If you and your business are new to shareholding and the powers of shareholders, our commercial solicitors are here to explain how shareholders’ rights work in practice.
- Brief overview of shareholders’ rights and liabilities
- Classes of shares
- Shareholders’ voting rights in detail
- Rights to receive dividends and preference shares
- Tax considerations for dividends
- Differences between private and public company shares
- What documents do you need to create and vary shareholders’ rights, and how do you go about creating them?
Brief overview of shareholders’ rights and liabilities
If you are operating your small business as a limited liability company, it’s likely that you and your directors manage your day-to-day affairs without too much thought to broader company ownership issues.
However, even if your small team are (for now) the only shareholders, it’s very important to separate the rights and obligations of the directors from those of the shareholders, because decisions made about share ownership while businesses are small or growing can have significant implications later on.
First, a word on shareholder rights and liabilities.
Any shareholder normally has the right to participate and vote in general meetings of the company on important matters, usually in the form of one vote per share. And if the company is profitable, a shareholder has the right to receive a share of those profits in the form of dividends, if the directors choose to pay them.
A shareholder is only liable, in the event of a company’s insolvency, up to the amount remaining unpaid for those shares, and may not receive their initial stake back if the company cannot pay the rest of its debts. On a winding-up of the company, assuming the company is solvent, the shareholders will receive back their initial capital, pro rata to their shareholding.
Classes of shares
If your business is a UK limited company, you probably chose to have a single class of ordinary shares when the company was formed, and the rights that attach to those shares are set out in the Articles of Association and defined by the general law. It is possible however to create different classes of shares, with different rights attaching to each class, such as the right to vote, and receive dividends so that shareholder rights are altered.
Even smaller companies consider it useful to create different classes of share. Your shareholders may consist of a number of different types of people who have had a stake in your business from the time it was created, such as friends, family members and founders, through to individuals who have provided financial backing in return for shares.
As your business starts to grow and become more successful, what seemed fair when starting out may seem inflexible or inappropriate as time progresses.
Alternatively, you might wish to consider offering employees share incentives (such as EMI share option schemes) as part of a benefit package, but not want these shares to come with a right to vote on company business. You may be looking for finance, but not want your backers to be able to vote or attend company meetings.
Or you may feel that certain individuals’ right to vote be ‘weighted’, because of their knowledge or status in the business, or want to give them differing rights to receive dividends or receive their stake back in the event of a winding-up.
When you create classes of shares in your company, it’s possible for one person to hold differing classes of shares. So, for example, that individual may hold ‘A’ shares that give him or her certain benefits, as well as ‘B’ shares that entitle the holder to different benefits.
In summary, any small or large company can elect to have differing classes of shares in order to:
- Give different shareholders different rights to dividends, for example a right to receive dividends before other shareholders (preferred shares), or to receive dividends only if certain conditions are met (deferred shares)
- Give voting rights to only one class of shares, or restrict (or weight) voting rights to one or more classes of shares, for example if you want to raise finance but want to keep majority control of your company
- Create a class of shares whose ownership and rights attaching to them are attached to a single group of people, like family members or employees, who won’t be able to vote or attend general meetings
- Give certain shareholders preferential treatment when it comes to receiving payment for their shares in the event of a company insolvency or winding-up
Shareholders’ voting rights in detail
The company decides what voting rights are attached to each share, and the options available are:
- Full voting rights
- No voting rights
- Voting rights in certain specified circumstances
Note that a shareholder’s right to vote relates normally to matters of company structure or constitution, as these are decided in general meetings to which shareholders are invited and may vote. If you wish to vary these rights, then it will normally be sufficient to provide for this in the Articles of Association, either on incorporation or later by amendment.
However, if you want a class of shareholder to have an influence or veto on matters of company business that are normally the prerogative of the directors, then you will usually need to provide for this in a shareholders’ agreement as well as changing the Articles.
Shareholders’ agreements also provide more protection for minority shareholders, as they cannot be changed without the consent of all parties, whereas the Articles of Association can be changed by a 75% majority.
By incorporating special voting rights in a shareholders’ agreement, holders of a certain class of shares can, for example, influence or block the directors from taking important decisions affecting the company’s business without their consent.
Special voting rights may include, for example:
- A right to appoint or influence the appointment of directors
- A right to have a say in the business operations
- An influence on the pay of directors
- A right to be informed or consulted before a company takes a particular action, for example incurs substantial loans, mortgages property or changes its business plan
- A right to additional or weighted votes on certain important matters
Rights to receive dividends and preference shares
If a company is profitable, the directors may decide to pay dividends, or a share of those profits, to the shareholders. If no classes of shares have been created, then each shareholder will have the right to receive a proportion of those dividends that relate to the number of shares they hold.
If you create different classes of shares, you can attach differing rights to receive dividends to each class.
It is also possible to create a class of shares known as ‘preference shares’, that give the holders the right to receive a fixed annual dividend before any other class of shareholders, or a certain proportion of the company’s profit in any given period. These are usually non-voting, and issued to employees or investors, as they enable a company to reward staff or raise finance without giving up voting control.
Here’s an example of several classes of shares, each with different rights, including a preferential right to repayment of capital on a winding up of the company:
|Nominal value per share||Voting rights||Dividend rights||Right to capital on winding up|
|Ordinary ‘A’ shares||£1||One per share||Equal rights to dividends||No right to payment unless B shares have been paid in full|
|Ordinary ‘B’ shares||£1||Non-voting||Equal right to dividends||Preferential right to payment|
|Preference ‘C’ shares||£50||Non-voting||7% preference share carrying a dividend of £3.50 per share each year||Only have right to capital once B and A shares have been paid|
Occasionally, in a high-growth business that is not yet profitable, a company may create a share class that has a cumulative right to a dividend that rolls up until the company has sufficient profit available to pay a dividend to that class of shareholder.
Tax considerations for dividends
Dividends are payable by a company from its profits, after deduction of its business expenses, and after corporation tax and any VAT has been paid. Dividends are payable to each shareholder according to their percentage of shares, and taking account of any preferential rights as described above.
Dividends are liable to income tax in the hands of individual shareholders on a sliding scale of rates, although a portion of the dividends are subject to a tax-free allowance.
Differences between private and public company shares
The main difference between private and public companies is that shares of public companies are offered for sale to members of the general public. Private companies frequently raise capital by ‘floating’ their shares on the stock exchange, that is, they become a public company. Owners of shares in public companies have the same rights to vote as those of private companies and may receive dividends, but given the large number of shares issued, unless the shareholder is an institutional investor holding a large number of shares, the voting right is not usually significant.
What documents do you need to create and vary shareholders’ rights, and how do you go about creating them?
Shareholder’s rights are described in the Articles of Association of the company. If you want to create new rights, or vary existing rights, these must be altered.
As previously mentioned, classes of shares are often created in the context of wider changes to the company’s business, like the creation of a joint venture, refinancing, creation of employee share options, or a scaling up in company operations requiring more complex arrangements between the founders and others. Because of the complex nature of these arrangements, the creation of new share classes is often additionally reflected in a shareholders’ agreement, and this should be drawn up by a professional advisor.
Any fundamental change to rights attaching to shares described in a shareholders’ agreement must also be reflected in the Articles.
The process for creating new classes of shares is as follows:
- Check that the Articles of Association allow for the creation of new share classes. Usually, they do allow for this, but they will still need to be amended to reflect the new arrangement.
- Check that there are no existing agreements such as shareholder agreements that would prohibit the creation of the new class of share.
- Shareholders resolve to create the new classes of share, and amend the Articles of Association.
- File the amended articles and resolution at Companies House.
- Allot the new shares.