Running a company often means balancing the needs of its shareholders and sometimes one size does not fit all. By introducing different classes of shares further flexibility can be achieved. For growing businesses, family companies, or those bringing in new investors, this can be a powerful tool for future planning.
Ordinary shares
In its simplest form, a company limited by shares will have one single class of shares with uniform rights. Ordinary shares are the most common type of shares and usually grant both income rights and capital rights, along with the right to vote on shareholder decisions. Income rights grant a shareholder a claim to a portion of a company’s profits by way of dividends and capital rights grant a shareholder a claim on the company’s assets in the event of winding up or sale of the company. Voting rights allow shareholders to vote on key corporate decisions, such as making changes to the company’s constitutional documents, or appointing directors to the board.
Shares will be of one class if they have uniform rights (that is, equal rights to vote, dividends, and capital). If your company has several shareholders, but only one class of shares, you may differentiate between your shareholders by giving each shareholder a different number of shares.
By way of example, a company is owned by three individuals, where individual A holds 50 shares, individual B holds 30 shares, and individual C holds 20 shares. If the company were to declare an annual dividend of £100 in aggregate (or likewise the company is sold to a third party for £100) those individuals will have the following rights:
- Individual A will have the right to £50;
- Individual B will have the right to £30; and
- Individual C will have the right to £20.
However, what happens if you require greater flexibility than this? Maybe for income tax reasons individual A does not want to receive dividend income in a particular year, but the other individuals do. Perhaps individual C is a founding shareholder who has given away a large proportion of his shares to his children (individuals A and B) as part of his succession planning, but he would ideally like to retain more control of the company decisions. That is where alphabet shares can help to give greater flexibility.
What are alphabet shares?
Alphabet shares are simply different classes of ordinary shares distinguished by their name or designation (such as 'A shares', 'B shares' and 'C shares'). Alphabet shares can be created by either allotting and issuing new shares or converting existing shares into a new class of shares.
Shares could be given to different shareholders depending on the rights that each shareholder, or group of shareholders, should have. For example, in a family investment company context, you might give each generation a different class of share – A Shares for the founders of the company, B Shares for their children and C Shares for their grandchildren.
The important bit is to make sure that the company’s articles of association properly cater for the rights attaching to different classes of shares. It is not enough to just call a different class a different name; different classes must have different rights which are properly set out. It is common for people to think that they have created different classes when in fact they have not, which can cause disputes later down the line.
Why use alphabet shares?
Using separate classes of shares allows you to tailor your shareholders’ rights in a way that reflects their individual contributions and expectations and gives you the flexibility you require.
A key benefit of alphabet shares is where they are used by companies to give its directors the ability to declare different amounts of dividend on the different share classes. Thus, enabling profits to be distributed in a tax-efficient manner at different rates between shareholders.
This structure can also allow businesses to tailor shareholder benefits, provide incentives to employees, allow founders to retain control, and facilitate family-owned companies. For example, a company could offer shares with limited or no voting rights to investors or employees to give certain shareholders a financial return rather than control of the company.
How can we help?
Introducing alphabet shares is not something to be taken lightly. The right structure can provide flexibility, but there are pitfalls to avoid. Merely assigning distinguishing names to different shares does not necessarily mean they will constitute separate class of share. Care will be needed to ensure that a company’s articles of association set out the rights for each class of shares and that the provisions are thought through. You will also need the correct advice to ensure any proposal is not challenged by HMRC.
Please contact us today to arrange a check of your articles of association to see what share rights you currently have in place.
If you’re thinking of introducing alphabet shares, or would like to discuss your company structure generally, please get in touch to discuss your requirements and next steps.