How can a company use multiple share classes? Henry Catchpole explains all
Having all shares in a company of the same class is appropriate and easier to administer in most cases. It enables all the shareholders to vote at shareholders’ meetings and share dividends proportionately according to their shareholdings.
However, there are no legal restrictions on how many share classes a company can have and many companies are choosing to either incorporate with more than one share class or having incorporated with just one share class, to divide the existing ordinary shares into multiple share classes or create an additional share class.
You can give each class a descriptive name, but it’s usual just to label multiple share classes as ‘A’ shares and ‘B’ shares and ‘C’ shares – which explains why multiple share classes used in this way are often called ‘alphabet shares’.
Alphabet shares allow companies to give different groups of shareholders different rights, including enhanced or exclusive rights for certain shareholders. While there aren’t pre-determined rules on which rights ‘A’, ‘B’ or other alphabet shares should have, there are common types of shares with certain combinations of rights that are a useful starting point.
Different share classes might vary in terms of:
- Voting rights.
- Rights to dividends and capital.
- Rights or restrictions on transferring shares or further shares in the class being given by the company.
- Special rights – such as the ability to appoint or remove directors on a particular share class.
While having some flexibility in shareholder rights can be helpful it’s also important for the company’s share capital structure to be clear and easily understood. As well as making company administration more straightforward, a comprehensible share structure might help if you’re looking to issue further shares in the future.
Where alphabet shares can help
Situations where some companies have found alphabet shares useful include:
- To retain special rights for the founders of a company while widening the shareholder base.
- In family companies, where the contribution and needs of family members differ.
- To pay different rates of dividends to different shareholders.
- When issuing shares to employees.
- To attract significant external investment.
- When pursuing an strategy to exit the business.
- When undertaking a joint venture with one or more partners.
- If there is a plan to buy back shares in the future.
- In certain privatised industries.
How do multiple share classes work?
In some ways, multiple share classes can operate independently of one another. For example, a dividend could be declared on one share class without being paid on another, although the correct process must be followed to approve the dividend.
However, in other ways the rights of different classes are interdependent. The following example of alphabet shares will help to illustrate how the rights of different classes relate to one another.
Each ‘A’ share carries one vote. In most companies, with a single share class and 100 ‘A’ shares in issue, this would mean a single share would provide one out of 100 available votes. So holding 51 shares would constitute a majority and enable the holder – or holders voting together – to make any decisions that don’t require a special majority.
But, in this case, we also have to consider the Preference ‘C’ shares. Not only are there 30 of these, but they carry enhanced voting rights – with five votes per each share meaning that together the ‘C’ shares carry 150 votes. In an extreme case, that would mean that the holders of the ‘C’ shares acting together (with 150 votes) could consistently outvote the ‘A’ shareholders (with 100 votes).
In practice, the position will be less clear cut, but someone considering buying ‘A’ shares and interested in influencing the direction of the company would be wise to investigate the position – particularly if the ‘C’ shares are owned or controlled by one or two shareholders.
While there are also 70 ‘B’ shares, these carry no voting rights whatsoever and the holders of these shares will not be able to vote on matters affecting the company. On its own, this would make the shares unattractive, but they’ll often have greater rights in other areas, such as an enhanced right to dividends or return of capital on winding up of the company.
Rights if the company is wound up
Regarding rights to capital on wind up, the rights of different classes are interdependent.
If the company is wound up, there may be a limit on available funds to return to shareholders. Assuming some monies are available but not enough to return capital on all shares, we have to look at the rights to capital on winding up that are attached to each share class. Typically there will be a prescribed order in which classes will be looked at, with a full return of the nominal value on one share class necessary before shareholders of another class will receive anything.
In our example, it is the Ordinary ‘B’ shareholders who have first call over any funds. The total nominal value of these shares is £70,000, so that amount would be required to repay them in full. If less than £70,000 is available, they would receive a proportionate partial return of capital.
Only if the ‘B’ shareholders receive a return of their nominal capital can we look at other share classes, with the next in line being the holders of the ‘A’ shares. The ‘C’ shareholders will only receive any return of capital if both the ‘B’ and ‘A’ shareholders have received the nominal value of their shares in full. A shareholder may just have shares in one share class or in multiple share classes, benefiting from a combination of the rights attached to the different shares.
Setting up multiple share classes
A company’s articles of association will need to accommodate multiple share classes, a task for which the standard Model Articles are unsuitable.
If you have very particular requirements, you will need to instruct a law firm to prepare a bespoke set of articles of association to meet your precise circumstances.
Tip: You can download a set of enhanced articles from our website at http://www.informdirect.co.uk/company-records/enhanced-articles-association/
Forming a company with more than one share class
As part of a company formation process, you’ll need to name each class and document the prescribed particulars attached to each and record who will hold the initial shares in each share class. You should also ensure that articles that properly cater for multiple share classes are used for the formation.
Be aware that many online formation services do not allow you to create multiple share classes or to use enhanced articles (Tip: use our service at www.informdirect.co.uk that offers multiple share classes and the ability to select enhanced articles or upload your own bespoke articles).
Adding a new share class after company formation
If you’ve formed your company with a single share class, it’s still possible to add further classes at a later date. To do so, the members will need to pass a shareholders’ resolution authorising a change to the company’s articles of association, either making specified changes to the existing articles or adopting an entirely new set.
While multiple share classes can offer advantageous flexibility to a company, it’s vital both to understand the implications and to ensure the arrangement is acceptable in the eyes of HMRC, rather than one intended primarily to avoid tax.
- Henry Catchpole is CEO of company secretarial software provider Inform Direct. ICPA members receive free use for three months – go to www.informdirect.co.uk for more details
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