Why Use different Share Classes in your Company?
For many small and medium sized businesses the need for different share classes is negligible. In fact it is much easier to run a company where all the share are to be of the exact same class. There is often no need to complicate things by introducing different share classes. This also means that all shareholders will have an equal vote at shareholders’ meetings and will also receive shareholder dividends in accordance to the amount of shares they hold.
However, there are no hard and fast rules or regulations about how many different share classes a company is allowed to have. Regardless of whether a company was formed with just one share class, they can choose to divide their ordinary shares into different share classes at a later date, or even create an additional share class for their company further down the line, should the need arise.
Labelling Share Classes
The most common way to label different share classes is to assign them an alphabetical letter, such as ‘A shares’ or ‘B shares’ etc. This is often much easier than giving each type of share a more descriptive name. So common is this practice that share classes using this method are often referred to as ‘alphabet shares’.
Alphabet shares are a simple way to allow different groups of shareholders to have different rights. This may mean having shares that offer shareholders more or less rights than are granted to others within another share class. So for example class A shareholders may have more voting rights, be entitled to a higher dividend share, and be able to transfer shares to others within the company. Whereas a class B shareholder may have less voting rights, so may only be eligible to vote at the annual AGM for example. They may also be restricted on the transfer of shares so may have to sell them back to the company rather than be able to transfer them to someone else should they want to leave.
With alphabet shares there are no pre-determined rules or guidelines on what rights to include within each share category. This is up to the company to decide. This can mean that a company can invent limitless classes of shares each with their own set of rules. However, most common types of shares all carry a number of rights which go across the board, so can be a very useful starting point for a company to build a new share class upon. What you have to consider though is the amount of administration needed to manage multiple share types held within your company. Creating too many different share classes could be an administrative nightmare to handle.
Structuring new share classes
Keeping things simple and easy to understand is always going to be advantageous when issuing new share classes. A company needs its share capital structure to be very clear and easy to grasp. Creating a comprehensive share structure plan will help. This not only makes share administration much smoother to manage, but it will also help when looking towards the future where you plan to issue further shares as your company grows.
Planning ahead and creating a share structure plan to implement can help when you need to widen your shareholder base, yet still retain special rights for the company founder or founding partners. It can also be useful for family businesses where family members contribute at different levels of commitment due to having other responsibilities.
Some other examples of how alphabetical shares can be useful:
- A plan for buying back shares in the future
- To attract external investment
- To pay different rates of dividends to different shareholders
- When issuing shares to employees
- When undertaking a joint venture
Operating multiple share classes
There can be a lot of administration involved in running multiple share classes within a company. Because each share class may have a different set of rules to the next, you have to be careful not to make mistakes and blindly issue dividends to all shareholders in one blanket payment where one class of shares rules may not allow this.
By creating different share classes you can allow regular dividend payments to be made to some shareholders that hold class A shares, but not to those holding class C shares, for example. No matter what structure you set up and operate, you must make sure that your operation does not breach any HMRC rules.
Preferential rights within shares
Some share structures can be created to give shareholders preferential dividends, which basically means that these shareholders will have the right to be paid their dividend before shareholders within any other share classes you may operate.
Most companies will set up their shares to offer the right to normal dividends across the board for all shareholders. This can mean that they are paid a dividend upon the company achieving a certain target or reaching a specific milestone, otherwise they could expect to see no dividend at all should the company fail to reach their set targets. However, anyone with preferential dividends may have the right to be paid a dividend, however small, no matter what the outcome.
Winding up a company
Should a company be dissolved for whatever reason, any company debts must first be paid off. Any company assets left after this can be divided up and distributed to the shareholders. Depending on which share class each shareholder belongs to, each will have a different right to capital distribution.
Obviously, those with preferential shares rights will rank first and above all other shareholders. Those shareholders within some classes of shares may only see a payout if enough assets remain once other share classes have been paid off in full.
Voting rights within different share classes
To keep things as simple as possible, most companies will issue share that either do carry voting rights, or do not. Keeping things simple like this is a lot easier to administer and operate, however, a company can use weighted or tiered voting rights if they so choose. For example, some share classes may include the right for extra voting powers should certain circumstances arise.
You may start out by issuing 100 ordinary class A shares with one vote per share. This means that if you own 51 shares that would constitute a majority, or a number of shareholders voting together to create a majority could influence the decisions that affect the company.
As the company grows you may want to offer 100 ordinary class B shares that contain no voting rights. Quite often these are offered to employees so that they can benefit from share dividends without actually needing to get involved with the politics of running the business. This can help build staff loyalty that can be especially useful in very specialist industries. Sometimes class B shares may actually give the shareholder greater rights to dividends on winding up of the company, above that of class A or C shareholders – the finer details are up to the company to decide.
Then later down the line you may want to offer 30 preferential class C shares that carry five votes per share. Carrying enhanced voting rights can mean these shareholders having more influence over the way voting goes. If all votes club together and vote the same way, this could act to outvote all of the class A shareholders.
How to set up multiple share classes
When you plan to offer multiple share classes, you will need to made sure your company articles of association include this. If you are unsure about how to structure your articles of association to accommodate this, then it would be wise to seek the help of a business law firm to prepare these for you.
You can form a company with just one share class and then add more share classes in the future. You can do this by passing a shareholders’ resolution authorising a change to the company’s articles of association. You can then either make changes to your articles of association or adopt a brand new set that reflect that your company offer multiple share classes.
If you know that you want to start a business from scratch offering more than one share class right from the beginning, then you can form your company with these share classes included. To do this you will need to name each class and document the prescribed particulars attached to each share class. You must also record who will be the holder or holders of the initial shares in each of your chosen share classes.
We would always advise consulting with a solicitor or accountant when planning to offer multiple share classes. This will help to ensure that your documentation is within HMRC guidelines.