Understanding Different Classes of Shares in a Limited Company
A limited company can seek investment through two broad categories: debt and equity. Taking loans is a method of debt financing, whereas selling shares is a form of equity funding. In England and Wales, companies can issue different types of shares to raise money. The most common shares are: 1) ordinary shares, 2) preference shares, 3) non-voting shares and 4) redeemable shares.
There are several advantages to issuing shares for both companies and shareholders, namely as a different method of returning capital to shareholders and minimising risk for investors.
Each type of share may be split into a separate class, detailing the rights the shareholder has. The types of shares and classes that a company can create are determined by its articles of association.
Different classes of shares have different rights which can relate to voting, dividends and capital, for example, according to the company’s Articles. Therefore, a limited company should carefully decide the classes of shares it wishes to issue.
Reasons a limited company may issue different classes of shares include attracting investment, pushing dividend income, for tax reasons, motivating and retaining employees, and restricting or enhancing the voting rights of certain shareholders.
1. Ordinary shares
These are the most common type of shares. Ordinary Shares are the default position.
These shares will have the following rights:
Right to vote on resolutions
Right to a dividend (receive after preference shareholders have been paid; this will be discussed later)
Right to the repayment of capital In the event of the company winding up (received after creditors have been paid)
With shareholder’s consent, companies can create different classes of ordinary shares; alphabet shares (e.g. Class A, B C and so on). This allows for greater flexibility for and retaining control of the company by specified individuals. If there are no differences expressed between the shares of the company, it is assumed that all shares of the company contain the same unrestricted rights.
Class A shares typically come with one vote for each share. These are offered to new investors. Shareholders are entitled to a dividend and share capital rights when the company is wound up.
Class B shares have greater benefits, offering more voting rights, up to 10 votes per share, and rights to capital. Therefore, are typically reserved for the founding members and early investors.
Class A and B shares are suited for long-term investments and high-contribution investors.
Class C shares usually do not provide voting rights, so are better suited for short-term investments. These are more appropriate for small, individual investors who are starting out.
It is also possible for companies to issue non-voting ordinary shares. This means that a shareholder can only carry voting rights if certain conditions are met, or there may be no voting rights at all, with no right to attend a general meeting.
2. Preference shares
Preference shares rank higher than ordinary shares in terms of dividends and capital (essentially they receive them ahead of ordinary shares). They are usually the value of an ordinary share (nominal value), with an additional premium on top. However, often carry limited or no voting rights. Types of preference shares include cumulative, non-cumulative, redeemable and non-redeemable.
Preference shares usually entitle the shareholder to a fixed dividend each year; a fixed income from the shares. However, this fixed income does not change depending on the success of the company. This dividend is usually expressed as a percentage of the nominal value.
Preference shares are a low-risk form of investment, issued for lower nominal values than ordinary shares. On winding up the company, the holders of preference shares are usually entitled to any arrears of dividends and their capital ahead of ordinary shareholders.
Cumulative preference shares are a type of preference share wherein, if a dividend payment is missed, the shortfall will be reimbursed when the company next obtains sufficient distributable reserves. Such a shareholder will not receive dividends until the arrears on cumulative preference shares have been paid.
3. Non-voting Shares
These shares usually carry no right to vote or attend general meetings.
This class of shares are usually issued when a company wants to ensure that control is not affected. They are usually given to employees as for the purpose of tax efficiency for both parties, the employees’ remuneration can be paid as dividends.
4. Redeemable shares
These are shares that can be redeemed by the holder of the shares. These are issued on the terms that the company will or may buy them back (or redeem) in the future. When the shares are redeemed, they are treated as cancelled.
Redeemable shares can be issued by private companies - so long as the Company’s Articles permits it. Express authorisation must be provided in the articles for a public company to issue redeemable shares.
Conclusion
Fundamentally, the shares your company issues is wholly dependent on its needs and company structure. For instance, while companies can issue non-voting shares, they tend to be more useful where companies want to ensure that the control of the company remains unaffected, this is particularly the case for family run businesses.
Each class of share carries its benefits and disadvantages, and it is therefore important that start ups, when deciding what Articles to adopt, ensure that the class of share is considered. Ultimately companies should seek legal advice that is tailored to your specific company.
Author: Neha Tavra -
Author: Neha Tavra -
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DISCLAIMER
This article has been written by law students for the sole purpose of providing informative insight. The information in this article is intended for educational purposes only and does not constitute legal advice, nor should the information be used for the purpose of advising clients. You should seek independent legal advice before relying on any of the information provided in this article.
Sources
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