Before setting up a UK company limited by shares, it’s important to have a basic understanding of shares. What are they? How do they work? How many should or can you have? The concept of limited company shares can be incredibly confusing at first, but it’s quite simple once you get your head around it!
If you’re forming a company on your own, it should be relatively easy to decide how many shares you want to create. If you’re planning to register a company with other people, it may then require a little more thought to ensure everyone is treated fairly and gets the most out of their investment. You may wish to speak to an accountant for advice if the ownership structure of your new business venture is complex.
What is a share?
In simple terms, a share is a portion of a company limited by shares. Each share is owned by one or more individuals known as ‘shareholders’. If you own a share, you also own part of the company and are entitled to receive some of the profits. Both the percentage of ownership and profit entitlement are dependent upon how many shares the company is divided into.
Imagine a pie chart, or a round cake cut up into slices. Each slice is a share of that whole cake. The cake might be divided into equal shares – two pieces, four pieces, eight pieces, etc. Or it might be divided unequally, with some slices being bigger than others. It’s exactly the same when it comes to shares in a limited company.
The Companies Act 2006 does not provide a definition of a share, but the most frequently cited legal definition is:
‘A share is the interest of a shareholder in the company measured by a sum of money, for the purposes of liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all the shareholders in accordance with (now sec33(1) of the Companies Act 2006).’ Farwell J. in Borlands Trustee v. Steel  1 Ch. 279 at p. 288.
Issuing the first shares in a new company
When a limited by shares company is set up (registered/incorporated) at Companies House, the first shareholders choose how many shares to issue. This information will be included on the company formation application form, with the names of initial shareholders also added to the Company’s Memorandum. The minimum requirement is one share. There isn’t usually an upper limit to the number of shares issued unless the shareholders choose to add a restriction in the articles of association.
When you register a new company, you choose how many shares to create. The decision will be based on the number of shareholders your company has, and any plans you may have to sell parts of the business to investors in the future. If you’re setting up a company on your own (as the only shareholder and director), you may wish to issue just one share to yourself. This will represent the whole company (100%), so you will have full control of the business and be entitled to all available profits.
Alternatively, you may want to issue more shares to yourself, or to other people if you are setting up the company with one or more business partners. Normally, even numbers of shares are preferred, such as two, four, six, eight, ten, 100, etc. This makes it easier to work out each shareholder’s percentage of ownership and, therefore, the percentage of company profits they are entitled to receive.
Examples of equal share divisions:
- Two shares – Each share represents 50% ownership of the company
- Five shares – Each share represents 20% ownership
- Ten shares – Each share represents 10% ownership
- 50 shares – Each share represents 2% ownership
- 100 shares – Each share represents 1% ownership
- 1000 shares – Each share represents 0.1% ownership
Note, if you have multiple share classes with different nominal values, then you will need to take into account the nominal value when working out the percentage ownership. For example, a company owned by two people – one with 1 share worth £1.00 and another with 1 share worth £0.20, then the former shareholder owns 83% of the Company, whilst the latter holds 16.67% of the Company.
When setting up a company, the decision is often based on the amount of capital invested by each shareholder. Usually, the more you invest, the bigger your shareholding will be.
Different types of shares
There are many different types, or ‘classes’, of limited company shares, including:
- Ordinary shares
- Preference shares
- Cumulative preference shares
- Non-voting shares
- Redeemable shares
- Alphabet shares
- Management shares
If your company is small and/or you’re setting up on your own, ordinary shares should be sufficient for your needs. This is the most popular type of share, so you probably won’t have to worry too much about all of the different classes we’ve listed. Nevertheless, it’s handy to have a basic understanding of the various share classes available to you.
A standard type of share with no special rights or restrictions attached to it. Each share provides equal rights to shareholders: the right to cast one vote at general meetings, the right to receive dividends (profits), and the right to share in any remaining capital or assets when the company is wound up. Shareholders can own multiple shares, which gives them more rights and control than those who own fewer shares.
Typically, this class carries a right to preferential treatment when dividends are paid out. The holder of a preference share would receive a fixed dividend sum (rather than a percentage of overall profits) before other shareholders receive their dividends. This is beneficial in situations where the business is facing financial difficulty. However, the shareholder could lose out if business profits increase. Often, preference shares carry no right to vote at general meetings.
This type of share holds the right that unpaid dividends from one year can be carried forward to the following years. This means that the shareholder is guaranteed to receive his or her profit entitlement at some point, even if the company has no distributable profits in the year in which the dividend should have been paid.
Non-voting shares carry no rights to vote at general meetings. Companies will usually issue these shares to employees so that part of their earnings can be paid as dividends. This is a tax-efficient strategy. Naturally, companies do not want their employees to be able to vote on important company matters, which is why these shares also carry no voting rights. The main shareholders in a company also issue this type of share to their family members.
As the name suggests, redeemable shares provide a company with the right to buy them back (‘redeem’ them) at some point in the future, either on a fixed date or in response to a particular event. Alternatively, the shareholder in question may also hold the right to redeem the shares. This type of share is often issued to directors with the proviso that they will be redeemed if and when the director leaves the company.
Management shares carry additional voting rights, such as 10 votes per share. This class is generally held by the original shareholders of a company, thus allowing them to retain more power and control over the business than other shareholders.
Rights attached to shares
To keep things simple, we’ll just deal with the rights attached to ordinary shares. If you are considering issuing different types of shares, however, we would urge you to consult an experienced accountant before making any decisions, because it can be quite a complex affair.
The rights attached to limited company shares are officially known as the ‘prescribed particulars’ and they are set out in a company’s articles of association, and sometimes a private shareholders’ agreement. You must include these prescribed particulars in the statement of capital when you register your company.
For a limited by shares company adopting the Model articles of association from Companies House, the prescribed particulars for ordinary shares are:
“each share is entitled to one vote in any circumstances”. This means that the shareholder can then cast one vote at general meetings for every share he or she owns.
“each share is entitled pari passu to dividend payments or any other distribution”. This reflects the basic right of the shareholder to receive a percentage of company profits in relation to each of his or her shares.
Capital distribution rights
“each share is entitled pari passu to participate in a distribution arising from a winding up of the company”. The shareholder has the right to a share of any money or assets at the time when the company is wound up.
Value of shares
Each share is specifically given a nominal value. This is usually £1, but it can be set at any amount. The nominal value does not reflect the true ‘market’ value of the share or the company, i.e. what the share or company is actually worth in monetary terms, if sold. It is simply chosen as the limit of liability of the shareholder.
The real value of a share is determined by the value of the company. For example, you could issue 100 shares, each of which has a nominal value of £1. The company’s share capital would only be £100, but the market value of the shares could be £300,000 if it were sold. This would then mean that each share had a true value of £3,000.
Profit entitlement from shares
Most shares carry the right to dividend distributions. A dividend is simply a payment of company profits made to the shareholders. Each shareholder’s profit entitlement is based on the number of shares he or she owns and what percentage of the company his or her shares represent.
For example, if your company issues 10 ordinary shares, the dividend distribution of each share is 10% of available profits. If you own 5 of those shares, you are also entitled to 50% of the company’s available profits. So, the more shares you own, the more profit you receive.
Paying for your shares
There is no legal obligation for the shareholders in private limited companies to pay for their shares, unless the company requests payment or becomes insolvent.
If a company becomes insolvent, it doesn’t have enough money to pay its debts. At this point, shareholders must contribute the nominal value of the shares they hold. This is known as their ‘limited liability’ to the company.
If the company still has debts after all shares have been paid up, there is no further obligation on the shareholders to settles these liabilities. Limited liability companies are responsible for their own debts beyond the nominal value of its issued shares.
However, directors (who are usually also shareholders) can be held liable to further claims and may face prosecution if they act illegally, neglectfully, and/or their conduct led to the company’s insolvency.
Issuing and selling shares after company registration
The number of shares you issue during the company formation process can be changed at a later date if need be, so don’t worry too much if you get it wrong or want to make adjustments. The ownership structure of a limited company is very flexible.
You can create new shares after your company has been registered, you can sell/transfer some or all of your shares to other people, you can buy back shares from other shareholders, and you can reduce the total number of shares your company has too. There are many options, but we would advise consulting your accountant before issuing or transferring shares to a new investor or business partner.