Welcome to the second article in our mini-series covering the basics of shares in which we’ll be covering the issue of shares.

Before reading this article, it will be useful to refer to article one for a full overview of share types, values and share class rights.

As before, the focus in these articles is on UK private companies limited by shares.

Shares issued on incorporation

Companies are incorporated with a minimum of one share in issue.

The parties who are the first shareholders of a new company are sometimes referred to as ‘subscribers’. Subscriber shares are often issued at par but it should be noted that shares are not always paid for on incorporation – payment may follow thereafter, such as once the bank account is set up.

As the issue of further shares in the lifetime of the company involves detailed processes to be followed, it’s always worth considering from the outset the share structure your new company may require.

Subsequent share issues – the what and the why

The allotment (or issue) of shares is the process by which a new or existing shareholders subscribe for additional shares and become members of a company.

The allotment of shares gives the person an absolute right to be registered in the company’s register of members.

Companies typically may wish to issue further shares to:

• Raise capital for various purposes, e.g. expanding operations or funding a new project.
• Bring in new shareholders.
• Pay off debt.

It should be noted that:

• A drawback of issuing share capital is that it can dilute the ownership of existing shareholders. This dilution might reduce the control shareholders have over the company (by having a lower % of votes) and could potentially lower the value of their shares if the company doesn’t use the funds raised to significantly increase its profits.
• While shares cannot be issued below nominal value, but they can be for ‘other than cash’ – i.e. in return for goods or services.

Authority required to allot shares

Directors cannot allot shares unless they have the authority to do so – this is generally to protect existing shareholders from the dilution of their shareholdings without their consent.

Before looking to allot shares, you will always need to first check a company’s constitutional documents (the Articles), together with any shareholder agreements to see if there are any additional restrictions or procedural points that will apply to the share issue which will vary the Companies Act rules.

Generally, there are two scenarios to consider:

• A private company with only one class of share issue, that wishes to allot further shares of the same class: here (unless the Articles or any shareholder agreements state otherwise) the directors are able to allot shares without any authorisation from shareholders (although see below on Pre-emption rights).
• In all other cases, the directors must be authorised by shareholders to allot further shares.

Allotting new shares – the procedures

As a starting point the following need to be agreed:

• The number of new shares to be issued.
• The names and addresses of the new shareholders.
• The price to be paid on allotment (see below on share premium).
• If any particular date of allotment is required.
• The nominal value and rights of any new share class that’s to be created.

An owner wishing to retain control of a company may consider retaining a certain level of voting rights – see article one: The Importance of voting rights. ‘Before and after’ percentages should therefore be calculated with care.

Once the allotment details are agreed, the directors need to:

• Check that they have authority to allot shares – or pass the necessary shareholder resolution.
• Consider and, if necessary, waive any pre-emption rights (see below).
• Resolve to allot shares.
• Obtain a letter or application from the new shareholders, or enter into a subscription agreement with them.
• Update the register of members.
• Make the necessary filings at Companies House:
  • Copies of any shareholder resolutions.
  • An SH01 form and, if the allotment has given rise to a change in the company’s PSC, the relevant forms to update the PSC records.
  • Issue new share certificates.

See our previous article concerning PSC records here.

The shareholder resolution authorising an issue of shares:

• Will state a maximum number of shares that can be issued.
• Will give a date when the authority expires (which cannot be more than five years away).
• Is generally passed as a written resolution signed by more than shareholders representing more than 50% of voting shares (although can be passed at a shareholder meeting).
• Will generally set out the rights attaching to any new class of share to be created.
• Is often passed at the same time as any resolution required to waive Pre-emption rights (see below).

Pre-emption rights

Under the Companies Act, a company is obliged to offer new shares (being issued for cash) firstly to its existing shareholders in the same proportion to the shares they already hold – to protect them from dilution (known as Pre-emption rights).

Pre-emption rights can be disapplied, either in a company’s articles (or in any shareholder agreement) or by passing a shareholder’s special resolution (to be signed by shareholders representing at least 75% of voting shares). A shareholder resolution can disapply the rights for a particular shares issue or generally going forward.

Share premium – when shares are allotted for more than their par value

The ‘premium’ on any share issue is the difference between the nominal value of the shares issued and the allotment price.

By issuing shares at a premium, an established company can ensure that the issue price reflects the real market value of the new shares – creating a fair and balanced position between new and existing shareholders.

It will also allow the issue of fewer shares whilst still generating significant reserves, minimising the dilution of existing shares and ensuring that changes to the controlling interest and dividend entitlements of shares are minimised.

Any premium paid is credited to a share premium account – the use of which is restricted.

Other categories of share issues

Bonus issues

Companies can use their share premium reserve to issue fully paid bonus shares to their members (without payment) as an alternative to paying dividends.

This enables the company to reward shareholders whilst retaining profits in the business that would have otherwise been used to pay dividends.

Rights issues

A rights issue is a common way for a company to raise fresh capital: issuing new shares (for cash), offering them first to existing shareholders at a preferential price compared to the usual market value.

EMI schemes

EMI schemes can be established to grant options to key employees (usually at senior manager level) to be allotted shares at a future date for a fixed price. EMI schemes are flexible and benefit from a number of tax incentives. They provide a tangible incentive for key employees to stay with the company.

Pre-emption rights don’t apply to employee share schemes.

How Gerald Edelman can help

Whilst we hope that this article provides a useful summary on share issues, we know that every company is different. If you wish to discuss the shares in your company, please contact us today.

Look out for our next article in this series which will cover Share Transfers!