This guide is based on UK law as at 1st February 2010, unless otherwise stated.
OUT-LAW's guide to Company personnel explains the position of shareholders. This guide explains the shares they hold.
Historically, companies have had two kinds of share capital: authorised and issued.
Authorised was the share capital the company has created and the maximum it can issue. A company with a £1m authorised share capital may, for example, have 10 million authorised shares of 10p each.
Issued is the share capital issued and held by shareholders. It may be all 10 million shares in the above example, or only nine million, leaving one million authorised but unissued.
The Companies Act 2006 did away with the concept of authorised share capital, leaving just the shares that have actually been issued. The notion of authorised share capital lives on in only one respect: where it appeared in a company’s memorandum before October 2009, it will be deemed to have transferred to the articles and, unless removed by a shareholder vote, will continue to act as a limit on the number of shares that can be issued.
A share will have a nominal or par value: 1p, 10p, £1 or any other sum in any currency. And it is an absolute rule that a share cannot be issued fully paid for anything less than its nominal value – that is, it cannot be issued at a discount. A company cannot issue a £1 share fully paid for 99p or less. A company thus has no ability to issue free shares (but it may buy shares in the market and give them as free shares to employees, say, as part of an incentive scheme).
A company can, however, issue shares nil or partly paid. That means it can issue a £1 share and take no money for it on issue; or it may issue the share paid as to 25p only. The amount unpaid (the full £1 or the balance of 75p) remains due and will have to be paid when the company calls for payment at a time anticipated in the terms of the share’s issue, or on a winding up if the company’s assets are not enough to settle its liabilities.
Of course, a £1 share will often be issued with a price being paid to the company well in excess of that sum; the difference between the nominal value and the price paid is the premium. The directors are under a duty in issuing shares (as in all things) to act in the best interests of the company, and if a £1 share has a market value of £1.50, they must have a good reason for issuing it for anything less than £1.50. The nominal value is only the minimum price at which shares can be issued.
Different classes of share
Unless the articles say otherwise, all shares will rank equally. But to the extent they are given different rights – to dividends, to a return of capital on winding up and on voting – they will comprise different classes of share. A company may have one class of share or it may have many.
Ordinary shares are the basic building block of a company’s share capital. They will carry votes (usually one each), have a right to a dividend if the directors decide to pay one, and also be entitled to share in any surplus on a winding up of the company. Other shares will take their rights, or lack of them, by reference to this base position. Non-voting shares are self-explanatory (and a rarity these days, generally shunned by investing institutions but favoured by companies with a substantial family shareholding – for example, Daily Mail and General Trust). Preference shares may have a preferential right to a dividend ahead of the ordinary shares, or to a return of capital, or both. Deferred shares will rank behind the ordinaries (and tend to be used in a capital reorganisation where there is a need to make the shares virtually valueless).
Where these different classes of share exist, the rights of each one can only be changed in line with requirements in the articles or, if they are silent, requirements in the Companies Act. The articles will commonly stipulate a certain level of consent to any change; in default, the Act requires the holders of 75 per cent in nominal value to consent in writing, or holders of shares of that class to pass a special resolution (resolutions are addressed in: Company meetings, an OUT-LAW guide)approving the change at a separate meeting. Outside investors in a non-listed company may often expand the definition of what amounts to a class right and so prevent certain acts of the company (for example, the payment of a dividend) without their prior consent.
Directors cannot issue newly created shares without shareholder authority to do so. Two provisions of the Companies Act 2006 are key here and will be familiar from any listed company AGM notice:
Section 549 stops the directors from issuing shares to anyone unless they are authorised to do so in the articles or by shareholders passing an ordinary resolution. This ban includes an agreement to issue shares and the grant of options that will result in a future issue of shares (although employee share schemes are exempt). Listed companies will ask shareholders to give them this authority each year at the AGM, but will have to respect certain limitations stipulated by institutional shareholders – the rule has been that only 15 per cent of the authorised share capital can be issued – and the authority has to be renewed at each AGM.
This rule does not apply to a private company with only one class of share. In that case, the directors are free to issue shares without shareholder consent, unless the articles provide otherwise.
Section 561 obliges a company to offer new shares first of all to its existing shareholders in the same proportions they already hold shares. In other words, it upholds shareholders’ right to be protected from dilution. If they are willing to pay the price asked for the new shares, they can have them. But this only applies where the shares are offered for cash – if a company is issuing shares in exchange for shares in another company, say, or in payment for a non-cash asset, there is no requirement to offer the shares to existing shareholders first of all.
The section can be disapplied, along with section 549, either in the articles or by a shareholder vote, though only by a special resolution.
Again, institutional shareholders have their price: only shares equal to five per cent of the issued share capital can be issued without first offering them to shareholders.
Rights issues and bonus issues
A rights issue is a common way for a company to raise fresh capital: it issues new shares, offering them first to existing shareholders. Indeed, section 561, discussed above, obliges a company to treat any issue of shares for cash as a rights issue unless the shareholders have first agreed otherwise. (A rights issue for a listed company will often not follow this procedure because of various practical difficulties and the additional requirements of the Listing Rules.)
A listed company rights issue will usually offer shares at a discount to the current market price, sometimes a heavy discount if the shareholders’ appetite for the shares needs to be stimulated. That discount means that there is an inherent value in the right to be offered the shares, and the shareholders in a listed company can trade those rights and realise that value if they do not want to take up the shares themselves.
Alternatives to a rights issue include an open offer where shareholders are invited to subscribe to a number of new shares based on their proportionate entitlements. This can be less complex than a rights issue but it does not give shareholders the opportunity to trade their rights to take up shares and so benefit from the discount. A vendor placing may also be used where one company is buying shares in another. Shares are allotted by the purchaser to the sellers of the target but the purchaser’s investment bank agrees to find investors or placees who will take those shares and so give the sellers cash. Institutional shareholders of the purchaser may insist on a clawback whereby those shares are first offered to them in proportion to their existing holdings.
A bonus issue involves no new money. Also called a capitalisation or scrip issue, it takes a sum from the company’s reserves (distributable profits that could be used to pay a dividend, or the share premium account) and capitalises it by using it to pay for the new shares. The issued share capital is increased without any new money being invested. The new shares are issued to existing shareholders pro rata to their shareholdings and so no dilution occurs.