Most small private companies just issue standard 'ordinary' shares. A single class of share keeps things simple by offering equal rights and responsibilities to all shareholders. The rights attached to the shares, including those related to voting, dividends and capital, are specified by prescribed particulars in the statement of capital and articles of association.
Different classes of shares
Before you choose to create an ownership structure with different classes of shares, you should be aware of the other most common classes of shares. They include:
- Preference shares
These shares have a preferential right to receive a dividend before other classes of shares. This is usually stated as a percentage of the nominal value of a share. Of course, it must be fixed so as to remove the possibility of the directors deciding to reduce it.
- Redeemable shares
These are issued on terms that the company has a right to buy them back at some future date. The date may be fixed or at the directors' discretion. Redeemable shares are often combined with preference shares to create redeemable preference shares. This enables the company to issue shares with a tempting, high initial return but which can be “bought in” by the company in better times ahead.
- Non-voting shares
As the name depicts, the holder is not entitled to vote but a fixed dividend is paid.
- Alphabet shares
This informal description is sometimes applied collectively to “A”, “B”, “C” and other classes named after letters of the alphabet. Rather than naming each class, when the shareholders want to differentiate the rights attaching to different classes of shares, those classes are often named simply by different alphabet letters.
- Deferred ordinary shares
These are shares where the holder is entitled to a dividend only after other classes of shares have been “served”.
- Management shares
This class usually has extra voting rights so the holder retains control over the company. These are usually designated simply as “A” or “B” shares.
Why shareholders choose a structure with different classes?
A company can be formed with different classes of shares. More often, the shareholders have a particular requirement, which can best be satisfied by changing the share structure in some way.
Why shareholders might need different classes of shares?
Here are some examples of circumstances that might result in the shareholders changing the structure of their company.
There is a joint venture. Party B, probably another company, is responsible to contribute the capital yet Party A wants to retain control. So Party A retains the original shares that carry most of the votes, leaving Party B to take a share of the rewards through non-voting preference shares, but not to interfere in the running of the company.
When the government privatises a business, it may decide to retain one or more shares which carry specific rights of veto; for example, to prevent control of the company from passing into foreign hands. This is usually referred to as a “golden share”. In practice of course, the holding retained by government may be substantial and not merely a single share.
When a company issues shares to employees under an incentive scheme or as part of a deal to induce an individual to join the team, the new shares may well have different rights from the shares retained by the original shareholders. Maybe the employees are to be entitled to receive dividends, but not vote on directors’ appointments or pay. The number of possible variations is infinite. The 2006 Companies Act allows a very wide range of possibilities. Sometimes such shares may be “deferred shares” with rights that accrue automatically on the satisfaction of some condition.
When a company introduces an outside investor, that person may require preferences on winding up, specific dividends, and other controls. Although these will be covered in detail in a loan agreement and shareholders’ agreement, the share structure may be affected too. Issues of control are further explained here.
If a share “buy-back” is planned for some future date, the shares to be bought back can be identified as a different class. In this way, the “ordinary” shareholders will have no claim when no offer is made to buy back their shares too.
To reduce inheritance tax, non-voting shares may be issued to children or other family members. However, HMR&C may not accept that control has passed, for valuation purposes, just because the shares have no vote. It is also a requirement to disclose who has significant control over a company, even if that control is not related to shareholdings.
What you should consider when you change your share structure?
When you select a framework of ownership and control for your company you should not only look at what rights attach to each class of shares, but also carefully consider each article of association in the light of your intentions. You will find it inconvenient and inefficient to change your articles more frequently than every five years or so, so this is a matter which will affect you for a long time.
In 2006, the Companies Act changed and consolidated old law, some of it unchanged since 1948. The 2006 act provided a set of “model” articles. Despite the name, they are not suitable for the operation of a small to medium sized private trading company, let alone to a specialised one. At the same time that you review and amend the articles of association for changes to rights, you should also review them more generally for other aspects about how the company works.
Net Lawman provides a number of template sets of articles. These and the guidance notes that accompany them provide an inexpensive and reasonably fast way of checking whether an artticle in your current set should be amended.