Alteration to share capital
Other than by allotment of new shares, a company’s share capital can be altered by:
- Subdivision; or
Shares are consolidated where the number of shares is reduced and each share carries a higher nominal value, i.e. 100 shares at £1 nominal value become 10 shares at £10 nominal value.
Subdivision is the opposite process whereby the value of shares is diluted as a greater number are created i.e. 10 shares at £10 each nominal value become 100 shares at £1 each.
Consolidation or subdivision of shares can be conducted by ordinary resolution of the members, unless the articles prohibit this. These changes do not cause a change in the overall share capital and as such are simply nominal changes.
Reduction of Share Capital
Reduction of share capital of a company is brought about under ss.641-653 of the Companies Act 2006. As this necessarily equates to a diminution of the share value of a company the rules on reduction are stringent:
- Shareholders may approve the reduction only by special resolution;
- The reduction must be sanctioned by the court;
- Creditors may have a right to object to the reduction; and
- Where the reduction affects different classes of shareholders, there may require to be a class rights issue under s630 Companies Act 2006.
The Companies Act 2006 has however introduced a simplified process of reduction for private companies under s641 (1)(b) where they no longer require court sanction. It is sufficient for private companies to submit a special resolution authorising the reduction along with a statement of solvency from each relevant director.
Maintenance of Capital
While a company is clearly permitted to use share capital as “working capital” for its business, it must not normally be returned to the investors while the company is operating as a going concern. Dividends therefore must only be paid out of profits and investments can only be returned to shareholders either after a properly approved reduction in capital process or where the company purchases its own shares.
Share Premium Account
The excess balance between the nominal value of shares and their proper valuation, known as the “share premium” must also be reflected in the company’s balance sheet under s610(1) Companies Act 2006. The company is liable to its shareholders for this amount and it must not therefore be distributed to members, but instead be maintained in the share premium account.
Company Purchase of Own Shares
A company cannot be registered as its own shareholders. However, shares can be transferred to a trustee or nominee for the company. A subsidiary is also prohibited from owning shares in its parent or holding company.
The practical effect of a company buying back its own shares is to return investment to the shareholder and causes a reduction in the company’s capital. There are however two ways in which this is permissible.
S684 of the Companies Act permitted companies to issue redeemable shares. These shares may be bought back by the company at the instance of the company or the shareholder. The articles of public companies must permit the creation of redeemable shares, however private companies are not prohibited from excluding this option. The terms of the redemption must either be set out in the articles or be agreed by the directors prior to the issue of the redeemable shares. Shares must be fully paid up prior to redemption and notice of redemption must be made to the Registrar of Companies within 28 days of the transfer. An accompanying statement of capital for the company must also be sent.
Share Buy Back
S690 of the Companies Act 2006 provides companies with the power to purchase their own shares, unless it is prohibited within the articles. A number of criteria require to be met to facilitate this:
- No shares can be purchased by the company unless they are fully paid up ( s691(1));
- The purchase requires to be approved by special resolution of the company ( s694(1));
- Members do not carry voting rights for the proportion of shares that are to be purchased ( s695).
The special resolution of the company will be invalid unless:
- Where a general meeting has been called, a copy of the contract is made available for members’ inspection at the general meeting and at the company’s registered office for a minimum period of 15 days ending with the date of the meeting; or
- Where a written resolution is used, a copy of the contract is sent to each eligible member at the same time as the written resolution.
On completion of the purchase, under s706 of the Companies Act 2006, the shares are then cancelled and the company’s share capital is reduced accordingly. A return must be made to the Registrar of Companies within 28 days of the purchase stating the number and nominal value of the shares purchased and the date of purchase. Stamp duty will be applied at 0.5% of the consideration. Notice of cancellation of shares must also be provided as well as a statement of post-purchase capital.
Financing Buy Back or Redemption of Shares
The buy-back or redemption of shares by a company will normally be financed out of distributable profits, or by the proceeds of a fresh share issue. Where shares are purchased or redeemed with funds from distributable profits, the capital of the company must still be maintained. S733 of the Companies Act 2006 requires the company to open a “capital redemption reserve” which equals the reduction in the share capital. This is reflected on the company’s balance sheet as a liability of the company to shareholders.
The two main rights normally associated with shareholdings are the right to vote on the company’s affairs and the right to dividends paid out of company profits.
Some shareholders are more concerned with control (voting rights), while others are more interested in their return on investment (rights to dividends). It is for this reason that companies are permitted to create different classes of shares, and to distinguish between voting and non-voting shares.
The two most common types of shares are ordinary and preference shares. Ordinary shares entitle the holder to a share in declared dividends and normally provide voting rights for the holder.
Preference shares are a more complex type of share. They generally have two main advantages in that they often carry the right to a fixed annual dividend, normally calculated as a percentage of the nominal value of each share. This dividend is guaranteed , and in the event of the company not having sufficient distributable profits to make the dividend payment, the entitlement can be carried forward until such time as there are sufficient funds available to make the payment. Secondly, on a winding up of the company, preference shareholders may rank above ordinary shareholders in having their investment repaid to them.
Normal practice however is that preference shares do not usually carry voting rights, and preference shares usually have dividend returns fixed at a pre-ordained level. In good times, this may result in ordinary shareholders receiving better dividends than preference shareholders. As a means of counteracting this, preference shares may have an additional “participation” right, which means that they would participate in the same rights that ordinary shares carry, without losing their preferred rights also. Rights of participation are not compulsory and should be negotiated along with all other rights between the shareholder and the company.
Redemption rights can attach to either ordinary or preference shares and despite being referred to as “redeemable shares” they are more properly classified as ordinary or preference shares with rights of redemption.