain rights are given priority over other shares and their rights, these are referred to as ‘preferred’ or ‘preference’ shares. Preference shares usually rank higher than ordinary shares. It is also possible to have different classes of ordinary shares. Often these are labelled ‘A’, ‘B’, ‘C’ and so on, commonly referred to as ‘Alphabet’ shares.
Here are some of the ways in which shareholder rights can be varied:
- You can give certain shareholders a preference over others in some way, for example the right to receive a dividend, the amount of the dividend, or the right to receive capital when the company is wound up
- You can defer certain shareholders’ rights to receive dividends or receive a return of capital, until other shareholders have been paid
- You can remove shareholders’ rights to vote, give them extra or enhanced voting rights or veto rights, or prevent holders from attending the annual general meeting of the company
How many different types of shares can your company have?
In theory, you can create as many classes of shares as you like. English case law has set out that you won’t, however, create different classes of shares just by dividing them up into blocks and giving them different names. Equally, if you create a group of shares with different rights to other groups of shares, you will be creating different classes of shares by default.
It is important that you assess the benefits of creating multiple share classes against the additional administrative and procedural requirements that having multiple share classes can create. Our team of expert corporate lawyers can help you in this assessment.
Companies usually only create new share classes where there is a clear business need to do so, for example, to attract investment, to optimise tax or to incentivise a work force. Where shares are issued and allotted are required to be distinct and carry varied rights to the other shares that form part of the share capital of the company. There are often different procedural steps required for obtaining each class of shareholder consent, so this could make passing important decisions of your company or holding shareholder meetings more complicated and time consuming.
Shareholders’ agreements and different share classes
When creating different share classes, it’s common for the shareholders (and the company) to enter into a shareholders’ agreement to fix their varied rights in place and to describe how the company will be run. A shareholders’ agreement typically covers the following matters:
- How the company’s affairs will be managed
- When meetings will take place, and the decision-making process
- What decisions of the directors, if any, will require the consent of certain shareholders, for example borrowing a certain amount of money or selling key business assets
- How directors are appointed and removed, and who has a say in this
- How the rights of minority shareholders will be protected
- Rules around the sale or transfer of shares, for example, to whom and at what price
- A mechanism to resolve disputes
- An exit mechanism for shareholders who wish to divest shares or to stop being a shareholder
Converting shares between different classes
According to the Act, any variation to the rights of a class of shares must comply with what is set out in your company’s articles of association and with the consent of your shareholders in that particular class. If the articles of association do not set out the process for the variation of shares, the Act says that your company will need the consent of three-quarters of its shareholders in that share class in writing (often by a special resolution of the shareholders of that class).
English case law has demonstrated that a variation that does not alter the rights of the share class and only affects how the shareholders can enjoy the existing rights may not be considered to be a variation to those class rights. However, a lot will turn on the facts and circumstances of the particular matter.
Where you have decided you want to convert existing classes of shares, the process for converting those shares will be dependant on the reason for the conversion. This section describes the process of converting shares from one class into another under the Act where the issued share capital and nominal value of the shares remain the same. If instead you intend to alter the share capital of your company by conversion of shares, you will have to make sure that you comply with the ways to alter share capital that are allowed and set out in the Act. Examples of reasons for converting share classes include where you are transferring shares between individuals who have, historically, held shares of a different class, or you are selling the company and the selling shareholders hold different classes.
The process for converting shares from one class into another (where the issued share capital and nominal value of the shares remain the same) is as follows:
- Pass a resolution to re-name, or re-designate the share class – this can be an ordinary resolution unless the company’s articles of association state otherwise
- If you need consent from other shareholders because you are also varying the rights of the share class, get that consent, and follow any other procedures required by the company’s articles of association and/or shareholders’ agreement (if relevant)
- Amend the articles of association to reflect the changes as necessary. For example you might need to pass a special resolution to amend your company’s articles of association where a new class of shares is being created
- File notices with Companies House about the change of name or designation of the share class and the variation of any rights, and file a copy of the articles of association and any special resolutions that have been passed
- Update the company’s register of members, and issue (or cancel) share certificates as necessary
Note that you cannot convert non-redeemable shares into redeemable shares.
Another way to convert shares into a different share class could be to change the number of shares into a smaller number of shares (with a larger nominal value) and then re-divide them into a large number of shares (each with smaller nominal values) with characteristics that are different to the class previously established, therefore creating a new class of shares from the original class that existed before the consolidation.